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DOOD

(3) As the Internal Revenue Service has worked with the present income averaging provisions, it has become apparent that the administrative limitation of 1333 percent may be relaxed to do more equity for those cases where income averaging is appropriate.

Arguments Against.-(1) Income should be accounted annually. This provision enlarges the present opportunity for taxpayers to avoid full taxation.

(2) The items excluded from averaging were excluded for good reason. Capital gains already is given favorable treatment because only 50 percent of the gains is taxed. Income from wagering should not be eligible for averaging because the receipt of such income should not be encouraged. Income from gifts should not be eligible for averaging since it does not result from any effort on the part of the. taxpayer.

(3) The 1331% percent requirement should not be reduced to 120 percent since this will allow averaging for unreasonably small increases in income.

(4) Liberalization of income averaging rules for persons who experience a substantial increase in their earnings should be deferred until income averaging rules are devised which will give relief to persons who experience a sharp decline in their earnings.

J. RESTRICTED STOCK PLANS

Present law. Present law does not contain any specific rules governing the tax treatment of restricted stock plans. Existing Treasury regulations generally provide that no tax is imposed when the employee receives the restricted stock. Tax is deferred until the time the restrictions lapse; at that time, only the value of the stock, determined at the time of transfer to the employee, is treated as compensation, provided the stock has increased in value. If the stock has decreased in value, then the lower amount at the time the restrictions lapse is considered to be compensation. Thus, under present regulations there is a deferral of tax with respect to this type of compensation and any increase in the value in the stock between the time it is granted and the time when the restrictions lapse is not treated as compensation.

Problem. The present tax treatment of restricted stock plans is significantly more generous than the treatment specifically provided in the law for similar types of deferred compensation arrangements. An example of this disparity can be seen by comparing the situation where stock is placed in an employee's trust as opposed to the giving of restricted stock directly to the employee. In the employee trust De situation, if an employer transfers stock to a trust for an employee and the trust provides that the employee will receive the stock at the gend of 5 years if he is alive at that time, the employee would be treated fras receiving, and would be taxed on, compensation in the amount of the value of the stock at the time of the transfer. However, if the employer, instead of contributing the stock to the trust, gives the stock directly to the employee subject to the restriction that it cannot be sold for 5 years, then the

the 5-year period. In t sesses the stock, and 1

re's tax is deferred until the end of tion, the employee actually pos1 receive the dividends, yet his

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(3) This provision helps correct the unfair discrimination in present law which favors those taxpayers who derive their income from the ownership of property as contrasted with those who earn their living from wages and salaries.

(4) The provision recognizes the desirability of a tax system in which no individual can avoid his fair share of the tax burden.

(5) The present tax improperly encourages investment of funds in certain areas for tax considerations rather than good business reasons and violates the principle that taxes should have a neutral impact on economic decisions.

Arguments Against.-(1) The primary intent of the provision is to tax tax-preferred income rather than disallowing deductions, It would be better to consider the various tax-preference items individually and to take whatever corrective action is necessary directly on those items.

(2) Enactment of a system which allocates deductions on the basis of the relation between taxable and tax-preferred items of income complicates the tax laws and adds considerable administrative difficulties to the existing system.

(3) The bill raises a constitutional question as to the power of Congress to tax (even indirectly) income from State and local government obligations.

(4) Since most of the so-called "preferences" in today's law involves conscious decisions by Congress to encourage specific types of investments, those provisions should not now be heedlessly diluted under the guise of tax reform.

I. INCOME AVERAGING

Present law. Under present law, income averaging permits a taxpayer to mitigate the effect of progressive tax rates on sharp increases in income. His taxable income in excess of 1333 percent of his average taxable income for the prior 4 years generally can be averaged and taxed at lower bracket rates than would otherwise apply. Certain types of income such as long-term capital gains, wagering income, and income from gifts are not eligible for averaging.

Problem.-The exclusion of certain types of income from income eligible for averaging complicates the tax return and makes in difficult for taxpayers to determine easily whether or not they would benefit from averaging. In addition, taxpayers with fluctuating income from these sources may pay higher taxes than taxpayers with constant income from the same sources or fluctuating income from different sources. Finally, the 133 percent requirement denies the benefit of averaging to taxpayers with a substantial increase in income and reduces the benefits of averaging for those who are eligible.

House solution.-The House bill extends income averaging to longterm capital gains, income from wagering, and income from gifts. It also lowers the percentage by which an individual's income must increase for averaging to be available from 333 percent to 20 percent. Arguments For.-(1) Permitting averaging for presently excluded income will result in simplification of the tax form and the averaging computation.

(2) In the case of capital gains, it is maintained that the 50 percent exclusion does not provide a form of averaging because it does not distinguish between taxpayers with fluctuating capital gains and those with constant capital gains, and therefore averaging for capital gains

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(3) As the Internal Revenue Service has worked with the present income averaging provisions, it has become apparent that the administrative limitation of 1333 percent may be relaxed to do more equity for those cases where income averaging is appropriate.

Arguments Against.-(1) Income should be accounted annually. This provision enlarges the present opportunity for taxpayers to avoid full taxation.

(2) The items excluded from averaging were excluded for good reason. Capital gains already is given favorable treatment because only 50 percent of the gains is taxed. Income from wagering should not be eligible for averaging because the receipt of such income should not be encouraged. Income from gifts should not be eligible for averaging since it does not result from any effort on the part of the. taxpayer.

(3) The 1333 percent requirement should not be reduced to 120 percent since this will allow averaging for unreasonably small increases in income.

(4) Liberalization of income averaging rules for persons who experience a substantial increase in their earnings should be deferred until income averaging rules are devised which will give relief to persons who experience a sharp decline in their earnings.

J. RESTRICTED STOCK PLANS

Present law.-Present law does not contain any specific rules governing the tax treatment of restricted stock plans. Existing Treasury regulations generally provide that no tax is imposed when the employee receives the restricted stock. Tax is deferred until the time the restrictions lapse; at that time, only the value of the stock, determined at the time of transfer to the employee, is treated as compensation, provided the stock has increased in value. If the stock has decreased in value, then the lower amount at the time the restrictions lapse is considered to be compensation. Thus, under present regulations there is a deferral of tax with respect to this type of compensation and any increase in the value in the stock between the time it is granted and the time when the restrictions lapse is not treated as compensation.

Problem. The present tax treatment of restricted stock plans is significantly more generous than the treatment specifically provided in the law for similar types of deferred compensation arrangements. An example of this disparity can be seen by comparing the situation where stock is placed in an employee's trust as opposed to the giving of restricted stock directly to the employee. In the employee trust situation, if an employer transfers stock to a trust for an employee and the trust provides that the employee will receive the stock at the end of 5 years if he is alive at that time, the employee would be treated as receiving, and would be taxed on, compensation in the amount of the value of the stock at the time of the transfer. However, if the employer, instead of contributing the stock to the trust, gives the stock directly to the employee subject to the restriction that it cannot be sold for 5 years, then the employee's tax is deferred until the end of the 5-year period. In the latter situation, the employee actually possesses the stock, and he can vote it and receive the dividends, yet his

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tax is deferred. In the trust situation, he has none of these benefits, yet he is taxed at the time the stock is transferred to the trust.

House solution.-The House bill provides that a person who receives compensation in the form of property, such as stock, which is subject to a restriction generally is subject to tax on the value of the property at the time of receipt unless his interest is subject to a substantial risk of forfeiture. In this case, he is to be taxed when the risk of forfeiture is removed. The restrictions on the property are not taken into account in determining its value except in the case where the restriction by its terms will never lapse. Generally, this provision applies to property transferred after June 30, 1969.

Arguments For.-(1) The House bill provision is supported on the grounds that it eliminates the disparity of tax treatment between various forms of deferred compensation by bringing restricted stock plans within the rules that Congress set forth as being the appropriate means by which an employee could be given a shareholder's interest in the business.

(2) Restricted stock plans are essentially compensation to an execu tive for services rendered. They represent incentives to key employees, and in many cases represent a significant portion of a taxpayer's total compensation.

(3) The provision is needed to close a loophole through which highly compensated employees are paid part of their compensation under circumstances whereby tax can be put off until the employee is in a lower tax bracket.

(4) The stock option rules provide sufficient opportunity for employees to receive an interest in their employers' business, yet, these rules are undermined by the less stringent requirements of restricted stock plans.

Arguments Against.-(1) The tightening of the rules on restricted stock plans may discourage employees' stock ownership of their employers' business.

(2) The bill would immediately tax the receipt of property which, in many instances, cannot be sold or otherwise disposed of by the taxpayer to pay the tax.

(3) The bill, in the case of forfeitable stock would tax capital appreciation of the property as ordinary income.

(4) Restricted stock plans are not, in fact, deferred compensation arrangements, but rather are a means of allowing key employees to become shareholders in the business.

(5) It is necessary to have these preferred stock plans so as to obtain and retain key employees.

(6) These tax incentives increase the economic productivity of business; hence, the benefits to everyone concerned are increased. (7) Little revenue appears to be involved; hence, there is no real benefit accruing from making a change.

K. OTHER DEFERRED COMPENSATION

Present law and problem.-Under present law, the Internal Revenue Service has allowed substantial tax benefits to be obtained with respect to certain types of deferred compensation arrangements for key employees. These arrangements are not required to meet the qualifica

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tions prescribed in the tax law for qualified pension and profit-sharing plans, and they are often available only to highly paid employees. Generally, under these arrangements, employees are permitted to defer the receipt (and taxation) of part of their current compensation until retirement, when they presumably will be in lower income tax brackets.

The following example is typical of these arrangements: The employer and the employee enter into a 5-year employment contract which provides for a specified amount of current compensation and an additional specified amount of nonforfeitable deferred compensation. The deferred compensation is credited to a reserve account on the company books. It is accumulated and paid in equal annual installments in the first 10 years after the employee's retirement.

Deferral is available only with respect to unfunded arrangements. In the case of funded arrangements (that is, where the employee has an interest in property), the employee is taxed currently on the contribution (provided his rights are nonforfeitable) even though he cannot immediately receive it. There is no tax deferral, and the tax imposed on the additional compensation is determined by reference to the employee's current tax bracket.

House solution.-The bill provides that the tax on deferred compensation is to continue to be deferred until the time the compensation is received, but that a minimum tax is to be imposed on deferred compensation received in any year in excess of $10,000. Generally, this minimum tax is the total increase in tax which would have resulted if the deferred compensation had been included in the taxpayer's income in the years in which it was earned. This provision does not apply to any nondiscriminatory pension or profit-sharing plan (whether funded or unfunded). Generally, this provision applies only to the portion of deferred compensation payments attributable to years beginning after 1969.

Arguments For.-(1) This provision is supported on the basis that the employee who receives deferred compensation has received, in most cases, a valuable contractual right on which an immediate tax could be imposed, and the bill represents a reasonable compromise between immediate taxation and complete deferral. The payment of the tax is deferred until the compensation is actually received, but the original marginal rate is preserved as a minimum rate.

(2) The tax treatment of deferred compensation should not depend on whether the amount to be deferred is placed in trust or whether it is merely accumulated as a reserve on the books of the employer corporation, because an unfunded promise by a large, financially established corporation is probably as sufficiently sound as the amount of deferred compensation which is placed in trust. Usually these benefits are not available to the average employee-taxpayer.

(3) The possibility of shifting income from high-bracket years to low-bracket years after retirement is generally available only to high-bracket and managerial employees who are in a financial position to demand them-not to the average employee.

(4) Another provision of this bill reduces maximum tax on earned income to 50 percent. With this lower rate, the incentive to seek deferral is lessened and the special tax treatment of deferred compensation can be ended without harsh consequences.