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ment from the return requirement may permit the utilization of longer periods for the return requirement without adversely affecting the flow of revenue from the VAT.

d. Treatment of related businesses

Under the bill, a taxable person would be permitted to elect to treat itself and all related businesses as one taxable person for VAT purposes, to the extent provided in regulations. A related business would encompass any business under common control with the taxable person under the more than 50-percent control test described in section 52(b) of the Code. However, for purposes of determining qualification for the small business exemption, all businesses under common control would be treated as one business. In addition, to the extent provided in regulations, a taxable person would be allowed to elect to treat any of its divisions as a separate taxable person.

e. Treasury notification and regulations

The bill would require a taxable person to notify the Internal Revenue Service if certain events occur. These reportable events would include a change in the form of a business or any other change that may affect VAT liability, VAT credit, or VAT administration with respect to the business.

The bill would also authorize the Secretary of the Treasury to issue regulations to implement the VAT.

f. Other administrative issues

There are several other administrative issues raised by the bill that might also be considered. The bill would require the Internal Revenue Service to administer the VAT (because the VAT is added to the Internal Revenue Code). One important issue is the number of additional personnel necessary to administer the VAT. The Treasury Department estimated in 1984 that once fully implemented it would cost $700 million per year to administer a VAT.42 For comparative purposes, the total budget of the IRS for fiscal 1984 was approximately $3.3 billion. Another issue is whether the administrative and judicial procedures currently contained in the Internal Revenue Code should be extended to the VAT.

The bill would be effective for transactions occurring after December 31, 1989. It is unclear how much time between enactment and the effective date the IRS would need to prepare itself and educate taxpayers concerning the VAT. It is possible that the IRS could require substantial lead time before it could properly begin administration of a VAT.

42 See Treasury Report, p. 124.


Present Law and Background

An estate freeze is a technique whereby an older generation seeks to cap the value of property at its present value and to pass any appreciation in the property to a younger generation. In doing so, the older generation retains income from, or control over, the property.

To effect a freeze, the older generation transfers an interest in the property that is likely to appreciate while retaining an interest in the property that is not likely to appreciate. Because the value of the transferred interest increases while the value of the retained interest remains relatively constant, the older generation has "frozen" the value of the property in the estate.

In one common form, the preferred stock freeze, a person owning preferred stock and common stock in a corporation transfers the common stock to another person. Since common stock generally appreciates in value more than preferred stock, the transferor has "frozen" the value of his holdings in the corporation. Other freezes utilize partnerships, trusts, options and joint ownership in property.

Estate freezes present three possibilities for avoiding transfer tax. First, because split interests with differing appreciation rights are inherently difficult to value, their creation can be used as an opportunity for undervaluing gifts. Second, such interests involve the creation of rights that, if not exercised in an arms-length manner, may be used as a means of subsequently transferring wealth free of transfer tax. For example, wealth may pass from a preferred shareholder to a common shareholder if the corporation fails to pay dividends on the preferred stock. Or, by exercising conversion, liquidation, put or voting rights in other than an arm'slength fashion (or by not exercising such rights before they lapse), the transferor may transfer part or all of the value of such rights. Third, the retention of a frozen interest may be used in order to retain enjoyment of the entire property. The transfer is, in reality, incomplete at the time of the initial transfer and, if the frozen interest is retained until death, the transfer is testamentary in nature.

In the Omnibus Budget Reconciliation Act of 1987, the Congress addressed the estate freeze transaction by including the value of the appreciating interest in the decedent's gross estate and crediting any gift tax previously paid (Code sec. 2036(c)). Such inclusion effectively treats the transfer as incomplete for transfer tax purposes until the freeze ceases. In the Technical and Miscellaneous Revenue Act of 1988, the Congress enacted safe harbors for the re

tention of debt and agreements to provide goods and services for fair market value.

Explanation of the Bills

The bills (S. 659, S. 838, and S. 849) 43 would repeal the estate tax inclusion with respect to valuation freezes retroactively from the date of its enactment (i.e., property transferred after December 17, 1987).

43 S. 659 (Senator Symms), S. 838 (Senator Heflin), and S. 849 (Senators Daschle, Heflin, Boren, and Symms).


Present Law and Background

New York State adopted legislation in 1987, generally effective for tax years beginning in 1988 (N.Y. Tax Law Art. 22, sec. 601(e)), that changed the formula used by noncorporate nonresidents with New York-source income to compute their New York income taxes. The legislation requires such nonresidents to pay income tax on their New York-source income based on the tax bracket they would be in if all of their income (both New York and non-New Yorksource) were New York-source. Prior to the legislation, such nonresidents' tax brackets were determined solely by reference to their New York-source income. New Jersey State legislators recently introduced retaliatory legislation that would tax New Yorkers who earn income in New Jersey at New York State tax rates, which generally are higher than New Jersey tax rates.

Other States, including California, have similar methods of computing income taxes of nonresidents with in-State income.

Federal tax law generally does not govern the State income taxation of nonresidents.


Explanation of the Bill

S. 800, introduced by Senators Bradley, Lautenberg, Dodd and Lieberman on April 13, 1989, would temporarily suspend the effect of the New York law described above, as well as any subsequent similar New York legislation and any State legislation that is enacted in response to such New York legislation.


The bill would establish an Interstate Taxation Commission to study all such legislation, including consideration of appropriate methods of determining the tax base, tax rates and allocation of income, deductions and credits in the taxation of interstate income, and whether equitable and effective taxation of such income would be best served by a Federal, regional or State formula. The Commission would be required to prepare and transmit a report on its study to the President and the Congress not later than 9 months after the date the members of the Commission are appointed.

The Commission would be comprised of the Attorney General of the United States (or his designee) and 3 members to be nominated by the President and confirmed by the Senate (1 each representing New York, New Jersey and Connecticut). The 3 nominees would be selected from a list of 6 individuals submitted to the President by each of the Governors of these States.

Effective Date

The moratorium period with respect to the State legislation described above would begin on January 1, 1988, and would end with any taxable year ending after the date which is one year after the date of the report to be prepared and transmitted by the Interstate Taxation Commission.

97-673 (44)

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