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The more things change....

The More Things Change ...

Right around this time last year, my predecessor wrote in this space regarding the repeal of Section 2036(c) of the Internal Revenue Code -- the so-called "estate freeze" rules. He explained the issue, talked about congressional attempts to relieve family businesses from the onerous burdens the law imposes, and detailed small business' efforts on the Hill to get relief.

Now, one year later, I am here to write on estate freezes again. Congress still has not fixed the problems it created when it enacted 2036(c). In fact, there are still too many legislators who don't see 2036(c) as a problem at all. But more on this in a minute.

For those of you who are new to the issue, a little background is in order. Under an estate freeze, a family business was able to avoid paying estate taxes when the firm's owner passed away. This was critical because, for most small businesses, there simply is not adequate cash flow to cover a large estate tax hit. And with a modest $600,000 estate exclusion before rates beginning at 37%, the estate tax hit is almost always large.

To institute a freeze, business owners would change the capital structure of the firm by issuing two types of stock: preferred voting and non-voting common. The preferred stock would represent the current value of the company, while the common would represent its future growth value. The owner would retain the preferred and pass the common stock to his or her "younger generation". By doing this, the estate was "frozen", and the heirs would avoid the transfer tax on the growth element of the family business.

Section 2036(c) prevents the use of estate freezes by valuing the business at the time of the owner's death rather than at the time of the recapitalization. This full amount is then included in the gross estate subject to estate tax.

More than one family business has been forced to close or sell out simply to meet the estate tax liability this situation creates. Section 2036(c) has made it literally impossible to plan for the inter-generational transfer of America's family-owned business. For the nation's small, family-owned businesses, 2036(c) is nothing short of a crisis.

Why is it unfair to include this amount in an estate, some might ask? After all, hasn't the decedent left something of value to his or her heirs?

While the answer to the latter question may technically be "yes", it nevertheless fails to consider the nature of family business. Most family businesses cannot absorb the expenses of estate taxes. Thus, a better question to be asked is: What has the Congress gained by taxing productive family businesses right out of existence?

Obviously, when businesses are forced to liquidate to satisfy their estate tax liability, no one wins. The owners lose their family business, employees lose their jobs, the local economy loses the company's spending and the nation's Treasury loses the taxes all these entities would pay on a continual basis.

More importantly, Section 2036(c) represents a significant breach of faith with America's entrepreneurial spirit. Small business, family business, is the backbone of that entrepreneurial spirit. As a policy matter then, the Congress should say, "Revenues, be damned! Let's help America's entrepreneur's survive the difficulties of inter-generation transfer." 2036(c) does precisely the opposite.

Why, then, did Congress enact Section 2036(c)? Fasten your seat belts for this one, folks. As best as we can tell, congressional staff assistants though the whole thing up. Without one shred of evidence indicating abuse in the area, these staffers decided that there was a widespread problem. The staffers then wrote the usual technical language and got it slipped into a tax bill without any prior public hearing.

Now, don't get the wrong idea about congressional staffers. They're generally a very competent, helpful bunch of people who really keep the work flowing here in Washington. But, in this instance, something in the system seriously malfunctioned. Small business has been forced to live with it ever since.

That's not to say that they've taken it lying down. Every small business group in Washington, including NSPA, has worked long and hard for relief in this area. Like so many things in the tax arena these days, however, 2036(c) relief has been tangled up in budget (i.e., deficit) politics.

We hope to succeed this year. It looks promising that repeal or reform of 2036(c) will be included in this year's tax bill. Nevertheless, a good deal of work still remains to be done. NSPA is doing its part. If you'd like to do yours, write to your senators and representatives and urge them to vote for elimination of these oppressive restrictions on family business. When you do write, be sure and send us a copy of your letter.

As the old saying goes, nothing is certain in life except death and taxes. Repeal of Section 2036(c) would at least make both a little easier.

Peter M. Berkery, Jr. Director of Congressional Relations/Tax Counsel
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Title Annotation:Internal Revenue Code and estate freezing
Author:Berkery, Peter M., Jr.
Publication:The National Public Accountant
Article Type:column
Date:Jun 1, 1990
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