where he possesses a power to borrow without collateral and reasonable interest, or retains a power to substitute assets without regard to fair market value, or retains a power to change beneficiaries or amounts of beneficial interest. The grantor should not be taxed where he retains in a fiduciary capacity a power to vote stock or to direct or veto the purchase, sale, or exchange of assets, because in none of the latter cases may the beneficiaries of the trust be deprived of the real and direct economic benefits on which the income tax is measured. It is recommended that no attempt be made to define by relationship persons having certain powers who are sufficiently subservient to the grantor to give him in effect the power involved. Such subservience should be established by the facts. If it exists in fact, the grantor should be taxed, but if it does not exist, he should not be taxed merely because he has a certain relationship to the possessor of the power. This statement does not attempt to go into the refinements which are necessary in cases where income is taxable to a person other than the one to whom it would be taxable under the general rules. There should be no arbitrary rules as to the taxation of estates in a manner different from the taxation of trusts if the 65-day and 12-month rules are eliminated. Such different treatment of the taxation of estates would probably create more problems than it would resolve. It is not believed that there is any abuse of the length of the period of administration of estates which cannot be dealt with under existing law. Experience has indicated that the annual income-tax exemption of trusts should be increased from the present amount of $100 to a point where the expense of preparing, filing, processing, and auditing returns will not be incurred by the trustee and the Bureau of Internal Revenue in respect of a relatively inconsequential amount of income and tax. An exemption of $300 would aid in accomplishing this objective and an increase to that amount is accordingly recommended. It does not appear that such increase would be large enough to induce the creation of multiple accumulation trusts. All property includible in the estate-tax return of a decedent should thereafter have an income tax cost basis of its value at the date of death (or 1 year later if optional valuation is elected). Under the present law certain transfers completed at death, such as by survivorship, including estates by the entirety, do not acquire such an income tax cost basis as is generally the case for other assets. There appears to be no reason of substance for this distinction after the decedent's death in such special cases, and in the interest of simplicity and consistency, this change should be made. Estates and trusts acquiring property through mortgage foreclosure should be permitted to retain therefor the adjusted income tax cost basis of the debt immediately prior to foreclosure (plus any expenses incurred in foreclosure and less any amounts collected on the debt) until ultimate sale of the foreclosed property. Many inequities result from the present rules and fairness impels the suggested change. Trustees of retirement trusts, such as those created by pension and profitsharing plans under section 165, are required to file certain information with the Commissioner of Internal Revenue annually with respect to such trusts. In like manner certain information is required to be filed with respect to entities believed to be nontaxable to which section 101 is applicable. However, no statute of limitations applies with respect to such information. It is recommended that the ordinary statute of limitations against the assessment of income taxes with respect to trusts and entities which are exempt under section 165 or section 101 should be applicable beginning with the filing of such information. Trustees should not be indefinitely subject to the possibility that a trust or entity believed to be nontaxable is in fact taxable with consequent penalties. Section 115 (g) (3) relating to amounts distributed by a corporation in redemption of its stock to an estate under certain circumstances is applicable only where the value of the stock exceeds 35 percent of the gross estate. Inequities result from this rule because claims against estates result in widely varying net estates. It is recommended that the limitation based on 35 percent of the gross estate be amended to apply to 35 percent of the gross estate less claims against the estate. It might also be desirable to permit expenses of administering the estate to be similarly deducted. It is also recommended that the period within which redemption may occur be increased by taking into account any suspension of the statute of limitations under section 875. The period under the present law is not long enough to cover cases where litigation or other cause prolongs the final determination of death taxes, which determination is necessary under this section. It is also recommended that a practical means be found to include within this section redemptions where stock in two or more corporations taken together comprise more than 35 percent of the decedent's gross estate less claims against the estate. STATEMENT OF AMERICAN FEDERATION OF LABOR, RE TOPIC 31, INCOME TAX TREATMENT OF ESTATE AND TRUSTS Present sections of the Internal Revenue Code dealing with taxation of income of estates and trusts, should be reexamined with a view to any needed revision. The American Federation of Labor would favor revision in the interest of greater efficiency and equity, but would oppose any amendments that would operate to permit tax avoidance on this type of income through loosening up of provisions governing taxation of income of short-term trusts or permit using the trust device to escape taxation. The Honorable DANIEL ALDEN REED, WABASH COLLEGE, Crawfordsville, Ind., June 23, 1953. House Office Building, Washington, D. C. DEAR CONGRESSMAN REED: I am writing to propose a single sentence amendment to Internal Revenue Code section 166 but first let me identify myself and tell my story: I am president of Wabash College, president of Associated Colleges of Indiana, chairman of the Commission on Colleges and Industry of the Association of American Colleges and director of the Council for Financial Aid To Education. In one way or another I am in communication with the college presidents of most of the small privately financed liberal arts colleges of America. I am writing you on my own behalf and at the request of my college president colleagues. The educational importance of these privately financed institutions can scarcely be overrated. Approximately one-half of the college students of America attend them. The other half attend tax-supported institutions. It is of first importance to the vitality of our educational system that this approximate balance between the tax-supported and the non-tax-supported institutions prevails. The economic situation which faces the majority of our privately financed institutions of higher learning is precarious. Particularly is this true of the smaller ones. It is to this matter and its partial alleviation that I write you. Privately financed colleges receive their revenue from three major sources: Student fees, income from endowment and private benefactions. Approximately 72 percent of current operating income in 1950 came from student fees, 11 percent from endowment income, and 13 percent from private benefactions. Tuition fees have been raised more than 60 percent in the last 10 years by the average privately financed college. In most cases tuition is as high as it can be without pricing the college out of the range of its present student body. Continued income from investments at about the present level can be anticipated. Endowment funds, on the other hand, are not apt to be increased as substantially in the future as in the past. It is to additional gifts for current operations that the average college must look for increased income to offset the strain under which it is operating. The sources of these gifts are varied. All colleges have numerous recurring small gifts from their alumni. Most receive gifts from their boards of trustees and from friends of the college. Many receive gifts from their church affiliation and in recent years there has been a heartening increase in both the number and aggregate total of gifts from corporations. These sources are not drying up. The strain comes from the fact that support from present sources has approximately reached its limit and financial needs continue to rise. Congress, cognizant of this fact, has been cooperative and helpful. The 5 percent deductions allowed on corporation earnings under Internal Revenue Code section 23 (G) has been of great assistance and promises to be even more so in the years ahead. The recent increase from 15 to 20 percent exemption allowance on gifts made by individuals under Internal Revenue Code section 23 (0) is another source of encouragement and help. My suggestion is that Congress go still further. At the present time the income of a trust is taxable to the creator of the trust if he retains any hold on the corpus (Internal Revenue Code, sec. 166). If Congress reversed this rule and permitted the creation of revocable trusts on a tax-free basis to the creator of the trust providing the income is paid to a tax-exempt institution it is my opinion colleges would benefit substantially. Particularly do I think this would be helpful to the smaller privately financed colleges because it is the tradition of these colleges that their patronage often lies with one family or a small number of families. The tax structure of the past few years has eliminated or greatly restricted support from such patronage. A revocable trust with tax-exemption status would reverse this situation. If you and your committee are favorably disposed toward such modification of the revenue law the following simple amendment to Internal Revenue Code section 166 would accomplish the end desired: "Provided, That this section shall not apply to income currently distributable to any corporation, community chest, fund, or foundation enumerated in section 101 (6) and any such income shall be deductible under section 162 (a)." FRANK H. SPARKS. Hon. DANIEL ALDEN REED, ASSOCIATION OF AMERICAN COLLEGES, Chairman, House Ways and Means Committee, House Office Building, Washington 25, D. C. DEAR CONGRESSMAN REED: Speaking for the 700 accredited colleges and universities in the United States which are members of the Association of American Colleges, I respectfully urge your committee to give sympatheic consideration and approval to the recommendations of Dr. Frank H. Sparks, president of Wabash College, as contained in his letter of June 23, 1953, attached hereto. The financial plight of privately financed liberal arts colleges of America, particularly the small college, is universally recognized. It is the earnest belief of the colleges in our association that Dr. Sparks' recommendation would be very helpful. Dr. Sparks' recommendation follows: "Amend Internal Revenue Code, section 166, entitled 'Revocable Trusts,' by adding at the end thereof: 66 “Provided, That this section shall not apply to income currently distributable to any corporation, community chest, fund, or foundation enumerated in section 101 (6), and such income shall be deductible under section 162 (a).'” In order to give you an idea of the group of institutions we represent, I attach a copy of the current membership list. Respectfully submitted. GUY E. SNAVELY. STATEMENT OF THE LOS ANGELES CHAMBER OF COMMERCE, LOS ANGELES, Calif., RE TOPIC 31, INCOME TAX TREATMENT OF ESTATES AND TRUSTS (1) That the complicated 65-day and 12-month rules for the determination of distributable income be eliminated and that there be substituted therefor a provision under which the beneficiary will be taxable on all distributions to the extent the distribution does not exceed the trust income for the taxable year. (2) That the income of a discretionary insurance trust be treated as taxable income of the grantor only to the extent it is actually used to pay premiums on insurance policies on his life. TOPIC 32-TREATMENT OF BAD DEBTS The CHAIRMAN. The next topic under consideration is_topic 32, Treatment of Bad Debts, and the first witness is Mr. C. Z. Meyer, vice president and comptroller of the First National Bank of Chicago. We are very glad to have you here, Mr. Meyer. STATEMENT OF CHARLES Z. MEYER, VICE PRESIDENT AND COMPTROLLER, THE FIRST NATIONAL BANK OF CHICAGO, CHICAGO, ILL. Mr. MEYER. Mr. Chairman and members of the committee, it is good to be here. The CHAIRMAN. Give your name and the capacity in which you appear. Mr. MEYER. My name is Charles Z. Meyer. I am vice president and comptroller of the First National Bank of Chicago. I would like to discuss in my statement the denial to reserve basis taxpayers of tax benefit rule on bad debt recoveries. Section 22 (b) (12) of the Internal Revenue Code, added by the Revenue Act of 1942, provides, in part, as follows: SECTION 22. GROSS INCOME. (b) EXCLUSIONS FROM GROSS INCOME.-The following items shall not be included in gross income and shall be exempt from taxation under this chapter: (12) RECOVERY OF BAD DEBTS, PRIOR TAXES, AND DELINQUENCY AMOUNTS.— Income attributable to the recovery during the taxable year of a bad debt, prior tax, or delinquency amount, to the extent of the amount of the recovery exclusion with respect to such debt, tax, or amount. For the purposes of this paragraph: (A) DEFINITION OF BAD DEBT.-The term "bad debt" means a debt on account of worthlessness or partial worthlessness of which a deduction was allowed for a prior taxable year. (D) DEFINITION OF RECOVERY EXCLUSION.-The term "recovery exclusion," with respect to a bad debt, prior tax, or delinquency amount, means the amount, determined in accordance with the regulations prescribed by the Commissioner with the approval of the Secretary, of the deductions or credits allowed, on account of such bad debt, prior tax, or delinquency amount, which did not result in a reduction of the taxpayer's tax under this chapter (not including the tax under section 102) or corresponding provisions of prior revenue laws, reduced by the amount excludable in previous taxable years with respect to such debt, tax, or amount, under this paragraph.. What this means with respect to a taxpayer using the direct chargeoff method of accounting for bad debts is at once apparent. If he recovers all or part of a bad debt previously charged off and deducted without tax benefit, he is entitled to use the recovery in any way desired, without its being subject to income taxation. Generally, of course, such a recovery will be reflected in surplus, increasing that figure and yet not being taxed. With respect to a reserve method taxpayer, the same should be true as there are no substantive differences in realization of income derived from bad-debt recoveries as between the two methods of accounting. However, the Commissioner denies the tax benefit provisions of section 22 (b) (12) to reserve-basis taxpayers in Regulation III, section 29.22 (b)` (12)–1 (a) (1) which contains the sentence: If a bad debt was previously charged against a reserve by a taxpayer on the reserve method of treating bad debts, it was not deducted, and it is therefore not considered a section 22 (b) (12) item. It may be that the Commissioner's denial stems from a misunderstanding of the accounting principles involved in the reserve method by both the Senate Finance Committee and the House Ways and Means Committee back in 1942. Both committees stated in their reports (C. B. 1942-2, pp. 427, 566): The amendments made by this subsection do not apply to recoveries on account of bad debts previously charged or chargeable against a reserve, by a taxpayer on the reserve method of treating bad debts, inasmuch as the amount of such recoveries is not taken into income as such but is merely credited to the reserve account and decreases the amount of the addition to the reserve which has previously been taken as a deduction in lieu of a deduction for specific bad debt items. The misunderstanding apparently arises in the phrase "decreases the amount of the addition*** which has previously been taken." Accounting authorities unanimously agree that such recoveries decrease the amount which may be deducted in the year of recovery, not in a previous year. Federal Tax Coordinator (vol. 1, D-31), states that since recoveries: * increase the reserve balance, thereby cutting the amount which might otherwise be deducted as an addition to reserve, they indirectly cause more income to be reported. Commerce Clearing House (531, C. C. H. 213.13) says: recoveries *** are credits to the reserve, thus decreasing the amount of addition to the reserve for the current year necessary to bring the reserve up to a reasonable amount. Prentice-Hall (1953, p. 45, 169): Under the reserve method of accounting for bad debts, recoveries are normally combined with the reserve, i. e., recoveries are credited to the reserve instead of being accounted for as a separate income item. The effect is to decrease the deduction that otherwise would be allowable for a reasonable addition to the reserve. For example, if the reasonable addition to the reserve is $12,000 and recoveries credited to the reserve amount to $5,000, the deduction in computing net income is $7,000. In such a case, the net income is larger by the exact amount of the recoveries than it would have been had there been no recoveries. I would like to go back just 11 years to August 11, 1942. We had a conference in the office of the Commissioner, then Mr. Guy T. Helvering. The draft of Regulations III had just come out. There were several errors in there. One glaring error that had to be corrected by letter, a copy of which I have here, read that the recoveries should be charged to the reserve rather than credited to the reserve. Mr. Helvering at the time stated time did not permit changing the regulation. I would like to read just this last paragraph, which is apropos to the point I am trying to make. This is in a letter from Mr. Helvering, addressed to the First National Bank of Chicago, my attention, dated August 11, 1952: The Bureau holds that such recoveries should be credited to the reserve for bad debts and are not required to be included in gross income. (I. T. 1825, C. B. 11-2, 144.) However, the crediting of such recoveries to the reserve has the effect of increasing the reserve and the balance of the reserve at the end of the taxable year is a factor in determining the reasonable addition to the reserve allowable as a deduction for the taxable year. It was hoped that that would be corrected in the period of 6 or 8 months. However, as you gentlemen remember, the war took a bad |