Statement of Richard M. Lipton on the Subject of Tax Simplification
April 26, 2001 3. Business Tax Provisions - Repeal or Simplify the Personal Holding Company Rules
The personal holding company rules were enacted in 1934 to tax the so-called "incorporated pocketbook." With differentials in the corporate and individual tax rates, individuals could, for example, place their investments in a corporation and substantially lower the Federal income tax paid on income generated by those investments, especially if the income was held in the corporation and reinvested for a long period of time. The personal holding company provisions attack this plan by imposing a surtax on certain types of passive income earned by closely held corporations that is not distributed (and thus taxed) annually. Over time, the personal holding company rules have been broadened to include many closely held corporations, both large and small, with passive income (whether or not such corporations are, in effect, "incorporated pocketbooks") and, thus, may create a trap for the unwary. In addition, the rules have become very complex and difficult for the IRS to administer and for taxpayers to comply with, and sometimes require taxpayers to rearrange asset ownership to comply with the rules. With maximum corporate and individual rates coming closer together and the repeal of the General Utilities doctrine, it is questionable whether the personal holding company rules should remain in the Code at all. Regardless of this debate, however, the rules should be significantly simplified to eliminate the substantial burden they impose on closely held corporations. - Repeal the Collapsible Corporation Provision
The repeal of the General Utilities doctrine in 1986 rendered section 341 redundant. By definition, a collapsible corporation is a corporation formed or availed of with a view to a sale of stock, or liquidation, before a substantial amount of the corporate gain has been recognized. Since 1986, a corporation cannot sell its assets and liquidate without recognition of gain at the corporate level; likewise, the shareholders of a corporation cannot sell their stock in a manner that would allow the purchaser to obtain a step-up in basis of the assets, without full recognition of gain at the corporate level. Because it was the potential for escaping corporate taxation that gave rise to section 341, it is now deadwood and should be repealed. Repeal of section 341 would result in the interment of the longest sentence in the Code – section 341(e). - Simplify the Attribution Rules
The attribution rules throughout the Code contain myriad distinctions, many of which may have been reasonably fashioned in light of the particular concern the underlying provision initially addressed. It is not clear, however, that the reasons originally leading to the differences justify the complexity the current attribution rules create. The attribution rules should be reexamined in light of the underlying concerns to harmonize and, if possible, standardize the rules. Even without reexamination, the attribution rules could be simplified by providing consistently either an "equal to" standard or a "greater than" standard for application of the ownership percentages. - Simplify the Loss Limitation Rules
The Code contains multiple rules limiting the ability of a taxpayer claim to use losses including: (i) section 465, which limits the deductibility of losses of individuals and certain C corporations to the amount at risk – that is, generally, the amount of the investment that could be lost plus the taxpayer’s personal liability for additional losses; (ii) section 469, which limits losses incurred in "passive activities"; (iii) section 704(d), which limits a partner’s distributive share of a partnership’s losses to the partner’s basis in the partnership interest; and (iv) section 1366(d), which limits an S corporation shareholder’s loss in similar fashion. There are numerous limitations and qualifications layered on each of these rules and definitions, and sections 465 and 469, in particular, are extremely complicated and difficult to comprehend. Section 465 originally applied only to certain types of activities deemed especially prone to abuse, such as the production and distribution of films and video tapes, but, in 1978, it was extended to virtually all other income-producing activities. Since the enactment of section 469, section 465 has become superfluous because there are very few situations in which a deduction would be denied because of the applicability of section 465 that would not also be denied because of the applicability of section 469. Substantial simplification could be achieved by combining, rationalizing and harmonizing the loss limitation provisions. - Simplify Section 355
Section 355 permits a corporation or an affiliated group of corporations to divide on a tax-free basis into two or more separate entities with separate businesses. Under section 355(b)(2)(A), which currently provides an attribution or "lookthrough" rule for groups of corporations that operate active businesses under a holding company, "substantially all" of the assets of the holding company must consist of stock of active controlled subsidiaries. As a result, holding companies that, for very sound business reasons, own assets other than the stock of active controlled subsidiaries are required to undertake one or more preliminary (and costly) reorganizations solely for the purpose of complying with this provision. Substantial simplification could be achieved by treating members of an affiliated group as a single corporation for purposes of the active trade or business requirement.
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