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June 20, 2008
Full text: 1934 Ways and Means Committee Report on Tax Avoidance

In 1934, the House Ways and Means Committee conducted a vigorous investigation of tax avoidance. Eager to boost fairness and enhance the revenue productivity of the personal and corporate income tax, lawmakers were emboldened by the reformist energy of the Franklin Roosevelt's New Deal. In cooperation with the Treasury Department, they prepared a comprehensive report that eventually became the basis for the Revenue Act of 1934. Tax Analysts has published the full text of the committee report, "Prevention of Tax Avoidance."


* * * *


                     PREVENTION OF TAX AVOIDANCE

                PRELIMINARY REPORT OF A SUBCOMMITTEE
                               OF THE
                     COMMITTEE ON WAYS AND MEANS
                             RELATIVE TO
               METHODS OF PREVENTING THE AVOIDANCE AND
                EVASION OF THE INTERNAL REVENUE LAWS
                  TOGETHER WITH SUGGESTIONS FOR THE
               SIMPLIFICATION AND IMPROVEMENT THEREOF

                     COMMITTEE ON WAYS AND MEANS

            ROBERT L. DOUGHTON, North Carolina, Chairman

SAMUEL B. HILL, Washington
THOMAS H. CULLEN, New York
CHRISTOPHER D. SULLIVAN, New York
MORGAN G. SANDERS, Texas
JOHN W. MCCORMACK, Massachusetts
CLEMENT C. DICKINSON, Missouri
DAVID J. LEWIS, Maryland
FRED M. VINSON, Kentucky
JERE COOPER, Tennessee
ASHTON C. SHALLENBERGER, Nebraska
CHARLES WEST, Ohio
JOHN W. BOEHNE, JR., Indiana
JAMES V. MCCLINTIC, Oklahoma
ALLEN T. TREADWAY, Massachusetts
ISAAC BACHARACH, New Jersey
FRANK CROWTHER, New York
JAMES A. FREAR, Wisconsin
HAROLD KNUTSON, Minnesota
DANIEL A. REED, New York
ROY O. WOODRUFF, Michigan
THOMAS A. JENKINS, Ohio
WILLIAM E. EVANS, California

                       E. W. G. HOFFMAN, Clerk

                    SUBCOMMITTEE ON TAX REVISION

                SAMUEL B. HILL, Washington, Chairman
THOMAS H. CULLEN, New York
FRED M. VINSON, Kentucky
JERE COOPER, Tennessee
ALLEN T. TREADWAY, Massachusetts
FRANK CROWTHER, New York
JAMES A. FREAR, Wisconsin
                       WALTER L. PRICE, Clerk

                        LETTER OF TRANSMITTAL

                                   WASHINGTON, December 4, 1933.

Hon. ROBERT L. DOUGHTON,
Chairman Committee on Ways and Means,
House of Representatives, Washington, D.C.
!EN
     MY DEAR MR. CHAIRMAN: Pursuant to House Resolution 183, passed
June 9, 1933, you appointed this subcommittee to investigate methods
of preventing the evasion and avoidance of the internal revenue
laws, to consider means of improving and simplifying such laws, and
to study possible new sources of revenue.

     In view of the fact that a new revenue bill is contemplated
during the coming session of the Congress, it is thought imperative
to transmit to the Ways and Means Committee a preliminary report
recommending methods of preventing tax evasion and avoidance,
together with certain suggestions for improving and simplifying the
revenue laws. Such a report is transmitted herewith.

     A report on new sources of revenue and a complete report on
simplification are contemplated by the subcommittee, but cannot be
transmitted at this time as the investigation of these matters is
not concluded.

     The preliminary report submitted herewith is divided into two
parts: Part I, containing what may be considered as covering the
major problems; and Part II, containing what may be considered as
covering the minor problems. These problems in both parts are taken
up in the general order in which they will occur in the revenue
bill.

     The subcommittee have given attention to these matters nearly
continuously except for the months of August and September. In
connection with their investigations they have had full cooperation
from representatives of the Treasury Department, of the legislative
counsel's office of the House, and of the staff of the Joint
Committee on Internal Revenue Taxation. It is hoped that the
preliminary report will be useful to the Committee on Ways and Means
in considering pending revenue legislation.
!NR
                                   Respectfully submitted.

                                   SAMUEL B. HILL,
                                   Chairman.
!EN
          PRELIMINARY REPORT ON PREVENTION OF TAX AVOIDANCE

                              FOREWORD

     This preliminary report has been prepared by the subcommittee
of the Committee on Ways and Means, appointed, as a result of House
Resolution 183, to investigate (1) tax avoidance, (2) simplification
of the revenue laws, and (3) possible new sources of revenue. The
report now submitted is confined to the first two named subjects,
namely, tax avoidance and simplification, and has for its immediate
purpose the presentation of recommendations or suggestions for
legislation which will prevent such tax avoidance or which will
simplify the existing revenue laws.

     It has been considered desirable to divide the report into two
parts so that the major problems may be discussed first. This
arrangement prevents duplication in the discussion, as some of the
minor problems must be answered consistently in view of the
recommendations in the case of the major problems.

     A tentative committee print of the Revenue Act of 1932 is
submitted with this report showing all the changes recommended in
that act by your subcommittee, which it has been possible to draft
in the time available. The few changes not drafted will be submitted
in such form at an early date.

                       PART I. MAJOR PROBLEMS

                       (1) Tax-Rate Structure

     (a) NORMAL TAX. -- Section 11 of the Revenue Act of 1932
provides for a normal tax equal to 4 percent of the first $4,000 of
the net income in excess of the credits provided in section 25, plus
8 percent of the balance over $4,000.

     Your subcommittee recommends the use of one normal rate of 4
percent and the adjustment of the surtax rates so that the tax
burden on incomes other than dividends and partially tax-exempt
interest will remain practically unchanged. The principal advantages
of this change are (1) simplification; (2) increased tax on
dividends; and (3) increased tax on partially tax-exempt interest.

     Our first revenue acts provided for one normal rate and
graduated surtax rates. There appears to be no good reason for
having both a graduated normal tax and a graduated surtax, since the
principle of ability to pay can be adequately taken care of by the
graduated surtax alone. Certainly, it is much simpler to have one
normal rate of tax. How the change can be made without appreciably
decreasing the revenue through adjustment of surtax rates will be
explained later.

     It is believed that dividends may be properly subjected to a
somewhat greater income tax. Under the Revenue Act of 1932 a single
man with a net income from dividends of $50,000 pays a tax of
$4,960, while a single man with a net income from salary of $50,000
pays a tax of $8,720. In such a case the man with dividend income,
under the recommendation of your subcommittee, will pay a tax of
$6,900. In other words, instead of paying $3,760 less tax than the
salaried man he will pay only $1,820 less tax. This is due to the
fact that dividends are now subject to an 8-percent exemption from
income tax, while under the proposal they will only be subject to a
4-percent exemption. It is the opinion of your subcommittee that
this increased tax on dividends can well be borne.

     In the case of partially tax-exempt income a similar result is
obtained from the single 4-percent normal rate, since this income is
also exempt from normal tax. Your subcommittee deliberated at length
in regard to the question of making all tax-exempt income taxable
but came to the conclusion that the only proper way to handle the
subject in its broad aspect was through an amendment to the
Constitution. However, it believes that the higher tax resulting
from the use of one 4-percent rate is justifiable. This higher tax
will apply only to obligations of the United States issued after
September 1, 1917, which are not wholly tax exempt. In exhibit A of
the appendix to this report a memorandum from the staff of the Joint
Committee on Internal Revenue Taxation will be found which treats at
length of the subject of wholly and partially tax-exempt interest.

     (b) SURTAX. -- Section 12 of the Revenue Act of 1932 provides
for surtax rates starting at 1 percent on net incomes of more than
$6,000 and reaching 55 percent on net incomes of more than
$1,000,000. Fifty-three different rate brackets are provided for in
this act.

     In view of the change recommended in the normal rates, your
subcommittee recommends changes in these surtax rates to maintain
the same tax on ordinary income as at present, and your subcommittee
deems it wise to recommend further the reduction in the number of
surtax brackets from 53 to 27 for the purpose of simplification.

     A comparison of the present and proposed surtax rates follows,
the much simpler form of the latter being obvious without argument:
!TA
                        PRESENT SURTAX RATES

                                         Percent
                 $6,000-$10,000              1
                 $10,000-$12,000             2
                 $12,000-$14,000             3
                 $14,000-$16,000             4
                 $16,000-$18,000             5
                 $18,000-$20,000             6
                 $20,000-$22,000             8
                 $22,000-$24,000             9
                 $24,000-$26,000            10
                 $26,000-$28,000            11
                 $28,000-$30,000            12
                 $30,000-$32,000            13
                 $32,000-$36,000            15
                 $36,000-$38,000            16
                 $38,000-$40,000            17
                 $40,000-$42,000            18
                 $42,000-$44,000            19
                 $44,000-$46,000            20
                 $46,000-$48,000            21
                 $48,000-$50,000            22
                 $50,000-$52,000            23
                 $52,000-$54,000            24
                 $54,000-$56,000            25
                 $56,000-$58,000            26
                 $58,000-$60,000            27
                 $60,000-$62,000            28
                 $62,000-$64,000            29
                 $64,000-$66,000            30
                 $66,000-$68,000            31
                 $68,000-$70,000            32
                 $70,000-$72,000            33
                 $72,000-$74,000            34
                 $74,000-$76,000            35
                 $76,000-$78,000            36
                 $78,000-$80,000            37
                 $80,000-$82,000            38
                 $82,000-$84,000            39
                 $84,000-$86,000            40
                 $86,000-$88,000            41
                 $88,000-$90,000            42
                 $90,000-$92,000            43
                 $92,000-$94,000            44
                 $94,000-$96,000            45
                 $96,000-$98,000            46
                 $98,000-$100,000           47
                 $100,000-$150,000          48
                 $150,000-$200,000          49
                 $200,000-$300,000          50
                 $300,000-$400,000          51
                 $400,000-$500,000          52
                 $500,000-$750,000          53
                 $750,000-$1,000,000        54
                 Over $1,000,000            55

                     Proposed surtax rates

                                         Percent
                 $4,000-$6,000               4
                 $6,000-$8,000               5
                 $8,000-$10,000              6
                 $10,000-$14,000             8
                 $14,000-$18,000            10
                 $18,000-$22,000            12
                 $22,000-$26,000            14
                 $26,000-$30,000            16
                 $30,000-$34,000            18
                 $34,000-$38,000            20
                 $38,000-$44,000            23
                 $44,000-$50,000            26
                 $50,000-$56,000            29
                 $56,000-$62,000            32
                 $62,000-$68,000            35
                 $68,000-$74,000            38
                 $74,000-$80,000            41
                 $80,000-$90,000            45
                 $90,000-$100,000           50
                 $100,000-$150,000          52
                 $150,000-$200,000          53
                 $200,000-$300,000          54
                 $300,000-$400,000          55
                 $400,000-$500,000          56
                 $500,000-$750,000          57
                 $750,000-$1,000,000        58
                 Over $1,000,000            59
!EN
     (c) CREDITS AGAINST NET INCOME. -- Under section 25 of the
Revenue Act of 1932, there are allowed as credits against net income
for normal tax (but not for surtax) purposes, dividends, interest on
obligations of the United States, personal exemptions, and credits
for dependents.

     To carry out the policy of retaining practically the same tax
burden on ordinary income, it is necessary in connection with the
proposed plan to allow the personal exemptions and credits for
dependents as an offset against surtax as well as normal tax.
Moreover, in accordance with the principle of ability to pay, there
seems to be no good reason why these credits should not be allowed
for the computation of both taxes. Under present law, for instance,
a single man with an income of $7,000 from dividends pays exactly
the same tax as a married man with 10 children having the same
income from dividends. The personal exemptions and credits for
dependents would appear to be in lieu of deductions for necessary
living expenses. They should obviously apply to both taxes as do all
other ordinary deductions.

     (d) EFFECT OF RATE STRUCTURE CHANGES. -- The changes
recommended in paragraphs (a), (b), and (c), above, are
interrelated, and it is now necessary to point out the combined
result of these changes. The exact results are shown in four tables,
which will be found in exhibit B of the appendix, showing the
present and proposed taxes on various amounts and kinds of net
income in the case of both single and married persons.

     An examination of these four tables is sufficient to determine
the following facts in relation to the effect of the changes
proposed in the rate structure of existing law:

     First. The tax on income from salaries, business, wholly
taxable interest, rents, royalties, etc., is not changed to a
consequential amount in any case. There is absolutely no change on
net income of $6,000 or less. Above $6,000 there is a slight
increase on the single man and a slight decrease on the married man.
These slight changes seem proper. Under existing law a married man
in this class pays a tax of $30,100 on an income of $100,000 while a
single man on the same income pays $30,220. This slight difference
in tax of $120 is obviously insufficient in view of the difference
in ability to pay of the two persons. Under the proposed rates these
two individuals will pay taxes of $29,810 and $30,620, respectively.

     Second. The tax on income derived from dividends and partially
tax-exempt Government obligations will be substantially increased as
a result of the proposed changes, although such tax will still be
substantially lower than the tax on earned income. For instance, at
present the married man's tax on an earned income of $100,000 is
$30,100; and on income from dividends of like amount $22,460. Under
the proposed rates the tax in the latter case will be $25,910
instead of $22,460. It is believed this increase can well be borne
both in the case of dividend income and in the case of income from
partially tax-exempt interest.

     The subcommittee is of the opinion that these changes in the
rate structure will increase the revenues of the Government by
approximately $36,000,000 annually.

                   (2) Depreciation and Depletion

     Your subcommittee has been impressed by the extent to which
taxable net income is reduced by the deductions for depreciation and
depletion, allowed under sections 23(k) and (l) of the Revenue Act
of 1932.

     While recognizing the soundness from an accounting standpoint
of these deductions, your subcommittee recommends that, for the
years 1934, 1935, and 1936 these allowances be reduced by 25
percent.

     In the first place, it must be remembered that these amounts
deducted from income do not represent cash outgo like wages,
repairs, and similar expenses, but are annual reserves generally
theoretically set aside to replace plant and property investments.
In the second place, the magnitude of such allowances depends on the
life of the property -- a very uncertain factor. The following
figures show the depreciation and depletion deductions shown on
corporation returns for 1930 and the net income and deficits thereon
both before and after these allowances:
!TA
                  CORPORATIONS REPORTING NET INCOME

Net income before depreciation and depletion          $9,295,599,253
Depreciation                          $2,622,845,724
Depletion                                243,940,819
                                      ______________   2,896,786,543
                                                      ______________
            Taxable net income                         6,428,812,710

                   CORPORATIONS REPORTING DEFICIT

Deficit before depreciation and depletion             $3,295,250,728
Depreciation                          $1,968,368,159
Depletion                                219,074,967
                                      ______________   1,582,338,126
                                                      ______________
      Deficit after depreciation and depletion         4,877,594,354
!EN
     Thus, in the case of profitable companies, net income is
reduced 31 percent by these allowances, while in the case of
unprofitable companies the deficits are increased by 48 percent.
These percentages will be much greater in the depression years 1931
and 1932. It should also be mentioned that the depreciation
allowance is more important from a revenue standpoint, as it is
nearly 10 times greater than the depletion allowance. Moreover,
depreciation has been increasing for years, while recently depletion
has been decreasing.

     Your subcommittee first investigated means of limiting the
amount allowed to a certain percentage of net income, but this was
found almost impossible to draft into law and was coupled with
certain inequities. In the face of the present emergency, and
because taxable net income is being completely wiped out by these
allowances in many cases, your subcommittee has come to the
conclusion that it will be wise to reduce the allowances made under
existing law by 25 percent for the three years 1934, 1935, and 1936.
This will furnish a fair trial of the limitation and will furnish
temporary stability of revenue at least. On the other hand, no
permanent injustice will be done individuals or corporations, as the
basis of the depreciable or depletable property will only be reduced
by the amount of these items allowable after the 25 percent
reduction.

     It is estimated that the adoption of this plan will result in
an increase in revenue of about $85,000,000 for each of the three
years mentioned.

                    (3) Capital Gains and Losses

     Existing law provides in section 101 for a special treatment of
the gains and losses resulting from the sale of capital assets held
over 2 years. The tax on gains on such sales is limited to 12-1/2
percent, with a corresponding limitation in case of losses. In the
case of assets held less than 2 years, the gains are taxed in full
and the losses allowed in full except in the case of stocks and
bonds, losses from which are limited under section 23(r).

     Our present system has the following defects:

     First. It produces an unstable revenue -- large receipts in
prosperous years, low receipts in depression years.

     Second. In many instances, the capital-gains tax is imposed on
the mere increase in monetary value resulting from the depreciation
of the dollar instead of on a real increase in value.

     Third. Taxpayers take their losses within the 2-year period and
get full benefit therefrom, and delay taking gains until the 2-year
period has expired, thereby reducing their taxes.

     Fourth. The relief afforded in the case of transactions of more
than 2 years in inequitable. It gives relief only to the larger
taxpayers with net incomes of over $16,000.

     Fifth. In some instances, normal business transactions are
still prevented on account of the tax.

     Your subcommittee has examined the British system, which
disregards these gains and losses for income-tax purposes. The
stability of the British revenue over the last 11 years is in marked
contrast to the instability of our own. In that period the maximum
British revenue was only 35 percent above the minimum, while in our
own case the percentage of variation was 280 percent.

     Your subcommittee, however, has been unable to reach the
conclusion that we should adopt the British system. It is deemed
wiser to attempt a step in this direction without letting capital
gains go entirely untaxed. Your subcommittee recommends the
following plan submitted by the staff of the Joint Committee on
Internal Revenue Taxation:

     First. To measure the gain or loss from the sale of property by
an individual according to the length of time he has held the
property, the following percentages of gain or loss are recognized
for tax purposes:
!NR
          100 percent if the capital asset has been held for not
     more than 1 year;

          80 percent if the capital asset has been held for more
     than 1 year but not more than 2 years;

          60 percent if the capital asset has been held for more
     than 2 years but not more than 3 years;

          40 percent if the capital asset has been held for more
     than 3 years but not more than 5 years.

          20 percent if the capital asset has been held more than 5
     years.
!EN
     Second. In the cases where the losses as computed above exceed
the gains so computed, the excess losses are entirely disallowed.

     Third. In the case of corporations the graduated percentage
reduction of gains and losses does not apply. However, capital
losses sustained by corporations are allowed only to the extent of
capital gains. Under the present law corporations are allowed to
offset capital losses against ordinary income.

     Fourth. The plan outlined above is not made applicable, for
obvious reasons, to stock in trade or property which is included in
the taxpayer's inventory.

     It is believed that the adoption of this plan will result in
much greater stability in revenue, will give all taxpayers equal
treatment, will encourage normal business transactions, and will
give a revenue of perhaps $30,000,000 additional under present
conditions without any substantial loss over a long period of years.

     The whole subject is described in greater detail in exhibit C
of the appendix. In any event, the method proposed is absolutely
safe from a revenue standpoint, inasmuch as capital losses cannot be
used to reduce ordinary income, while gains are taxed in full or in
part in proportion to the time for which the property has been held.

                   (4) Personal Holding Companies

     Perhaps the most prevalent form of tax avoidance practiced by
individuals with large incomes is the scheme of the "incorporated
pocketbook." That is, an individual forms a corporation and
exchanges for its stock his personal holdings in stock, bonds, or
other income-producing property. By this means the income from the
property pays corporation tax, but no surtax is paid by the
individual if the income is not distributed.

     For instance, suppose a man has $1,000,000 annual income from
taxable bonds. His tax under existing law will be $571,100. However,
if he forms a holding company to take title to the bonds and to
receive the income therefrom, the only tax paid will be a corporate
tax of $137,500 as long as there is no distribution of dividends.
Thus, a tax saving of $433,600 has been effected.

     It is true that section 104 of our income tax law puts a
50-percent penalty on this accumulation of profits to avoid
surtaxes, but, nevertheless, there seems no doubt that this form of
avoidance is still practiced to a large extent. By making partial
distribution of profits and by showing some need for the
accumulation of the remaining profits, the taxpayer is able to
defeat the Government in proving a purpose to avoid surtaxes.

     Your subcommittee, therefore, recommends that the present
section 104 be divided into two parts, one dealing with the personal
holding company and the other with all other corporations which
accumulate unreasonable surpluses. The part dealing with personal
holding companies has been entirely rewritten, while the present law
has been retained with a few modifications to provide for the other
companies.

     In regard to the personal holding companies, your subcommittee
recommends that they be defined as any corporation 80 percent of
whose gross income for the taxable year is derived from rents,
royalties, dividends, interest, annuities, and gains from the sale
of securities, and whose voting stock to the extent of more than 50
percent is owned by not more than five individuals at the close of
the taxable year. In computing the number of individuals who own the
majority of the voting stock of a corporation it is proposed to
count as one all members of a family in the direct line as well as
the spouse and brothers and sisters.

     It is recommended that a tax of 35 percent be levied on the
"undistributed adjusted net income" of such corporations. This
undistributed adjusted net income is determined by adding to the net
income of a corporation the amount of dividends received from other
corporations and the amount of partially tax-exempt interest and by
subtracting therefrom Federal income taxes paid, contributions or
gifts not otherwise allowed for income-tax purposes, and actual
losses from the sales or exchanges of capital assets to the extent
to which they are not otherwise allowed. From the result of this
computation, which gives what is called the "adjusted net income",
there is to be subtracted an arbitrary allowance of 10 percent of
the adjusted net income and the dividends paid to stockholders
during the taxable year. The purposes of the two last-named
deductions are (1) to allow such corporations a reasonable reserve
for contingencies and (2) to prevent the additional tax from
applying to sums actually distributed.

     The effect of this system recommended by your subcommittee is
to provide for a tax which will be automatically levied upon the
holding company without any necessity for proving a purpose to avoid
surtaxes. It is believed that the majority of these corporations are
formed for the sole purpose of avoiding the imposition of the surtax
upon the stockholders.

     In regard to the tax on other corporations which improperly
accumulate surpluses for the avoidance of surtaxes, only two major
change need be made. First, it is recommended that the rate of tax on
these other corporations be reduced to 25 percent. The 50 percent
rate now imposed is entirely too high to be readily enforceable. It
represents a tax of much more than would have been imposed if the
surplus had been distributed. Moreover, such surplus, even after the
payment of tax, is still subject to the surtax in the hands of the
individual when ultimately distributed. Second, the present law
imposes the tax upon the entire net income; that is, the tax is the
same whether 50 percent of the net income was distributed or whether
none of it was distributed. It is, therefore, recommended that the
tax be applied to the net income after the amount of such net income
has been diminished by the amount of dividends paid during the
taxable year.

     Much more might be said in regard to corporations which are
formed or availed of for the purpose of preventing the imposition of
surtaxes upon the stockholders. Several instances have recently been
developed in connection with the investigations of the Senate
Committee on Banking and Currency, and, therefore, it is believed
unnecessary to go into this matter further.

     Your subcommittee believes that its recommendation now made in
respect to these companies is of the utmost importance and,
furthermore, that it will result, directly or indirectly, in
increasing the annual revenue of the Government by not less than
$25,000,000.

                  (5) Exchanges and Reorganizations

     Your subcommittee makes the following recommendations with
respect to exchanges and reorganizations:
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          (a) That the exchange and reorganization provisions
     contained in section 112 of existing law be abolished;

          (b) That in cases where the immediate payment of the tax
     on a gain resulting from an exchange or reorganization results
     in undue hardship to the taxpayer, the Treasury be granted
     authority to extend the time for the payment of that portion of
     the tax attributable to such gain for a period not in excess of
     2 years.
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     The elimination of the exchange and reorganization provisions
will serve a twofold purpose. First, it will close the door to one
of the most prevalent methods of tax avoidance. Second, it will
greatly simplify the income tax law by eliminating some of its most
complicated provisions. The underlying principle behind all of the
exchange and reorganization provisions of the present law is that
they do not result in tax exemption, but that the tax is postponed.
It is claimed that many of the so-called exchanges or
reorganizations result in mere paper profit, and that to tax them at
the time of the exchange will seriously interfere with business.
However, under the existing system the taxpayer is able to escape
tax on these gains entirely by being permitted to elect the year in
which he shall report such gain.

     Many of the exchanges and reorganizations which the Supreme
Court holds result in taxable income under the Revenue Act of 1917
and prior acts, are now made tax-free under the present law. Your
subcommittee is of the opinion that any system is unsound which does
not tax gains in the year in which realized. The year of realization
is the year in which such gains become income under the
Constitution, and to defer the taxing of gains until later years
opens a wide field of tax avoidance.

     For these and other reasons stated in the report of the staff
of the joint committee contained in exhibit D of the appendix, your
subcommittee is of the opinion that the exchange and reorganization
provisions of the present law should not be retained. It is
estimated that this change will result in a saving to the Government
of at least $18,000,000 annually.

          (6) Dividends out of Pre-March 1, 1913, Earnings

     The present law, in section 115, provides that if a corporation
pays a dividend out of earnings or profits accumulated before March
1, 1913, or out of increase in value of property accrued before
March 1, 1913, the dividend in either case is not taxable to the
stockholder.

     Your subcommittee recommends that these dividends be subjected
to the surtax in the hands of the stockholder as in the case of any
other dividend received. Such action was recommended by the
Committee on Ways and Means and approved by the House in connection
with the Revenue Acts of 1928 and 1932, but the Senate rejected the
proposed change. The subject, therefore, has been fully discussed in
the past.

     The present system is equivalent to allowing a large volume of
dividends from the stock of domestic corporations to go entirely
tax-free and to swell the already large total of tax-exempt income
from Federal, State, and local obligations. It is believed that the
recommendation of your subcommittee, if followed, will result in an
increased annual revenue of approximately $6,000,000.

                       (7) Foreign Tax Credit

     Your subcommittee recommends complete elimination of the
provision of the present law (sec. 131, Revenue Act of 1932)
allowing foreign income taxes to be credited against Federal income
tax. The present provision discriminates in favor of American
citizens and domestic corporations doing business abroad as compared
with those doing business in this country. For instance, an American
citizen who pays a State income tax is only entitled under the
present law to deduct such tax from his gross income in arriving at
his net income subject to the Federal tax. He is not permitted to
offset his State income tax against his Federal income tax. However,
if an American citizen pays an income tax to a foreign country, the
present law allows him, under certain limitations, to reduce his
Federal income tax by the amount of such foreign tax. Furthermore, a
domestic corporation doing business in this country is also only
allowed a deduction from gross income for the income taxes paid to
the States. However, an American corporation doing business abroad,
either directly or through a subsidiary company, is entitled,
subject to certain limitations, to offset its Federal tax by the
amount of income taxes paid to a foreign country. This
discrimination is particularly noticeable in view of the recent
decision of the Supreme Court holding that the term "foreign
country" as used in the credit sections means not only a foreign
state recognized in international law but any political subdivision
thereof, no matter how small.

     Under the Revenue Acts of 1913, 1916, and 1917, a taxpayer was
not entitled to any credit for taxes paid to a foreign country.
These early acts permitted taxes paid to a foreign country to be
deducted only from gross income, which was also the rule applied in
the case of State, county, and municipal taxes.

     Your subcommittee is of the opinion that taxes paid to foreign
countries should be treated in the same manner as taxes paid to the
States and should only be allowed as a deduction from gross income.
It is estimated that the elimination of the foreign-tax credit will
increase the Government revenues by about $10,000,000 annually.

                      (8) Consolidated Returns

     Section 141 of existing law permits corporations, which are
affiliated through 95 percent stock ownership, to file consolidated
returns.

     Your subcommittee recommends that this permission be withdrawn.

     The subject of consolidated returns has long been in
controversy. The revenue bill of 1913, as passed by the House,
prohibited the consolidated return which had been previously allowed
under the regulations of the Treasury Department. The bill as passed
by the Senate and finally enacted specifically provided for the
consolidated return. The revenue bill of 1928, as passed by the
House, denied the right to file consolidated returns, but this
provision was eliminated in the Senate. During the consideration of
the revenue bill of 1932 a compromise was effected resulting in the
levying of an additional tax of three fourths of 1 percent on the
consolidated net income. This additional tax was increased to 1
percent by the National Industrial Recovery Act.

     It cannot be denied that the privilege of filing consolidated
returns is of substantial benefit to the large groups of
corporations in existence in this country. This is especially true
in depression years, for the effect of the consolidated return is to
allow the loss of one corporation to reduce the net income and tax
of another, and during a depression more losses occur. Another
effect of the consolidated return is to postpone tax. This is
because there is no profit recognized for tax purposes on
intercompany transactions, and profits on a product of the
consolidated group, passing through the hands of the different
members of the group, are not taxed until the product is disposed of
to persons outside the group.

     In the past, when any corporation could carry forward a net
loss from one year to another, the consolidated group did not have
such a great advantage over the separate corporation. Now that this
net loss carry-over has been denied, the advantage of the
consolidated return is much greater on a comparative basis.

     Your subcommittee is of the opinion that, at least in the first
few years, an annual increase in revenue of $20,000,000 will result
from the proposed elimination of the consolidated return.

                       (9) Partnership Losses

     Under the present law (sec. 182, Revenue Act of 1932) as
interpreted by the Treasury, a member of a partnership is entitled
to reduce his ordinary income by a net loss of the partnership of
which he is a member, according to his distributive share in the
partnership. For instance, an individual might have an income of
$100,000 from sources outside the partnership. If he has a one-half
interest in a partnership which has a net loss of $100,000, he is
able to reduce his taxable income by 50 percent. Your subcommittee
is of the opinion that partners should not be permitted to offset
against their ordinary income, losses sustained by the partnership.
It is estimated that this change will increase the revenue by at
least $7,000,000 annually.

                      (10) Problems Passed Over

     (a) EARNED INCOME. -- The Revenue Acts of 1924, 1926, and 1928
all gave a credit for earned income. This relief was continued in
the revenue bill of 1932 as passed by the House, although the tax
credit was changed to a deduction in the interest of simplification.
The relief was finally eliminated in the Senate solely because of
the necessity for more revenue. Your subcommittee has examined this
question and believes some moderate form of earned income relief
justifiable. The principle of taxing earned income at somewhat lower
rates than investment income is recognized by practically all other
nations having an income tax. However, while recognizing the equity
of this principle, your subcommittee has refrained from making a
recommendation thereon until the revenue requirements of the
Government are made known.

     (b) OFFICERS' SALARIES. -- Your subcommittee debated at length
the advisability of limiting the amount of the deduction allowed to
a corporation on account of salary or other compensation received by
any officer of the corporation. The numerous examples of excessive
officers' salaries brought to light during the past year were not
overlooked.

     It appears that, while some desirable purpose might be
accomplished from the limitation mentioned, no gain in revenue could
be expected. On the contrary, if lower officers' salaries were
actually paid, a loss in revenue would result. This comes about
because high salaries bear not only the normal tax but heavy
surtaxes, while distributions in dividends would bear no normal tax
and on account of the spread of the amount distributed among all the
stockholders would bear less surtax in the aggregate.

     In view of the above, your subcommittee refrains from making a
recommendation on this subject.

     (c) COMMUNITY PROPERTY INCOME. -- The income-tax situation
existing in eight States of the Union having community property laws
has been carefully considered. No recommendation in regard thereto
is made by your subcommittee in view of the legal difficulties
involved.

     (d) INTOXICATING LIQUORS. -- Considerable attention has been
given to the question of liquor taxes, but in view of the fact that
the President has created an interdepartmental committee to study
the questions involved, it was the thought of the subcommittee that
further consideration should be deferred until recommendations were
received from the President. It is the thought of the subcommittee,
however, that in the event additional legislation is required, the
same should be handled by separate legislation and not made a part
of the general revenue bill, in order to expedite its passage so as
to protect the Treasury from loss of revenue.

     (e) FUTURE ISSUES OF UNITED STATES OBLIGATIONS. -- Your
subcommittee is generally favorable to the policy of making all
future issues of Federal Government obligations subject to surtax.
However, no recommendation is made thereon in the absence of
definite recommendations from the Treasury Department on this
important matter connected with the fiscal policy of the Government.

     (f) EQUITABLE PROVISION. -- Due to the effect of the statute of
limitations, it quite frequently happens that the same item of
income is taxed twice or not at all. This comes about through the
inclusion of such item in the return for the wrong year. In the same
way it happens that deductions from income may be allowed twice or
not at all.

     Your subcommittee is of the opinion that these inequities
should be cured, so that the Government might at least get the tax
once on an item of income and not be obliged to allow a deduction
twice. It is also deemed equally desirable that a taxpayer should
not be taxed twice on the same item of income and allowed a proper
deduction from net income once.

     The subcommittee will endeavor to submit a recommendation on
this important problem at a later date if certain practical
difficulties can be overcome.

                       PART II. MINOR PROBLEMS

                            (1) Annuities

     Section 22(b)(2) of the Revenue Act of 1932 provides for taxing
annuities, but not until the total amounts received exceed the total
amount paid for the annuity.

     Your subcommittee is of the opinion that the tax on annuity
receipts to the extent that they represent income should not be
postponed as permitted by present law. Such receipts are, as a
matter of fact, part interest and part return of capital. Therefore,
it is recommended that some amount representing the portion of the
annuity receipts consisting of interest be made subject to the
income tax. In order to facilitate administration, it is recommended
that an arbitrary rule be adopted that 3 percent of the amount paid
for the annuity shall be deemed to be interest. This rule is applied
only to annuity contracts.

     (2) Interest on Money Borrowed to Purchase Tax-Exempt Securities

     Section 23(b) of the Revenue Act of 1932 prohibits the
deduction of interest on indebtedness incurred or continued to
purchase or carry tax-exempt securities.

     It appears that under the present wording of the law deposits
in banks are not treated as indebtedness incurred to purchase such
securities. Therefore, a taxpayer carrying on the banking business
may deduct all the interest paid on deposits even though such
deposits are invested in tax-exempt securities. Your subcommittee
believes that interest paid on deposits invested in tax-exempt
securities should be disallowed as a deduction for income-tax
purposes. A change in the wording of this section is, therefore,
recommended to accomplish this result.

        (3) Deduction of Death and Gift Taxes from Net Income

     Section 23(c) of existing law allows a deduction for estate,
inheritance, legacy, succession, and gift taxes in computing net
income subject to income tax.

     These taxes constitute expenses or charges which are not
incurred in the production of income, and liability for them
attaches regardless of whether there is any income. They are, in
fact, mere charges imposed upon the transfer of capital. Your
subcommittee, therefore, recommends that such deductions be
disallowed for income-tax purposes.

                         (4) Gambling Losses

     Section 23 of existing law does not limit the deduction of
losses from gambling transactions where such transactions are legal.
Under the interpretation of the courts, illegal gambling losses can
only be taken to the extent of the gains on such transactions. Your
subcommittee recommends a similar limitation on losses from
legalized gambling. Under the present practice, many taxpayers take
deductions for gambling losses but fail to report gambling gains.
This limitation will force taxpayers to report their gambling gains
if they desire to deduct their gambling losses.

(5) Future Expenses in Case of Casual Sales of Real Property

     Under section 23(o) of the Revenue Act of 1932, if an individual
makes a casual sale of real property, he is permitted to reduce the
gain from such sale by expenditures which he has contracted to make
but which cannot be determined until later years. Your subcommittee
recommends that this provision be eliminated as surplusage.

     (6) Dividends from Foreign Corporations

     Section 23(p)(2) and section 25(a)(2) treat dividends from a
foreign corporation in the same manner as dividends from a domestic
corporation, provided such foreign corporation receives more than 50
percent of its gross income from sources within the United States.
Your subcommittee is of the opinion that all dividends received from
foreign corporations should be treated alike, regardless of whether
such foreign corporation has income from sources within the United
States. Accordingly, it is recommended that section 23(p)(2) and
section 25(a)(2) be eliminated. The effect of this recommendation
will be (a) to deny a deduction to a domestic corporation for all
dividends received from foreign corporations, and (b) to deny to any
individual receiving such dividends the exemption from normal tax.

     (7) Disallowance of Deductions Attributable to Tax-Exempt Income

     It is proposed to add to section 24(a) of existing law a
paragraph which will prevent the deduction of an item which is
allocable to the production of income wholly exempt from the income
tax.

     For instance, interest on State securities, salaries received
by State employees, and income from leases of State school lands are
exempt from the Federal income tax. It is obviously improper to
allow any deduction for expenses incurred in the production or
acquirement of such income. Accordingly, your subcommittee
recommends that a provision be inserted in the law specifically
denying deductions allocable to such classes of income.

     (8) Disallowance of Losses Between Members of Family

     It is proposed to add to section 24(a) of existing law a
paragraph which will deny losses to be taken in the case of sales or
exchanges of property between members of a family, or between a
shareholder and a corporation in which such shareholder owns a
majority of the voting stock. The term "family" is defined to
include brothers and sisters, spouse, ancestors, and lineal
descendants.

     Many instances have been brought to light where transactions
have taken place for the sole purpose of taking a loss for
income-tax purposes. It is believed that the recommendation of the
subcommittee, if followed, will effectually close this opportunity
for tax avoidance.

     (9) Accrued Income and Accrued Deductions of Decedent

     Sections 42 and 43 of the Revenue Act of 1932 define the period
in which items of income and of deduction shall be included.

     Your subcommittee recommends adding to the first of these
sections a provision requiring the income-tax return of a decedent
to include amounts of income accrued up to the date of his death,
regardless of the fact that he may have kept his books on the cash
basis. In the case of the second of these sections, a provision
should be added allowing deductions to be likewise accrued.

     Since the courts have held that income accrued by a decedent
prior to his death is not income to the estate, it follows that
unless such income is taxable to the decedent it will escape income
tax altogether. For the same reason, unless expenses which accrued
prior to death are allowed to the decedent, they cannot be used. The
recommendation made by the subcommittee remedies these defects.

     (10) Casual Sales on Installment Basis

     Section 44(b) of the Revenue Act of 1932 allows the use of the
installment method of reporting income where the initial payments do
not exceed 40 percent of the selling price. The limit under former
acts was 25 percent.

     Your subcommittee recommends that the percentage be changed to
30 percent, for it is believed that the present high limit results
in an unreasonable postponement of tax in cases where such tax can
well be paid.

     (11) Allocation of Income

     Section 45 of existing law gives authority to the Commissioner
to allocate items of income or deductions between trades or
businesses which are owned or controlled by the same interests, when
necessary to prevent evasion of taxes.

     Your subcommittee recommends two minor changes in this section:
(1) the inclusion of the word "organizations," along with trades and
businesses, and (2) the addition of the word "avoidance" along with
evasion. These changes give the Commissioner somewhat greater
latitude in applying this section.

     (12) Income Tax Receipts

     Section 56(h) requires the collector to furnish the taxpayer
with an income-tax receipt upon payment of his income tax. This
section is cumbersome in language and has been rewritten for the
purpose of uniformity and simplification. As rewritten, it
corresponds to the more concise language used, in connection with
requiring receipts for gift and estate-tax payments.

     (13) Sale of Mines and Oil or Gas Wells

     Section 102 of existing law provides that in the case of the
sale of mines and oil or gas wells where the principal value of the
property has been demonstrated by prospecting or discovery work done
by the taxpayer, the tax attributable to such sale shall not exceed
16 percent of the selling price.

     This provision was inserted in the law apparently as a subsidy
to encourage the development of new mines and oil wells. In the
present state of overproduction there is no need to continue this
subsidy, and your subcommittee recommends the elimination of the
entire section.

     (14) Basis for Gift in Case of Loss

     Under section 113(a)(2) of the present law, if a taxpayer
acquires property by gift he is required to use as his basis the
property had in the hands of the donor. This section has been
utilized to transfer losses from one person who has little income to
another person with a large income. For instance, a taxpayer has
property which cost him $100,000, but which is now practically
worthless. If he sells the property himself, the loss on the sale
will not do him any good, due to the fact that he has no income
against which to offset it. He transfers such property by gift to a
relative or close friend with a large income, and such relative or
close friend makes the sale and reduces his income by a $100,000
loss. To prevent this, your subcommittee recommends that the donee
be required to use as his basis for determining loss the cost to the
donor or the market value of the property at the time of the gift,
whichever is lower.

     (15) Basis for Property Passing by Power of Appointment

     The last sentence of section 113(a)(4) of the Revenue Act of
1932 prescribes the basis for gain or loss in the case of property
passing under a general power of appointment exercised without
consideration by will or deed in contemplation of death. Property
transferred in this manner is included in the decedent's gross
estate for estate-tax purposes. The income tax law lays down a
special rule for determining the basis for computing gain or loss
upon the sale of such property.

     Your subcommittee sees no reason for adopting a special rule
for this type of property. If such property passes under a general
power of appointment exercised by will, its basis for gain or loss
should be the same as that prescribed in the case of other property
passing by bequest, devise, or inheritance. On the other hand, if
the property passes under a power of appointment executed by deed
without consideration and in contemplation of death, it represents a
gift and should be subject to the same basis rule which applies to
other gifts in contemplation of death. It is believed that an
amendment to existing law should be made to accomplish this result.

     (16) Basis for Property Transmitted at Death

     Under section 113(a)(5) of the Revenue Act of 1932, the basis
for determining gain or loss, for income-tax purposes, on the sale
or other disposition of property transmitted at death, is, in the
following cases, the fair market value thereof at the time of the
death of the decedent:
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          (1) Where personal property was acquired by specific
     bequest;

          (2) Where real property was acquired by general or
     specific devise, or by intestacy;

          (3) Where the property, real or personal, was acquired by
     the decedent's estate from the deceased.
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     In all other cases, if the property was acquired by will or
intestacy, the basis is the fair market value of the property at the
time of distribution to the taxpayer.

     Included within the phrase "all other cases" is personal
property acquired by general or residuary bequest. Thus, where a
trustee acquires personal property by general bequest, the basis of
the property, on a sale by him, is the value at the time of
distribution to him. The basis to the executor, in all cases, is the
value of the property at the date of the decedent's death.

     Oftentimes, the executor and trustee under a will are one and
the same person. Thus, in the case of a general bequest of personal
property, he is in a position to make use of one-basis of valuation
or the other according to which will most benefit the estate. The
trustee, of course, may use a later basis than the executor, and
where it is desired to sell personal property subject to a trust
during the period of administration, the executor-trustee may
determine whether it would be most advantageous to sell as executor
or as trustee. Where the personal property has increased in value in
the hands of the executor, under a general bequest, the property may
be distributed to the trustee, who may use the higher basis in
computing gain or loss on the sale, thereby diminishing the taxable
increment and greatly reducing or entirely avoiding the income tax.

     Section 113(a)(5) of the Revenue Act of 1932 is a reenactment
of a similar provision contained in the 1928 act. The change in the
1928 act was made because there was some doubt as to the meaning of
the term "date of acquisition," which was the term used under the
Revenue Act of 1926. Since the 1928 act was passed, the Supreme
Court has defined "the date of acquisition" to mean the date of
death in the case of all property passing by bequest, devise, and
inheritance, whether real or personal. (Brewster v. Gage, 280 U.S.
327.) Your subcommittee recommends that section 113(a)(5) of the
Revenue Act of 1932 be changed to conform to the language contained
in the Revenue Act of 1926, so that a uniform basis rule may be
required in the case of property passing at death, whether real or
personal.

     (17) Basis of Property for Loss (Acquisition Before March 1,
1913)

     Under section 113(a)(13) of existing law, the basis for
determining gain or loss in the case of property acquired prior to
March 1, 1913, is its cost or fair market value as of that date,
whichever is greater. This rule when applied to losses in some
instances grants the taxpayer a loss when no loss has been actually
sustained. For instance, suppose a taxpayer bought property for
$20,000 prior to March 1, 1913, which was worth $75,000 on that
date. If he sells such property in 1933 for $60,000, he is allowed a
loss of $15,000, although he has in fact made a gain of $40,000.
Your subcommittee is of the opinion that no loss should be allowed
in any case where the selling price exceeds the taxpayer's
investment in the property.

     (18) Distributions in Liquidation

     Section 115(c) of the Revenue Act of 1932 treats a liquidating
dividend as a sale of stock. This rule has serious objections, as it
permits wealthy stockholders to escape surtax upon corporate
earnings or profits distributed in the form of liquidating
dividends. For instance, a corporation may have a surplus of
$1,000,000. If the surplus is distributed as an ordinary dividend,
it is subject to the surtax rates in the hands of the shareholder.
If it is distributed as a liquidating dividend, it is subject only
to the flat capital gain rate of 12-1/2 percent in the case the
shareholder has held his stock for more than 2 years. In addition to
permitting the wealthy shareholder to escape surtax, the present
rule also discriminates against the small shareholder. If the
corporation makes a distribution of surplus as an ordinary dividend,
it is exempt from the normal tax. Accordingly, a small shareholder,
not being in the surtax brackets, is materially affected by the form
of the distribution. If the distribution is made in the form of a
liquidating dividend, the exemption from normal tax does not apply.
This does not seem fair when it is considered that liquidating
dividends may represent earnings or profits which if distributed as
an ordinary dividend would be exempt from normal tax. The present
law thus makes the tax depend upon the form of the distribution.
Your subcommittee recognizes that liquidating dividends do contain
some of the elements of a sale in that the stockholder is
relinquishing in whole or in part his investment in the corporation.
On the other hand they also contain some of the elements of an
ordinary dividend insofar as they represent a distribution of
earnings or profits.

     Your subcommittee is of the opinion that the fairest method of
treating liquidating dividends is to combine both the sale feature
and the dividend feature. It is accordingly recommended that a
liquidating dividend be treated as a sale of the stock, with the
provision that the amount of gain to a shareholder shall be taxed as
an ordinary dividend to the extent that it represents a distribution
of earnings or profits, and as a gain from sale of property to the
extent that it does not represent such a distribution. This will
prevent the large shareholder from escaping the surtax on the
earnings of the corporation and will also relieve the small
shareholder from payment of the normal tax on liquidating
distributions out of earnings or profits.

     (19) Interest Received by Nonresident Aliens

     Section 119(a)(1) of the present law defines the income upon
which nonresident alien individuals and foreign corporations are
required to pay a Federal income tax. The Board of Tax Appeals has
construed the present law to exempt nonresident aliens and foreign
corporations from Federal income tax on any interest paid by the
United States, the territories, or the District of Columbia, on
their obligations, tax refunds, or judgments. Obviously, Congress
did not intend to make such income exempt from the Federal income
tax. Accordingly, section 119(a)(1) has been amended to make it
clear that such interest is taxable.

     (20) Unlimited Deduction for Charity

     Section 120 of the Revenue Act of 1932 provides for the
allowance of charitable contributions in full where for the
preceding 10 years 90 percent of the taxpayer's net income has been
distributed by such contributions.

     Section 23(n) imposes a 15-percent limitation on charitable
contributions in the general case in respect to the amount allowable
in respect to net income.

     Your subcommittee is of the opinion that section 120 should be
eliminated.

     (21) Withholding -- Tax-Free Covenant Bonds

     Section 143(a) provides for the withholding by a corporation
or other obligor of an amount equal to 2 percent of the amount of
interest paid on bonds or other obligations which contain a
provision by which the obligor agrees to pay any portion of the tax
imposed upon the obligee. The tax is not required to be withheld at
the source where the obligee files with the obligor a statement that
he is not taxable under the income tax on account of his income
being less than the amount of his personal exemption. The bondholder
is entitled to a credit against his tax where there has been
withheld a tax at the source on his account.

     Your subcommittee recommends that this system of withholding a
tax on tax-free covenant bonds be entirely discontinued. The system
originated in the 1913 act, where general withholding was employed
to collect a large portion of the tax. The withholding policy has
now been abandoned and the withholding on tax-free covenant bonds is
an exception to the general rule. It is an administrative nuisance
and requires the payment of many small refunds. Simplification and
reduction in administrative expense can be secured by the
elimination of this section. No loss in revenue will result from the
change.

     (22) Information Returns

     Sections 148 and 149 of the Revenue Act of 1932 authorize the
Commissioner to require returns or statements from corporations in
respect to the dividends paid shareholders, and from brokers in
respect to business transacted with customers.

     In view of recent disclosures as to stock-exchange practices,
it is recommended by your subcommittee that these sections should be
amended to require every corporation to file information returns as
to dividends paid to any one person in an amount in excess of $1,000
annually, and to require every exchange broker dealing in stocks,
bonds, etc., to file statements showing the names, addresses, and
gross business transacted with persons whose gross business exceeds
$100,000 annually.

     It is hoped that these information returns and statements will
enable the Commissioner to prevent more effectively tax evasion. A
penalty not to exceed $1,000 is recommended for failure to file the
information returns described above.

     (23) Annuities Acquired by Bequest

     Section 162(b) and (c) of existing laws deals with the net
income of estates and trusts. It has been brought to the attention
of your subcommittee that if a widow receives an annual income from
a trust in lieu of dower, the trust may deduct the payments to her
from its net income and the widow will pay no income tax on the
payments received.

     A similar situation has arisen in the case of annuities
established by will. If the trustee is required to pay to the
beneficiary a fixed sum each year, regardless of whether the trust
has any income, all of the amounts received by the beneficiary are
exempt from income tax, although in some years they are actually
paid out of income.

     Your subcommittee recommends curing these defects in a
reasonable manner by providing that the income of the estate or
trust may be reduced by income paid to the beneficiaries only if
such amounts are includable in the income of such beneficiaries.

     (24) Interest Paid or Accrued -- Insurance Companies

     Section 203(a)(8) provides for the deduction of interest "paid
or accrued" by life insurance companies. Insurance companies are on
the cash receipts and disbursements basis and the Supreme Court has
held that in such cases the word "accrued" means paid. Your
subcommittee, therefore, recommends for the purpose of clarification
that the words "or accrued" be eliminated from this section. The
change will have no effect on the application of the deduction.

     (25) Ninety-Day Letter -- Petition to Board

     Section 272(a) of the Revenue Act of 1932 gives the taxpayer 60
days in which to appeal to the Board of Tax Appeals from a
deficiency notice mailed to him by the Commissioner. A considerable
number of such deficiency notices are mailed to prevent the running
of the statute of limitation and are based on incomplete
information. It is believed that if more time were allowed between
the date of mailing of the notice and the date required for the
filing of the taxpayer's petition a large number of deficiencies
could be settled by conference between the representatives of the
Commissioner and the taxpayer, without the necessity for a petition.

     Your subcommittee, therefore recommends extending this period
for filing a petition to 90 days. It is believed that such action
will result in less delay in the collection of the tax and in
relieving the Board calendar of numerous cases.

     (26) Statute of Limitations -- Assessments

     Section 275 of the Revenue Act of 1932 provides that income
taxes must be assessed within 2 years after the return was filed.

     Your subcommittee is of the opinion that the 2-year period is
too short and should be extended to 3 years. The longer period is
not intended to create delay in tax collections, but to prevent the
escape of taxes legally due, and to eliminate the necessity for
ill-considered deficiency letters in difficult cases. The revenue
should be increased by this change.

     Subsection (c) of this section provides that if a corporation
fails to file a return but each shareholder includes in his return
his distributive share of the net income of the corporation, then
the corporate tax may be assessed within 4 years after the last date
on which the shareholder's return was filed. Under the general rule,
if a corporation fails to file a return, the corporate tax may be
assessed at any time. Your subcommittee sees no reason for making an
exception to the general rule merely because some of the
shareholders have included corporate income in their returns. It is
accordingly recommended that subsection (c) be eliminated.

     There has been considerable difficulty from an administrative
standpoint in keeping a record of the date which starts the
assessment period. Under the present law the tax must be assessed
within a certain period after the return is filed. The statute
prescribes a last date for filing both fiscal and calendar year
returns. In many cases, returns are filed before the due date and
for this reason it is very difficult to maintain a proper record. It
is, therefore, recommended by your subcommittee that all returns
filed before the last due date be deemed to have been filed on the
last due date for assessment purposes.

     (27) Understatement of Gross Income

     Section 276 provides for the assessment of the tax without
regard to the statute of limitations in case of a failure to file a
return or in case of a false or fraudulent return with intent to
evade tax.

     Your subcommittee is of the opinion that the limitation period
on assessments should also not apply to certain cases where the
taxpayer has understated his gross income on his return by a large
amount, even though fraud with intent to evade tax cannot be
established. It is, therefore, recommended that the statute of
limitations shall not apply where the taxpayer has failed to
disclose in his return an amount of gross income in excess of 25
percent of the amount of the gross income stated in the return. The
Government should not be penalized when a taxpayer is so negligent
as to leave out items of such magnitude from his return.

     (28) Statute of Limitations -- Refunds

     Section 322 of the Revenue Act of 1932 provides that no credit
or refund shall be made after 2 years from the time the tax was
paid.

     Your subcommittee in view of the change recommended in
paragraph (26) also recommends that this period be changed from 2 to
3 years. As a matter of fairness, the period in which the taxpayer
may recover overpayments should be the same as the period for
assessment by the Government.

     However, your subcommittee believes that under existing law the
taxpayer has a longer period than the Government, since the
taxpayer's period starts with the payment of the tax while the
Government's period commences with the filing of the return. When a
tax is paid in installments, the taxpayer now has 9 months longer
than the Government to secure tax adjustments.

     To correct this inequality, your subcommittee recommends that
the statute of limitations on refunds shall run within 3 years from
the time the return was filed or within 2 years from the time the
tax was paid, whichever period expires the later.

     (29) Claims for Credit

     Your subcommittee recommends incorporation of H.R. 5904 into
the proposed legislation. This will save the Government $15,000,000
by preventing the Commissioner from refunding certain income taxes
which were due on the merits but for which the taxpayers are
demanding refunds on technical grounds. This bill passed the House
during the last session but was not acted upon by the Senate due to
the short time before adjournment.

     (30) Sales of Personalty by Distraint -- Section 3192, Revised
Statutes

     Under the present law the collector can bid in at a distraint
sale only personal property which is subject to tax such as
oleomargine, tobacco, spirits, etc. He cannot buy for the United
States a Liberty bond or a Treasury note offered at a distraint
sale. If no bid was made, he would be compelled to readvertise and
offer again for sale the security seized under distraint. If an
entirely inadequate bid was made for such security, the collector
would be compelled to accept it. To remedy this, your subcommittee
recommends that the collector be given power to establish a minimum
price for personal property offered by him for sale under the
process of distraint (as it is with respect to realty, R.S. 3197),
and to bid in the same for the United States.

     (31) Effective Date of New Revenue Bill

     The question of retroactivity of the proposed legislation was
considered by your subcommittee. In many cases it is impossible to
make the proposed changes retroactive on account of constitutional
objections. Furthermore, some doubt exists as to the possibility of
passing the bill by March 1, which certainly should be done if the
changes are to be given effect in returns filed on March 15.

     Therefore, the wording of the bill in section 1 will make the
act applicable to any taxable year beginning after December 31,
1933.

     Under prior laws, the policy was to divide fiscal years into
two parts and tax each part under the different act applicable
thereto. Your subcommittee recommends discontinuing this troublesome
practice, since there are no substantial rate changes. This will
make the administrative work of handling fiscal year returns easier,
and will simplify the act by eliminating part of section 48 (a) and
all of sections 105 and 132.

     If the Committee on Ways and Means desires to make certain
provisions retroactive, this can be done in each special case,
provided there is no constitutional bar to such retroactively.

     (32) Items Passed Over

     The following propositions have received favorable action by
your subcommittee but will not be finally recommended in view of
difficulties of working them out, until such difficulties can be
overcome.

     (a) Section 52: It is believed desirable to make the officers
of a corporation subject to penalty for the failure of the
corporation to make a return. It appears that some difficulty exists
in holding such officers liable for penalties under existing law in
such a case because the statute requires the corporation to make the
return.

     (b) Section 113: The present law does not specifically provide
for any cost basis in the case of the sale of mining grants. The
Treasury has ruled that in the case of mining grants the basis for
computing gain or loss from such sales shall be the value at the
date the minerals are discovered. Your subcommittee believes the
present law should be clarified so that the basis in such cases
should be the cost to the person securing the grant.

     (c) Section 115: It was hoped to tax distributions in kind by
corporations on a more equitable basis, but no plan has been devised
which overcomes constitutional objections.

     (d) Section 311 (d): This section deals with transferee
proceedings. It has been contended that under existing law a
transferee who pays all the tax may be without remedy to enforce
contribution from the other transferees. Your subcommittee is
sympathetic to remedying this situation if it can be done.

     (e) Your subcommittee is in favor of allowing a tax exemption
for estate-tax purposes where the property has already been taxed by
the estate tax in the hands of a prior decedent within 5 years as is
permitted by present law. Your subcommittee is not in favor of
allowing this exemption the second time when the property passes
from the second decedent to the third as is permitted by present
law.

     (f) Your subcommittee is of the opinion that a citizen of the
United States should be subject to the estate tax on real property
located abroad.

     (g) Your subcommittee is of the opinion that all trusts which
have not been subject to estate or gift taxes should be taxed on
dissolution. The constitutional questions arising in this
connection, however, are serious.

     (h) Your subcommittee is of the opinion that suits against the
collector for recovery of taxes should be abolished and that all
such suits should be brought against the United States. At present
either course can be pursued.

     (i) Your subcommittee is of the opinion that where a circuit
court of appeals refuses to hear a case on account of wrong
jurisdiction, it should be allowed to determine the correct
jurisdiction.

                             CONCLUSION

     It is believed that the major changes proposed in part I of
this report may result in additional revenue of about $235,000,000
per annum in a full year of operation, and that the minor changes
proposed in part II may result in further revenue of $35,000,000 --
giving a grand total of $270,000,000. When business returns to
normal, the additional revenue from these changes should be greater.

     In any event, your subcommittee is of the opinion that if the
changes proposed are adopted, the income-tax burden will be more
fairly borne by all taxpayers with very few opportunities of escape
therefrom by legal avoidance. The sooner all persons pay their full
share of income taxes, the sooner some relief in the existing tax
burden may be expected.

                              APPENDIX

                              EXHIBIT A

       MEMORANDUM ON WHOLLY AND PARTIALLY TAX-EXEMPT INTEREST

     Much attention recently has been given to the question of
whether the interest on Federal, State, and local bonds should be
subject to taxation by the Federal and State Governments. A
consideration of the facts in connection with the subject does not
lead to an obvious conclusion. However, such facts as seem most
important will be pointed out, and certain suggestions made in
connection with the matter as appear to warrant consideration.

     The total interest-bearing indebtedness of the Federal, State,
and local Governments is estimated to be approximately
$40,500,000,000 at this time. The annual interest charge on this
amount is estimated to be approximately $1,805,000,000. The larger
part of this latter sum is entirely free from Federal and State
income taxes, although it is true that some of the Federal bonds are
subject to surtaxes. Also, practically all of the bonds are subject
to estate and inheritance taxes, and to the income tax insofar as a
profit is realized upon the sale thereof.

     Naturally we have accurate figures as to the total amount of
Federal securities. On August 31, 1963, the total interest-bearing
debt of the United States, outstanding, amounted to $22,722,597,630,
of which amount $12,860,055,350 was subject to surtax, and
$9,862,542,180 was wholly tax exempt as to both income and surtax.
It appears that the average annual interest charge on this Federal
debt will be approximately $825,000,000, indicating an average
interest rate of approximately 3-5/3 percent.

     From incomplete data available, this office estimates the
present State and local indebtedness to be about $17,800,000,000.
The annual interest charge on this sum is probably not less than
$980,000,000, indicating an average interest rate of 5-1/2 percent.

     Our revenue acts provide that taxpayers, both individual and
corporate, shall report the interest received from these wholly or
partially tax-exempt bonds. There is no penalty for not so reporting
the wholly tax-exempt interest, and there might be some question as
to the legality of such a penalty. In any event, it seems certain
that a very considerable amount of the wholly tax-exempt interest is
not reported on the returns. This, of course, makes no difference in
our present revenue, but is disturbing when we make a statistical
study of this question.

     It has already been pointed out that our present annual
interest charge on the total Federal, State, and local debt will
amount to approximately $1,805,000,000. In 1930 this interest charge
amounted to considerably less -- probably to about $1,370,000,000.
Nineteen hundred and thirty is the latest year on which we have
complete income tax statistics, and in this year we can account for
the following amounts of wholly or partially tax-exempt interest on
the income-tax returns:
!TA
(1) Individuals with net income of $5,000 and over:
    Interest on State and local bonds                $172,841,118
    Interest on wholly exempt United States bonds      51,308,177
    Interest on partially exempt United States
    bonds (including farm loan bonds)                  38,133,605
                                                    _____________
            Subtotal                                  262,282,900

(2) Corporations -- all:

    Interest on Federal, State, and municipal bonds   536,260,563

(3) Individuals with $5,000 gross but no net income:
    Interest on partially exempt Government bonds       5,738,139
                                                      ___________
Grand total                                           804,281,602
!EN
     It is apparent therefore, that the actual figures on the 1930
income-tax returns account for only $804,281,602 out of a total of
probably $1,370,000,000 of wholly or partially tax-exempt interest
paid out in that year. While we can account for some of this
difference of $566,000,000 as going to the individuals with net
incomes of less than $5,000, to tax-exempt corporations, and to
foreign individuals and corporations, it must be admitted that the
larger portion of the difference probably is the result of the
tax-exempt interest not being reported on the returns. However, our
figures seem sufficiently complete to form a basis for estimates.

     Before speculating, however, as to how much revenue may be
derived from the taxation of this interest, it will be necessary and
interesting to observe the distribution of this kind of interest
among our smaller taxpayers, our middle class, and our wealthy
class. This distribution need be made only for individuals, since
the corporate rate of tax is constant while the individual rates of
tax are graduated. Furthermore, it can be computed from the figures
already given that the corporations appear to hold about 67 percent
of the total of Federal, State, and local obligations.

     The wholly and partially tax-exempt interest reported by
individuals with net incomes of over $5,000 has been computed for
the years 1924, 1927, 1929, and 1930. This interest has been broken
up into two groups: (1) United States securities and Federal farm
loan bonds; and (2) State and local obligations. The interest
derived from each of these groups has been further classified so as
to show the amount received in each case by individuals with net
incomes of over $5,000 and not over $25,000, by individuals with net
incomes of over $25,000 but not over $100,000, and by individuals
with net incomes of over $100,000. These facts are shown in the
following four tables covering, respectively, the 4 years already
named:
!TA
  WHOLLY AND PARTIALLY TAX-EXEMPT INTEREST REPORTED BY INDIVIDUALS
        WITH NET INCOMES OF OVER $5,000 BY NET INCOME CLASSES

                         United
                         States
         Net income     securities
Year       class           and
                         Federal
                        farm loan
                          bonds

1924    $1,000-$25,000  $41,530,723  66  $22,295,874  35 $63,826,597
      $25,000-$100,000   42,885,831  08   46,548,494  32  39,434,025
         Over $100,000   35,556,241  42   49,802,812  58  85,362,068

            Total       119,974,495  51  118,648,180  49 238,622,675

1927    $1,000-$25,000   29,417,257  57   30,036,240  42  59,432,497
      $25,000-$100,000   35,550,097  41   51,389,027  59  37,139,124
         Over $100,000   39,579,448  36   70,710,492  64 110,289,940

            Total       114,546,802  43  152,335,709  57 266,882,581

1929    $1,000-$25,000   32,222,421  53   29,018,872  47  51,241,203
      $25,000-$100,000   31,244,723  37   54,817,648  62  85,582,368
          Over 100,000   36,920,848  30   85,216,837  70 128,137,683

            Total       100,287,990  37  109,553,254  83 209,941,344

1900    $1,000-$25,000   33,133,796  46   18,589,450  54  71,723,246
        $25,000-$100,000 30,899,843  33   61,954,130  67  92,652,973
        Over $100,000    25,508,142  26   72,297,538  74  97,908,001

            Total        82,441,782  24  172,841,118  88 282,282,900
!EN
     The following facts may readily be noted from the above tables:

     First. The interest received, and hence the amount of Federal
securities held, by all our individual taxpayers with net incomes of
over $5,000 has steadily declined. In 1924 the interest received
amounted to about 120 million; in 1927, to about 115 million; in
1929, to about 100 million; and in 1980, to about 80 million, a
decline of 30 percent from 1924 to 1930.

     Second. The interest received, and hence the amount of State
and local obligations held, by all our individual taxpayers with net
incomes of over $5,000 has somewhat increased. In 1924 the interest
received amounted to about 119 million; in 1927, to about 152
million, in 1939, to about 170 million and in 1980, to about 173
million an increase of 45 percent from 1924 to 1980.

     Third. The class of taxpayers with net income of from $5,000 to
$25,000 do not find the Federal bonds nonattractive. In 1924, 60
percent of their interest was received from such bonds and 35
percent from State and local bonds, while in 1930 the Federal
interest received amounted to 46 percent and the State and local
interest to 54 percent.

     Fourth. In the case of the middle class of taxpayers with net
incomes between $25,000 and $100,000, the proportion of Federal to
State and local interest received is much less than in the smaller
class and the shift to State and local investment greater. For
instance, in 1924, of the total interest received by this class, 48
percent came from Federal securities and 52 percent from State and
local obligations, while in 1980, 33 percent came from the former
source and 67 percent from the latter.

     Fifth. In the case of the wealthy taxpayers with net incomes of
over $100,000, the unattractiveness of the Federal issues becomes
even more pronounced and the shift to State and local issues still
greater. In 1924 this class received 42 percent of their total
interest from Federal securities and 58 percent from State and local
obligations. In 1930, however, 26 percent came from Federal sources
and 74 percent from State and local sources.

     It is our conclusion from the above facts that the small
taxpayer finds Federal bonds quite as attractive as State and local
bonds, because the greater security offered by the former offsets
the higher interest rate of the latter. In the case of the larger
taxpayers, however, we are forced to the conclusion that State and
local issues are preferred over Federal issues, not because this
class of taxpayers desire less security, but because the State and
local issues are entirely free from surtax while the majority of the
Federal bonds are subject to such tax.

     What additional revenue could be secured by subjecting all this
interest on the public debt to tax? Based on the data available and
the existing tax rates, we believe the maximum revenue which the
Federal Government could obtain would not exceed $160,000,000
annually. Of this amount, about $90,000,000 would come from
individuals and about $70,000,000 from corporations.

     A study of the market quotations on Government bonds indicates
that the wholly tax-exempt securities are slightly preferred over
the partially exempt securities. This is true in spite of the fact
that both classes of securities are wholly tax exempt when in the
hands of corporations. Thus, a broad tax-free market is now open to
corporations for the bonds which are only partially tax exempt in
the hands of individuals. If this were not the case, authorities
seem to agree that future bond issues by our governmental units
would necessarily bear a higher interest rate.

     An increase in interest rate of one fourth of 1 percent on
$40,000,000,000 would cost our Government $100,000,000 annually; an
increase of one half of 1 percent would cost $200,000,000 annually.
Of course, the increase in interest costs would not take effect
immediately if Congress taxed bonds already issued in tax-exempt
form without retirement and reissue. However, to do so would raise a
serious question of breach of faith and might be construed to
violate the Constitution.

     At the present time, substantial revenue could be secured by
taxing the interest on all Federal, State, and local bonds if the
income tax were applied to old as well as new issues. The question
of whether such a procedure is right or wrong from a moral
standpoint is one which is beyond the scope of this memorandum.

     It is the opinion of this office that if the income tax were
applied in full to all future issues of these bonds the increased
interest cost would nearly offset the additional revenue secured.

                             SUGGESTIONS

     If it is desired to subject all Federal, State, and local bonds
to the income tax of both Federal and State Governments, it appears
that the fairest way, and the only one free from legal
uncertainties, would be to present the issue to the people through
an amendment to the Constitution.

     It is suggested that for present purposes it might be well for
the Congress to consider the advisability of making all future
issues of Federal interest-bearingbearing obligations subject to the
surtax. This would restrict the opportunity now existing for the
avoidance of this tax. In fact, much might be said, even in the case
of a constitutional amendment, in favor of making the interest on
Federal, State, and local bonds subject to surtaxes but not to
normal taxes. It would have the effect of preventing tax avoidance
without materially increasing the interest rate.

     There is some possibility, in view of certain decisions of the
Supreme Court of the United States, that even under existing law
interest on governmental bonds can be reached by an excise tax in
the case of individuals or corporations carrying on business. This
question is discussed in the appended memorandum prepared by Mr.
Stam, counsel to this committee.

     As already stated, no obvious conclusion is apparent in
connection with this matter. It is a subject of importance, and
needs further investigation and study.
!NR
                                   Respectfully,

                                   L.H. PARKER
                                   Chief of Staff.
!EN
           POWER OF CONGRESS TO TAX TAX-EXEMPT SECURITIES

     Many proposals have been submitted suggesting the taxation by
the Federal Government of the income received from State and
municipal securities. It is settled doctrine that without a
constitutional amendment Congress has no power directly to tax the
income received from State and municipal securities (Metcalf and
Eddy v. Mitchell, Adms., 269 U.S. 514, 521; Pollock v. Farmers' Loan
and Trust Company, 157 U.S. 429; National Life Insurance Co. v.
U.S., 43 Sup. Ct. 593). However, there is a possibility that such
income might be reached through an excise tax measured by the net
income from all sources. In the case of corporations, it seems clear
that this can be done. The corporation excise tax of 1909 taxed the
privilege of carrying on or doing business by corporations. The tax
was measured by the net income of the corporation from all sources.
Since the subject of the tax was an exercise of a franchise or
privilege, the Supreme Court held that Congress had the power to
include in the measure of the tax the income from tax-exempt
securities, although such income could not be directly taxed (Stone
Tracy Company v. Flint, 220 U.S. 107). Moreover, some of the States
through corporation excise taxes are now taxing the income from
Federal securities by measuring the excise by the net income of the
corporation from all sources. In at least two of the States, namely,
California and New York, their power to do this has been upheld by
the Supreme Court (Pacific Company v. Johnson, 285 U.S. 480;
Educational Films Company v. Ward, 282 U.S. 379). In the California
case, the Supreme Court made the following statement as to this
point:

     "The owner may enjoy his exempt property free of tax, but if he
asks and receives from the State the benefit of the taxable privilege
as the implement of that enjoyment, he must bear the burden of the
tax which the State exacts as its price."

     So far as individuals are concerned, there is a possibility
that the income received by them from tax-exempt securities may also
be reached through an excise. To do this, we must first find a
taxable privilege upon which to base the excise. It seems clear that
all trades, avocations and employments by which individuals acquire
a livelihood may be made the subject of an excise or privilege tax.
(See the Stone Tracy and Pollock cases, cited above.) Accordingly,
if Congress levied an excise on individuals engaged in any business,
occupation, trade, avocation, or employment, it seems entirely
possible that such tax could be measured by the net income of the
individual from all sources, including the income from tax-exempt
securities. As stated by the Supreme Court in the Stone Tracy Co.
case, "there is no rule which permits a court to say that the
measure of a tax for the privilege of doing business, where income
from property is the basis, must be limited to that derived from
property used in the business." It is up to Congress to determine
the measure of the excise and it seems entirely possible that the
measure of such excise could be the net income of the individual
from all sources, including tax-exempt securities.

     Under this proposed scheme, there would be three taxes levied
by the Congress: (1) An excise tax upon the carrying on or doing
business by corporations, measured by the net income from all
sources; (2) an excise tax upon individuals engaged in any trade,
occupation, avocation, or employment, measured by the net income
from all sources; and (3) a net income tax imposed upon all
individuals and corporations not subject to the excise tax.

     By this scheme, most of the income from tax-exempt securities
could be reached. Those persons that would escape would be only
those who do not engage in any trade, avocation, or employment, but
merely hold securities. This scheme would also not extend to State
employees engaged in governmental functions of the State, for such
occupations being governmental in character could not be reached
even through an excise.
!NR
                                   COLIN F. STAM,
                                   Counsel.
!EN
                              EXHIBIT B

       INCOME TAX ON INDIVIDUALS -- PRESENT AND PROPOSED TAXES

          MARRIED PERSON WITH INCOME FROM SALARY, BUSINESS,
                     OR WHOLLY TAXABLE INTEREST
!TA
         Income          Present                 Reduc-
                          law        Proposed     tion     Increase
____________________________________________________________________

    $1,000                   $0            $0
    $1,500                    0             0
    $2,000                    0             0
    $2,500                    0             0
    $3,000                   20            20
    $3,500                   40            40
    $4,000                   60            60
    $4,500                   80            80
    $5,000                  100           100
    $6,000                  140           140
    $7,000                  210           200        $10
    $8,000                  300           280        20
    $9,000                  390           365        25
   $10,000                  480           455        25
   $12,000                  680           650        30
   $14,000                  900           880        20
   $16,000                1,140         1,120        20
   $18,000                1,400         1,380        10
   $20,000                1,680         1,670        10
   $22,000                2,000         1,980        20
   $24,000                2,340         2,300        40
   $26,000                2,700         2,650        50
   $28,000                3,080         3,010        70
   $30,000                3,480         3,400        80
   $35,000                4,590         4,450       140
   $40,000                5,800         5,620       180
   $45,000                7,140         6,955       185
   $50,000                8,600         8,410       190
   $55,000               10,190         9,985       200(5)
   $60,000               11,900        11,680       220
   $65,000               13,740        13,495       245
   $70,000               15,700        15,445       255
   $75,000               17,790        17,530       260
   $80,000               20,000        19,735       265
   $85,000               22,340        22,085       255
   $90,000               24,800        24,535       265
   $95,000               27,390        27,110       280
  $100,000               30,100        29,810       200
  $125,000               44,100        43,760       340
  $150,000               58,100        57,760       340
  $175,000               72,350        71,985       365
  $200,000               86,600        86,235       365
  $250,000              115,600       115,210       390
  $300,000              144,000       144,210       399
  $400,000              208,000       208,185       415
  $500,000              263,000       208,100       440
  $600,000              234,000       324,135       455
  $700,000              385,000       885,135       465
  $800,000              447,100       446,610       490
  $900,000              508,100       508,610       490
$1,000,000              571,100       570,610       400
$2,000,000            1,201,100     1,200,585       515

          SINGLE PERSON WITH INCOME FROM SALARY, BUSINESS,
                   OR WHOLLY FROM TAXABLE INTEREST

         Income          Present                 Reduc-
                           law        Proposed     tion    Increase
____________________________________________________________________

    $1,000                   $0            $0
    $1,500                   20            20
    $2,000                   40            40
    $2,500                   60            60
    $3,000                   80            80
    $3,500                  100           100
    $4,000                  120           120
    $4,500                  140           140
    $5,000                  160           160
    $6,000                  240           240
    $7,000                  330           320       $10
    $8,000                  420           410        10
    $9,000                  510           500        10
   $10,000                  600           600
   $12,000                  800           820                   $20
   $14,000                1,020         1,060                    40
   $16,000                1,260         1,320                    60
   $18,000                1,520         1,600                    80
   $20,000                1,800         1,900                   100
   $22,000                2,120         2,220                   100
   $24,000                2,400         2,560                   100
   $26,000                2,820         2,920                   100
   $28,000                3,200         3,300                   100
   $30,000                3,600         3,700                   100
   $35,000                4,710         4,780                    70
   $40,000                5,920         6,010                    90
   $45,000                7,260         7,360                   100
   $50,000                8,720         8,860                   140
   $55,000               10,310        10,480                   170
   $60,000               12,020        12,220                   200
   $65,000               13,860        14,080                   220
   $70,000               15,820        16,060                   240
   $75,000               17,910        18,160                   250
   $80,000               20,120        20,410                   290
   $85,000               22,460        22,820                   360
   $90,000               24,920        25,270                   350
   $95,000               27,510        27,920                   410
  $100,000               30,220        30,620                   400
  $125,000               44,220        44,600                   380
  $150,000               58,220        58,600                   380
  $175,000               72,470        72,840                   370
  $200,000               85,720        87,090                   370
  $250,000              115,720       116,080                   360
  $300,000              144,720       145,080                   360
  $400,000              208,720       204,070                   350
  $500,000              263,720       264,060                   340
  $600,000              324,720       325,050                   330
  $700,000              285,720       386,050                   320
  $800,000              447,220       447,540                   320
  $900,000              509,220       509,540                   320
$1,000,000              571,220       571,540                   320
$2,000,000            1,201,220     1,201,530                   310

           MARRIED PERSONS WITH ALL INCOME FROM DIVIDENDS
                    OR PARTIALLY TAX-EXEMPT BONDS

    $1,000                   $0            $0
    $1,500                    0             0
    $2,000                    0             0
    $2,500                    0             0
    $3,000                    0             0
    $3,500                    0             0
    $4,000                    0             0
    $4,500                    0             0
    $5,000                    0             0
    $6,000                    0             0
    $7,000                   10             20               $   10
    $8,000                   20             60                   40
    $9,000                   30            106                   75
   $10,000                   40            156                  110
   $12,000                   80            270                  190
   $14,000                  140            420                  280
   $16,000                  220            580                  365
   $18,000                  220            770                  480
   $20,000                  440            970                  530
   $22,000                  600          1,200                  600
   $24,000                  780          1,440                  600
   $26,000                  980          1,710                  720
   $28,000                1,200          1,990                  790
   $30,000                1,440          2,300                  800
   $35,000                2,150          3,150                1,000
   $40,000                2,900          4,120                1,160
   $45,000                3,900          5,265                1,355
   $50,000                4,989          6,510                1,580
   $55,000                6,150          7,885                1,735
   $60,000                7,480          9,330                1,920
   $65,000                8,900         10,995                2,004
   $70,000               10,400         12,743                2,285
   $75,000               12,180         14,630                2,400
   $80,000               12,900         16,635                2,675
   $85,000               13,900         18,785                2,888
   $90,000               17,900         21,085                2,075
   $95,000               20,150         23,410                3,200
  $100,000               22,400         25,910                3,400
  $125,000               34,400         28,800                4,400
  $150,000               40,400         51,800                5,400
  $175,000               58,710         85,085                6,375
  $200,000               70,900         78,335                7,378
  $250,000               25,900        105,210                9,360
  $300,000              120,900        132,310               11,380
  $400,000              171,980        137,285               15,228
  $500,000              273,900        243,200               19,300
  $600,000              270,900        300,235               23,375
  $700,000              320,000        357,235               22,275
  $800,000              383,400        414,710               31,250
  $900,000              437,400        472,710               35,250
$1,000,000              491,480        530,710               39,250
$2,000,000            1,041,400      1,201,685               79,225

           SINGLE PERSON WITH ALL INCOME FROM DIVIDENDS OR
                     PARTIALLY TAX EXEMPT BONDS

    $1,000                   $0            $0
    $1,500                    0             0
    $2,000                    0             0
    $2,500                    0             0
    $3,000                    0             0
    $3,500                    0             0
    $4,000                    0             0
    $4,500                    0             0
    $5,000                    0             0
    $6,000                    0            40               $    40
    $7,000                   10            80                    70
    $8,000                   20           130                   110
    $9,000                   30           180                   150
   $10,000                   40           240                   200
   $12,000                   80           380                   200
   $14,000                  140           540                   400
   $16,000                  220           720                   500
   $18,000                  320           920                   604
   $20,000                  440         1,140                   700
   $22,000                  600         1,380                   780
   $24,000                  780         1,640                   806
   $26,000                  980         1,920                   940
   $28,000                1,200         2,220                 1,020
   $30,000                1,440         2,540                 1,140
   $35,000                2,150         3,420                 1,270
   $40,000                7,900         4,450                 1,400
   $45,000                3,900         5,600                 1,700
   $50,000                4,900         6,900                 1,940
   $55,000                8,150         8,220                 2,170
   $60,000                7,480         9,800                 2,400
   $65,000                8,900        11,520                 2,620
   $70,000               10,400        13,300                 2,940
   $75,000               12,130        15,200                 3,060
   $80,000               18,900        17,200                 2,200
   $85,000               18,900        19,400                 3,500
   $90,000               17,900        21,710                 2,780
   $95,000               20,180        24,160                 4,010
  $100,000               22,400        26,600                 4,200
  $125,000               14,400        30,840                 5,100
  $150,000               40,400        32,640                 6,130
  $175,000               58,710        85,380                 7,170
  $200,000               70,980        79,130                 8,179
  $250,000               95,900       108,120                10,160
  $300,000              120,900       122,120                12,100
  $400,000              171,900       198,110                16,150
  $500,000              223,900       244,100                20,140
  $600,000              276,909       301,000                24,130
  $700,000              329,900       203,000                28,120
  $800,000              383,400       415,500                32,120
  $900,000              437,400       472,180                36,120
$1,000,000              491,400       531,180                40,120
$2,000,000            1,041,400     1,121,570                50,110
!EN
                              EXHIBIT C

               MEMORANDUM ON CAPITAL GAINS AND LOSSES

     The wisdom of including in taxable income gains from the sale
of real estate, stocks, bonds, and other assets of a capital nature
has long been a subject of controversy. A like question arises as to
the wisdom of permitting losses from such sales to be deducted from
income.

     Speaking generally, we have always taken account of gains and
losses from capital transactions in the computation of net income,
while Great Britain has pursued the opposite policy and disregarded
such gains and losses in determining net income.

     Two reports have been made by the staff of the joint committee
on this subject. A summary of the first report will be found on
pages 40 to 48 of the Report of the Joint Committee on Internal
Revenue Taxation, dated November 15, 1927. The second report is
entitled "Supplemental Report on Capital Gains and Losses", and was
published under date of June 9, 1929. The data contained in these
reports cannot be repeated here for lack of space, but will be
relied on to a considerable extent in advancing certain suggestions
in connection with the matter.

     The great advantage of the English system lies in the stability
which it gives to the income-tax revenue. The stability of their
revenues and the instability of our own can be readily seen from the
following comparison of Federal and British income-tax receipts:
!TA
                      United States       Great Britain
Fiscal year           (millions of        (millions of
                        dollars)           dollars/1/)

1923                      1,691                1,938
1924                      2,542                1,724
1925                      1,761                1,748
1926                      1,974                1,652
1927                      2,200                1,482
1925                      2,173                1,521
1929                      2,331                1,436
1930                      2,410                1,443
1931                      1,800                1,582
1932                      1,067                1,782
1933                        747                1,528

Total, 11 years          21,058               17,833
Average annual revenue    1,915                1,621
!EN
                          FOOTNOTE TO TABLE

     /1/ Converted to dollars at the rate of $4.86 per pound
sterling.

                      END OF FOOTNOTE TO TABLE

     While the above figures show on their face the instability of
our income-tax revenues and the stability of the British revenues
from the same source. It may be interesting to analyze the results
in terms of percentages, as follows:

     (1) The minimum British income-tax revenue in the last 11 years
was collected in 1929, when it amounted to $1,436,000,000; the
maximum revenue was collected in 1923, when it amounted to
$1,936,000,000. Thus, the maximum annual revenue from income tax was
only 35 percent above the minimum revenue.

     (2) The minimum Federal income-tax revenue in the last 11 years
was collected in 1933, when it amounted to $747,000,000; the maximum
revenue was collected in 1924, when it amounted to $2,842,000,000.
The maximum annual revenue from income tax was 230 percent above the
minimum revenue.

     (3) The average annual British revenue from income tax in the
11-year period 1923 to 1933, inclusive, was $1,621,000,000. The
maximum annual revenue during this period was 19 percent above this
average, and the minimum 11 percent below it.

     (4) The average annual Federal revenue from income tax in the
11-year period 1923 to 1963, inclusive, was $1,915,000,000. The
maximum annual revenue during this period was 48 percent above this
average, and the minimum was 61 percent below it.

     While this stability of the English revenue is not entirely due
to their treatment of capital gains and losses, it is a very
important factor in producing this condition. It is easy to show
that much of the instability of the Federal income-tax revenue is
due to our system of taxing these gains and losses. For instance,
let us analyze the individual income-tax returns for the calendar
year 1928, a prosperous year; and for 1961, a year of depression:

                      INDIVIDUAL RETURNS, 1938
!TA
Revenue:
   Capital gains (from sale of assets
     held over 2 years)                 $1,879,780,038
        Tax                                             $234,972,505
   Other gains (from sale of assets
     held 2 years or less)               2,928,141,616
        Estimated tax                                    822,000,000
                                                       _____________
           Total revenue                                 556,972,505
                                                       =============
Reduction in revenue:
   Capital losses (from sale of assets
     held over 2 years)                     41,011,320
        Tax reduction                                      5,126,415
   Other losses (from sale of assets
     held 2 years or less)                 171,743,165
        Estimated tax reduction                           17,100,000
                                                       _____________
           Total reduction in revenue                     22,226,415
                                                       =============

           Net gain in revenue (revenues
             less reduction in revenue)                  534,746,090
                                                       =============

Total revenue, 1928 individual returns                 1,164,254,037
Percent of total revenue from gains tax                           46

                      INDIVIDUAL RETURNS, 1931

Revenue:
   Capital gains (from sale of
     assets held over 2 years)         $   166,131,451
        Tax                                              $20,766,431
   Other gains (from sale of assets
     held 2 years or less)                 283,276,380
        Estimated tax                                     31,200,000
                                                       _____________
           Total revenue                                  51,966,431
                                                       =============
Reduction in revenue:
   Capital losses (from sale of assets
     held over 2 years)                    190,607,424
        Tax reduction                                     23,825,928
   Other losses (from sale of assets
     held 2 years or less)               1,043,625,622
        Estimated tax reduction                          114,400,000
                                                       _____________
           Total reduction in revenue                    138,225,928
                                                       =============
           Net loss in revenue (reduction
             in revenue less revenue)                     86,259,928
                                                       =============
Total revenue 1931 individual returns                    241,282,875
Percent reduction in revenue by treatment
  of gains and losses                                             26
!EN
     From the above it can be seen that our revenue in a good year
may be increased 46 percent and in a bad year decrease 26 percent by
our system of taxing gains and crediting losses from the sale of
capital assets in the case of individuals alone.

     In the case of corporations a similar condition exists which
also tends to instability. The figures for the gains and losses
which are available in the case of corporations are as follows:
!TA
                                    Gains from       Losses from
                                 sales of capital   sales of capital
                                       assets            assets
____________________________________________________________________

1929                              $1,315,294,500           (1)
1930                                 645,316,417       $231,749,379
!EN
                          FOOTNOTE TO TABLE

     /1/ Not available.

                      END OF FOOTNOTE TO TABLE

     To complete the statistical picture of gains and losses
realized from the sale of assets by individuals, such gains and
losses will be shown for the period 1917 to 1931, inclusive, in the
following table:
!TA
                           Year               Profits        Losses
____________________________________________________________________

1917                                  $318,170,617      $110,720,384
1918                                   291,185,704       571,468,120
1919                                   999,264,287     1,175,140,997
1920                                 1,020,542,719     1,680,304,148
1921                                   462,858,873     1,832,041,653
1922                                   991,351,580     1,251,980,891
1923                                 1,172,154,428     1,619,082,743
                                     _______________________________
Subtotal - High tax years            5,258,828,308     5,241,347,937
                                     ===============================
1924                                 1,512,714,092       896,906,467
1925                                 2,932,228,340       658,078,024
1926                                 2,378,542,908       212,789,639
1927                                 2,894,582,036       278,100,309
1928                                 4,307,921,454       212,784,435
1929                                 4,084,500,175     1,038,971,413
                                    ________________________________
Subtotal - Prosperous years         19,211,549,705     3,292,600,332
                                    ================================
1930                                 1,193,130,398     1,213,671,526
1931                                   449,407,831     1,234,233,046
                                    ________________________________
Subtotal - Depression years          1,642,538,229     2,547,904,572
                                    ================================
Grand total                         26,109,716,142    14,081,852,841
!EN
     In view of the above figures, the following observations may be
made:

     First. During the high-tax period, 1917 to 1923 inclusive,
losses exceeded gains by approximately 3 billion dollars.

     Second. During the prosperous and low-tax years, 1924 to 1929
inclusive, gains exceeded losses by approximately 16 billion
dollars.

     Third. During the depression years, 1930 and 1931, losses
exceeded gains by approximately 1 billion dollars.

     It seems perfectly fair to conclude, therefore, that our system
of treating gains and losses for tax purposes results in an unstable
revenue; it greatly reduces our revenue in war years and years of
depression, and greatly increases our revenue in prosperous years.
This result is unfortunate, for our revenue is reduced during those
periods when we are most in need of revenue and increased when
additional revenue is not required.

     It is true that in the Revenue Act of 1932 and in the National
Industrial Recovery Act certain changes were made in our law for the
purpose of reducing the effect of losses on ordinary income subject
to tax. Unfortunately, no data are yet available as to the effect of
these measures.

     The history of our taxation of gains and losses from the sale
of assets of a capital nature (not including stock in trade) is,
briefly, as follows:

     Under the Revenue Act of 1913, all gains from the sale of such
assets were subject to income tax. Losses from such sales were not
allowed.

     Under the Revenue Acts of 1916 and 1917, gains from such sales
were subject to income tax. Losses from such sales were allowed only
to the extent of the gains arising from such sales.

     Under the Revenue Act of 1918, gains from such sales were
subject to income tax and losses were allowed in full against income
of any kind.

     Under the Revenue Act of 1921 (as applicable to 1922 and 1923),
a new treatment of these gains was devised. Gains from the sales of
real estate, stocks, bonds, etc. were divided into two groups, the
first consisting of those where the asset had been held for more
than 2 years, and the second where the asset had been held for 2
years or less. The first group was called "capital assets" and the
gains arising therefrom "capital gains." It was provided that the
taxpayer would not be required to pay on these "capital gains" a tax
of more than 12-1/2 percent. This was a considerable relied from
taxation, for in these years the surtax rates reached 50 percent. In
the case of the second group, gains and losses arising in
transactions of 2-years or less, the treatment was as in the 1918
act, was an in the 1918 act, that is, gains were taxed is full and
losses allowed to full. A "capital net loss" was also allowed in
full in spite of the fact that a capital net gain was not taxed at a
rate of more than 12-1/2 percent.

     Under the Revenue Acts of 1924, 1926, and 1928, the system
remained the same, except that the inconsistency in regard to the
treatment of "capital net losses" was cured. These acts provide that
in the case of such losses (arising in transactions covering more
than two years) the reduction in tax must not exceed 12-1/2 percent
of the amount of the capital net loss.

     The Revenue Act of 1932 was enacted during a period of
depression when the need for revenue was acute. It was known that
the revenue from the income tax had greatly declined and a part of
this decline was correctly ascribed to the wiping out of ordinary
income by the deduction therefrom of both classes of losses
previously described. The Congress therefore provided that the
losses from sales of stocks and bonds held two years or less could
only be taken to the extent of the gains from similar sales. This
prevented the reduction of ordinary net income from other sources by
these losses. However, it was provided that losses disallowed in one
year (to an amount not in excess of the net income) could be carried
over and applied against short-term gains in the subsequent year. As
far as "capital gains and losses" were concerned, these were treated
in the 1932 act exactly as in the preceding acts of 1924, 1926, and
1928.

     The National Industrial Recovery Act merely took away the right
of carrying over disallowed short-term losses to the subsequent
year.

     A careful study of the effect of the Revenue Acts of 1913 to
1928, inclusive has been made. The data are not yet available for an
accurate study of the effect of the Revenue Act of 1962. From a
study of the acts prior to 1932, the conclusion has been definitely
arrived at that normal business transactions in respect to the sales
of real estate, stocks, bonds, etc., will not occur under high
surtaxes and that it is to the advantage of the Government from a
revenue standpoint to give some relief on long-term gains. It has
not been proven, of course, that our present system is the best
obtainable.

     The main questions are now confronted. Should we retain our
present system? Should we modify it? Should we adopt the English
system?

     First, what are the defects of our present system? These
defects seem to be as follows:

     (1) It produces an unstable revenue -- large receipts in
prosperous years, low receipts in war and depression years.

     (2) In many instances, our tax reaches the mere increase in
monetary value resulting from the depreciation of the dollar instead
of reaching a real increase in value.

     (3) Taxpayers take their losses within the 2-year period and
get full benefit therefrom, and delay taking gains until the 2-year
period has expired thereby reducing their taxes.

     (4) The relief afforded in the case of long-term gains (capital
gains) is inequitable. It only gives relief to taxpayers with net
income of over $16,000.

     (5) Our system is unfair in that it taxes short-term gains in
full but does not allow short-term losses except to the extent of
such gain.

     (6) In some instances, normal business transactions are still
prevented on account of the tax.

     On the other hand, what would be the probable defects of the
English system if applied in this country under conditions as they
exist here and in respect to the other provisions of our income tax
law? These probable defects appears to be as follows:

     (1) A somewhat less revenue over a long period of years.

     (2) Opportunity for tax evasion through the conversion of
income into gains from the sale of assets.

     (3) Escape from taxation of mere speculative stock market gains
which are perhaps more able to bear tax than almost any other type
of income.

     (4) Accumulation of wealth would be somewhat easier.

     (5) The present moment is not an advantageous time, for the
Government, in which to make the change to the British system, if we
are at the bottom of price levels.

     If we balance these defects of our own system and the probable
defects in the British system if applied in this country, there
appears to be little choice. It is true, however, that both of these
systems might be perfected. Therefore, this office is proposing for
consideration a plan which takes a middle ground between the two
systems and, it is hoped, eliminates in part some of the defects of
both. This plan is as follows:

     (1) Put all gains and losses from the sale of the property of
the taxpayer (whether or not connected with his trade or business,
but not including stock in trade, or property properly included in
inventory, or held primarily for sale to the customers of the
taxpayer in his trade or business), into one group.

     (2) Compute the "capital net gain", if any, from this group of
transactions by computing the excess of the sum of the "capital
gains" over the sum of the "capital losses", after multiplying each
"capital gain" or "capital loss" by --
!NR
          100 percent if the capital asset has been held for not
     more than 1 year;

          80 percent if the capital asset has been held for more
     than 1 year but not more than 2 years;

          60 percent if the capital asset has been held for more
     than 2 years but not more than 3 years;

          40 percent if the capital asset has been held for more
     than 3 years but not more than 5 years;

          20 percent if the capital asset has been held for more
     than 5 years.
!EN
     (3) Include in gross income subject to tax the "capital net
gain", if any, as computed in (2) above. If there is a "capital net
loss", it is not to be deducted from gross income.

     How this plan will minimize the defects of our present system
may be indicated as follows:

     (1) The first defect in our present system, already noted, was
instability of revenue. The proposed plan will give somewhat less
receipts in prosperous years, but substantially greater receipts in
depression years. Thus, greater stability will be obtained.

     (2) The second defect was the tax on the mere increase in
monetary value resulting from the depreciation of the dollar. This
defect while not removed will be minimized by the lower tax.

     (3) The third defect was the opportunity afforded by our
present system for taxpayers to realize their losses within the
2-year period and their gains outside the 2-year limit. This will be
largely eliminated by the graduated scale extending over a longer
period of years.

     (4) The present system is defective in that it is inequitable,
giving no relief to the small taxpayers and very large relief to the
wealthy taxpayers. This defect is completely cured in the proposed
system, all taxpayers being given equal treatment.

     (5) The proposed system is somewhat more fair than the present
system. All short or long term losses can be charged off against
short or long term gains. At present a short term loss can not be
charged off against a long term gain.

     (6) Normal business transactions should be somewhat encouraged
rather than discouraged by the proposed plan.

     The defects that would probably be found in the British system
if applied to our country seem also to be largely avoided by the
proposed plan, as follows:

     (1) The revenue would be greater in good years and not less in
bad years under our proposed plan than it would be under the British
system.

     (2) Opportunity for tax evasion feared under the British plan
is reduced to a minimum.

     (3) Mere speculative profits (less than 1 year transactions)
would be subjected to tax in full.

     (4) Accumulation of wealth would be retarded more under the
proposed plan than under the British plan.

     (5) The present year is not an unfavorable time in which to put
the proposed system in effect, as many losses have not yet been
realized.

     In conclusion, then, what are the main advantages that can be
secured from the method proposed? It would seem, first, that greater
stability would be secured; second, that all taxpayers would be
treated alike; third, that normal business transactions would not be
discouraged; and, fourth, that no substantial loss in revenue even
over a long period of years would be incurred. Finally, the proposed
method is based on the following principle:

     "The tax on the capital gain should approximate the tax which
would have been paid if the gain had been realized in equal annual
amounts over the period for which the asset was held."

     In view of our graduated rate structure, it is believed this
principle is sound. To tax in 1 year at high surtax rates the entire
capital gain which has accrued over a long period of years seems
obviously unfair.

     The method here proposed is designed especially for
individuals. However, it is recommended that consideration be given
to applying the same method to corporations in case tax-free
reorganizations are eliminated. Such a plan would permit corporate
reorganizations with the payment of a tax considerably reduced below
the standard rate. A moderate tax now is, perhaps, better than a
higher tax "x" years from now.
!NR
                                   Respectfully submitted.

                                   L. H. PARKER,
                                   Chief of Staff
!EN
                              EXHIBIT D

             MEMORANDUM ON EXCHANGES AND REORGANIZATIONS

     Under the Revenue Acts of 1913, 1916, and 1917, Congress taxed
all gains from transactions involving exchanges or reorganizations
in the year in which such gains were realized. The Supreme Court in
a number of cases arising under those acts held that gain was
realized in fact in the year in which the exchange or reorganization
took place. This was true, although the taxpayer did not receive
actual cash but stock or securities, which the court regarded as the
equivalent of cash. However, serious opposition to taxing gains of
this character developed. It was claimed that such gains were mere
"paper profits", i.e., the taxpayer had realized nothing tangible
and to tax them seriously interefered with normal business
adjustments.

     The Revenue Act of 1918 continued the policy adopted in the
prior income tax laws of taxing gains when realized, with the one
exception of an exchange of stock for stock (in connection with the
reorganization, merger, or consolidation of a corporation) when the
stock or securities received had no greater aggregate per or face
value than the stock exchanged. The history of the act discloses
that the House defeated a Senate amendment designed to extend this
privilege to other types of transactions.

     The first serious change in this policy occurred in the Revenue
Act of 1921. That act exempted from immediate tax exchanges of
investment and business property for property of like kind and
exchanges of stock or securities in connection with corporate
reorganizations. It was soon found that these provisions left the
door wide open for various devices to avoid tax. Most important of
these devices was one whereby property could be transferred to a
corporation and its cost to the corporation determined by the fair
market value of the property at the time of the transfer. The
corporation would then use such enhanced value in computing its gain
from a subsequent sale. Moreover, the exchange provisions permitted
a tax-free exchange of stock or securities not connected with a
reorganization. Many brokers, investment houses, and bond houses
established exchange departments and advertised to their customers
that they could exchange securities in such a manner as to result in
no taxable gain. The situation became so serious that Congress in
1923 was forced to pass a special act removing the exemption in the
case of stock or securities exchanged otherwise than through a
corporate reorganization.

     The Revenue Act of 1924 is the nucleus about which the present
provisions were built. While the later acts have made certain
changes in these provisions, such changes were designed to plug up
some of the more obvious loopholes without attempting to make any
change in principle. All of the reorganizations which the Supreme
Court held to result in taxable income under the Revenue Act of 1917
and prior acts are now made tax free under the present law.

     The exchange and reorganization provisions of the present law
will now be briefly discussed. Under section 112 of the Revenue Act
of 1982, gain or loss is recognized upon the sale or exchange of
property with certain specified exceptions. These exceptions provide
that no gain or loss shall be realised in the following ??:

     (1) If investment property or property used in a trade or
business is exchanged for property of a like kind. This rule does
not apply to stock in trade, property held primarily for sale, or
stocks or bonds.

     (2) If common stock in a corporation is exchanged solely for
common stock in the same corporation;

     (3) If preferred stock in a corporation is exchanged solely for
preferred stock in the same corporation;

     (4) If stock or securities are exchanged solely for other stock
or securities in a corporate reorganization;

     (5) If property is exchanged by a corporation for stock or
securities in another corporation pursuant to a corporate
reorganization;

     (6) If property is transferred to a corporation by one or more
persons and immediately after the transfer such person or persons
are in control of the corporation.

     Furthermore, if stock or securities are distributed to a
shareholder upon reorganization of a corporation without surrender
of his stock or securities, on gain is recognized in the shareholder
from such receipt. Moreover, if in any of the share transactions the
taxpayer receives money or other property in addition to the
property specified and there is in fact a gain from the exchange of
reorganization such gain is recognized at that time in the extent of
the other property or money received. However, this last rule does
not apply to a corporation if the corporation distributes such money
or other property to its stockholders.

     In support of the theory that the above provisions do not result
in tax exemption but merely in tax postponement, the law contains
other provisions designed to prevent the taxpayer from stepping up
his original cost when he sells the property received in exchange for
the old property. The general theory is that the property received in
exchange takes the place of the old property. In the case of property
transferred to a corporation, the law also requires the corporation
to use as its basis the cost of the property to the transferor. If
after the transfer such transferor controls a majority interest in
the corporation.

     The underlying principle behind all of the exchange and
reorganization provisions of the present law is that they do not
result in tax exemption, but that the tax is postponed until a gain
is realized from a pure sale or what amounts to a pure sale. The
reasons assigned for such a policy are --

     (1) That such provisions prevent much of the uncertainty and
litigation which was involved in the prior income-tax laws;

     (2) Normal business adjustments will not be interfered with if
so-called "paper profits" are exempted;

     (3) The revenues of the Government will be increased by
preventing taxpayers from taking colorable losses.

     The Bureau has now had an experience of more than a decade in
the administration of these provisions. This experience shows that
the abuses under the present policy far outweigh the advantages. In
the first place, the provisions of the present law are very
involved, difficult to understand, and particularly hard to
interpret in the light of actual cases as they arise. The
interpretation placed upon these provisions by the Treasury has been
overturned by the courts in many cases, so that at present there is
a great deal of confession and uncertainty.

     In the second place, the administrative problems in
ascertaining the value of property made necessary under the prior
acts have not been greatly reduced by the provisions of the law, for
where money or other property is received in addition to stock or
securities, it is necessary to value the stock or securities in
order to determine whether an actual gain has been realized. In many
corporate reorganizations, while cash is not involved, the acquiring
corporation generally assumes some of the indebtedness of the old
corporation, which indebtedness is regarded as the equivalent of
cash.

     The second reason assigned for the change in policy appears to
have been based upon the complaint that taxing the gain when
realized seriously interfered with normal business readjustments.
The very high tax rates of the 1917 and 1915 acts, it was claimed,
impaired upon the taxpayer the burden of having available
substantial cash at a time when the transaction resulted in a more
"paper profit". While this claim undoubtedly has some merit, it is
believed that the present that the present provisions have been
utilized for other purposes of an indefensible character. Many
reorganizations have been undertaken for the purpose of avoiding,
taxes. Furthermore, the present provisions have encouraged the
injection into business structure of an uneavery, such as the
organization of large holding companies and the overcapitalization
of business.

     The third reason assigned was that these provisions would
prevent the taking of heavy losses, thereby resulting in an increase
in the revenues of the Government. While these provisions may have
rendered it more difficult for taxpayers to take losses, it by no
means closed the door. The taxpayer upon "legal advice" prior to the
arrangement of the terms of the transaction may still take
substantial losses in most instances without actual interferences
with his original plan and purpose.

     The statute provides that upon the sale or exchange of property
the entire amount of gain or loss shall be recognized, with certain
exceptions. The exceptions are the exchange and reorganization
provisions already referred to. If a taxpayer desires to take a
loss, it is easy to arrange a transaction falling without the
exceptions. On the other hand, if it is desired to pay no tax on the
gain, the transaction can be so arranged as to come within the
exceptions. In addition, losses from the sale or exchange of stocks
and bonds are limited, to a large extent, to the gains from such
sales or exchanges, so in many cases a stock or bond loss even if
recognized could not be utilized by the taxpayer.

     Instead of increasing the Government revenues, these provisions
appear to result in a considerable loss of revenue. The theory of
postponing the gain by shifting the original cost basis of the
transferor over to the transferee or by requiring the transferor to
keep his original cost basis for the property he receives in
exchange does not compensate the Government for exempting the prior
transaction from tax. This is due to the fact that in the year which
the taxpayer chooses to realize the gain he may have heavy losses,
or the tax rates may be different. Death and other elements may also
enter in to create a new cost basis for the property.

     One of the main objections to the reorganization provisions in
that the recognition of gain depends more upon the form of the
transaction than upon the essential facts, undue importance being
given to "expert advice." Therefore, in practice, the sections
sometimes result in double taxes and sometimes in complete tax
exemption. In many cases the shifting of the cost basis of property
over to a transferee corporation frequently causes the tax burden to
fall upon the backs of new stockholders, who have paid full market
value for their stock.

     The following examples show how the provisions of the present
law are availed of to avoid taxes justly due the Government:

                             CASE NO. 1

     A owns a piece of undeveloped real property which cost him
$100,000, but from which he is receiving no income. This property is
now worth $600,000. He exchanges it for improved business property
worth $600,000. Under the exchange provisions of existing law. A
realizes no gain from this exchange. Under the Revenue Act of 1913
and prior acts, he would have been taxable on a gain of $500,000. It
is claimed that under existing law, A, by being required to retain
his original cost of $100,000 for the improved property, does not
escape tax on the $300,000 gain but that payment of such tax is
postpone until such time as A sells the improved city property.
However, this is not true. There are many ways in which A, under
existing law, may escape the payment of any tax whatever on this
gain or may materially reduce the amount of such tax. The following
are some of the methods by which A may secure complete or partial
tax avoidance with respect to this gain:

     (1) He may elect to realize a gain in a year in which it is
convenient to take substantial losses from other transactions,
thereby materially reducing his tax or escaping tax altogether.

     (2) If A had been taxed on the gain at the time of the
exchange, he would have been subject to the full surtax rate if the
undeveloped real property was acquired within 2 years prior to the
exchange. By the exchange provisions, he is enabled to convert such
ordinary gain into a capital gain by holding the improved property
for a period of 2 years compared from the time he acquired the
unimproved property.

     (3) If A dies before mail he improved property, its cost banks
is changed from the $300,000 cost of the original property to the
value of such improved property at the time of his death. Thus, if
the value of the improved property at the time of his death is worth
$600,000, and the execution or beneficiaries of A's estate sold the
property, the Government would collect no income tax whatever on the
transaction. Moreover, if the value at the date of death was
$800,000 and the executor or beneficiaries sold the property for
$800,000, there would be a deductible loss of $200,000.

     (4) From a practical standpoint, the exchange and
reorganization provisions lead to tax avoidance, due to the
difficulty of the persons administering the law in tracing the
property through a series of exchanges and reorganizations.

                             CASE NO. 2

     A owns a piece of undeveloped real property which cost him
$100,000, but from which he is receiving no income. This property is
now worth $800,000. He exchanges it for improved business property
worth $400,000 and cash amounting to $200,000. The total gain
realized by A from this transaction is $500,000. Under the exchange
provisions of the present law he would only be taxed upon an
immediate gain of $300,000. The theory is that the balance of the
gain, namely, $300,000, is postponed until A sells the improved
business property. However, for the same reasons set out in case no.
1, A may never pay any tax on this $300,000, or may materially
reduce the amount of this tax.

                             CASE NO. 1

     Corporation A has a capital of $1,000,000 and $100,000 surplus.
It desires to distribute this surplus to its stockholders without
subjecting the stockholders to any income tax on this distribution.
It organizes corporation B, to which it transfers this $100,000
surplus is exchange for all of the stock of corporation B. This is a
reorganization under the present law. Corporation A can then
distribute the stock of corporation B to its stockholders and the
stockholders will and be subject to any tax upon the receipt of B's
stock (because this is a distribution of stock acquired under a plan
of reorganization and is exempt from tax by section 112(g) of the
Revenue Act of 1932).

     Under the Revenue Act of 1918 and prior acts the distribution
of the stock of B to A's stockholders would constitute a dividend to
them and they would pay a tax accordingly.

                             CASE NO. 4

     Corporation A owns all the stock of corporation B. Corporation
B has surplus of $1,000,000, and included among its assets are
distillers' warehouse requests, which cost it $100,000, but which are
now worth $500,000. It is desired to sell these warehouse receipts
without the payment of any tax. This can to case is the following
manner:

     Corporation B distributes the warehouse receipts to corporation
A by declaring a dividend in kind. This being a dividend from one
corporation to another corporation A pays no tax upon its receipt.
The cost basis for these warehouse process in A's hands is now
$500,000. A sells the warehouse receipts for $200,000 its cost
basis) and, therefore, pays no tax on the sale.

                             CASE NO. 5

     A. as individual owns certain real estate which cost him
$100,000 but is now worth $2,000,000. A desires to sell this
property but wishes to pay no tax on $100,000. Can A got this
$1,000,000 without paying a tax? Yes: this can be accomplished
through the reorganization section of the present revenue act.

     A organizes corporation X and transfers the property to
corporation X for all of its capital stock. There is no profit in
this transfer because it is a transfer where the transferor is in
control of the corporation after the transfer (sec. 112(b)(5)).
After corporation X has earned a surplus in excess of $1,000,000, A
organizes corporation Y and transfers to it all the stock he owns, a
corporation X for its capital stock. (No gain on this
transaction -- sec. 122(b)(4).)

     Corporation X now transfers the property to corporation Y as a
dividend in kind. No tax on this transaction. (Corporation does not
pay a tax on a dividend received.) The property is now in the hands
of corporation Y and the basis in the same as in the hands of the
transferor corporation (corporation X), namely, $1,000,000.
Corporation Y now sells the property for $1,000,000 cash; and
realtime no gain because of its basis.

     A being in control of corporation Y, can now control the
disposition of this money, i.e., he can invest it, or borrow it,
thus obtaining the use of the $200,000 gain without paying a tax.

                             CASE NO. 6

     Corporation X has a capital of $1,000,000 (10,000 shares, par
value $106) and a surplus of $800,000. It desires to distribute this
surplus to its stockholders without subjecting it to any tax. To
accomplish this, corporation Y is organized and corporation X
transfers the surplus of $500,000 to corporation Y in exchange for
all of Y corporation's stock. This is a tax-free reorganization
under the present law and no gain is recognized to corporation X or
Y from this exchange (sec. 112(b)(4)(i)(1)(B), Revenue Act of
1963). Corporation X then distributes Y corporation's stock to its
stockholders without the surrender of their stock, each stockholder
receiving the same number of shares of stock in corporation X which
he has in corporation X. X corporation's stockholders are not taxed
upon the receipt of Y stock (sec. 112(g), Revenue Act of 1968). X
corporation's stockholders then liquidate corporation Y. By this
method they acquire the $500,000 surplus. A is the owner of 1,000
shares of corporation X for which he paid par ($100 per share, or)
$100,000. As a result of the reorganization, he receives 1,000
shares of corporation Y. The basis of Y's stock is $50 a share, or
$50,000. Since a liquidating dividend is treated as a sale of the
stock. A is only required to pay a tax on the excess of the
liquidating dividend over his basis for Y's stock. Since the
liquidating dividend does not exceed his basis for Y stock, he pays
no tax whatever.

                             CASE NO. 7

     A owns all the capital stock in corporation no. 1. Corporation
no. 1 owns 1,000 shares of corporation no. 2. A desires to obtain
these shares of corporation no. 2, so he can sell them, thereby
obtaining money, but he does not want them declared to him as a
dividend by corporation no. 1, as such dividend would be subject to
surtax, but he is willing to pay a tax computed under the capital
gain provision of the revenue act. Can he do this? Yes, it can be
accomplished by means of the reorganization provision of the revenue
act.

     Corporation no. 3 is organized. Corporation no. 1 transfers to
corporation no. 3 the 1,000 shares of corporation no. 2, in
consideration of which corporation no. 3 transfers all of its
capital stock to A. Corporation no. 3 then liquidates and
distributes its assets to A. A then sells the 1,000 shares of stock
of corporation no. 2.

     The Board of Tax Appeals held in Gregory v. Commissioner (P.H.
1933, per, 386) that the liquidation of corporation no. 3, whereby A
received the stock of corporation no. 2, resulted in a capital gain,
the difference of the basis attributable to corporation no. 3 stock
and the value of corporation no. 2 stock no received. The subsequent
sale of corporation no. 2 stock for no more than the value at the
time of the liquidation resulted in no further gain.

                             CASE NO. 8

     Corporation no. 1 owns a minority interest in corporations no.
3 and no. 4. Corporation no. 2 likewise owns a minority interest in
corporations no. 3 and no. 4. Corporation no. 1 desires to get
control of corporations no. 3 and no. 4. Corporation no. 2 is
willing to sell its interest in corporations no. 3 and no. 4, but
does not want to pay a tax on any gain it might derive from a sale
of its holding in corporations no. 3 and no. 4. Can this be done?
Yes, it can be accomplished by means of the reorganization provision
of the revenue act.

     Corporation no. 2 forms corporation no. 5, and transfers its
holdings in corporations no. 3 and no. 4 to it is exchange of the
capital stock of corporation no. 5. Corporation no. 3 then transfers
its holding of corporation no. 5's stock in corporation no. 1. In a
few days corporations no. 1 and no. 5 are merged and no. 1 becomes
the owner of the stock of no. 3 and no. 4 which was formerly owned
by no. 2.

     In view of the matter already presented, the following
suggestions are made:

     (1) To abolish the exchange and reorganization provisions of
the present law.

     (2) To eliminate all of the exchange and reorganization
provisions of the present law, except those permitting an individual
to incorporate his business without being subject to tax.

     (3) To require gain to be realized and the tax determined at
the time of the exchange or reorganization under plan (1) or plan
(2), but not to enforce payment of the tax for a period (A) within 2
years from the date the tax is due, or (B) within 6 months after the
property is received is sold, whichever date is the earlier. Under
this plan, the Government should be protected by the giving of the
proper bond and the suspension of the statute of limitations during
this period. In any case where cash is received at the time of the
exchange it is believed that the tax should be paid immediately up
to the extent of the cash received.

     Under all of the above plans, provision should be made for
continuing the basis provisions of existing law with respect to
property acquired pursuant to an exchange or reorganization
consummated prior to the enactment of the proposed act. This will
prevent a taxpayer who has acquired property in a tax-free exchange
or reorganization from avoiding tax by getting a stepped-up basis.

     This memorandum has been prepared by Mr. Colin F. Stam,
counsel, and Mr. G. D. Chestren, corporation auditor, of the staff
of the Joint Committees on internal Revenue Taxation. It meets with
the approval of the undersigned.
!NR
                                   Respectfully submitted.

                                   I. H. PARKER, Chief of Staff.