make larger contributions on their own behalf than under H.R. 10. However, the additional cost attributable to this factor would be more than counterbalanced by the fact that the approach would base the allowable deductions of the self-employed only on their earned income and would not allow extra deductions to be taken automatically by older people without employees.

A portion of the revenue loss resulting under this approach would also be due to the coverage under new pension plans of employees of self-employed persons. While it is difficult to estimate the total revenue effect, we believe that the annual overall revenue loss attributable to the coverage of self-employed people and their employees in new pension plans as outlined above would range between $150 million and $250 million before taking into account offsets due to corresponding changes in the corporate pension and profit-sharing area. In the long run some part of this revenue loss would have resulted apart from the approach since, with the rapid growth of pension plans, a significant number of the employees covered under the new pension plans might eventually have been covered by pension plans in any event. The long run revenue loss resulting from the approach we have described should be considerably less than that resulting from H.R. 10 in its present form, particularly since it avoids the precedent that the latter would offer.

It is difficult to estimate the increase in revenue that would result from placing the limitations described above on qualified plans covering owner-managers of corporations and from elimination of the present capital gains treatment of lumpsum distributions. However, the revenue effect of these changes should over the years provide significant offsets to the revenue loss from extending coverage under pension plans to self-employed people.

The Treasury believes that the alternative approach as outlined is more sound and equitable than the measure now under consideration. However, the committee and Congress in considering the alternative approach must also consider whether, if the tax base is to be further limited and legislation which will reduce tax collections enacted, this particular area is entitled to first priority. Any legislation should also take into account current and future budgetary requirements and the essentiality of substantial debt reduction in fiscal 1961 and subsequent years.

If your committee desires to recommend legislation along the lines of this approach, the Treasury staff will cooperate with the Joint Committee staff in drafting a bill. This plan represents a different approach to the problems involving the self-employed and, as an integral part of the approach, concerns (1) corporate plans covering stockholder-employees with substantial proprietary interests, (2) the capital gains treatment now accorded to certain lump-sum distributions by pension and profit-sharing plans, and (3) possibly, the gift and estate tax exemptions now provided for pension rights attributable to employer contributions under qualified plans. While the Treasury is not advised as to whether in the discretion of the committee it is intended that hearings be held concerning all aspects of the approach as outlined, we should point out that the changes suggested are both substantive and important.

Sincerely yours,

FRED C. SCRIBNER, Jr., Under Secretary of the Treasury.

EXHIBIT 28.-Statement by General Counsel of the Treasury Lindsay, May 11, 1960, before the Senate Finance Committee on the Treasury alternative approach to H.R. 10

It is a privilege to appear before this committee. We had the opportunity to state our views on H.R. 10 in its present form before this committee last June and therefore will not repeat our objections to the bill at this time. We are mindful of the committee's announcement that these hearings are on that part of the Treasury alternate to H.R. 10 which proposes amending existing law by limiting benefits of pension plans covering owner-managers of corporations.

Before discussing the proposed limitations, it is necessary briefly to describe, in general terms, the alternate to H.R. 10.

General description of alternate to H.R. 10

The alternative approach is described in Under Secretary Fred C. Scribner, Jr.'s letter of April 1, 1960, to the chairman of this committee. In brief, it would

allow, subject to limitations, self-employed individuals (including partners) the right to be included in qualified pension plans. This would permit selfemployed individuals to secure the benefits of such a pension plan only by establishing a plan meeting the requirements of the Internal Revenue Code as to nondiscrimination of benefits and coverage. In other words, a self-employed person would have to give his employees, if any, access to pension benefits on a comparable basis in order to obtain these benefits himself. His plan, however, would not necessarily have to cover all employees, but could exclude seasonal and part-time workers as well as full-time employees with not more than five years of service. While an owner without employees could establish a qualified pension plan for himself, the terms of the plan would have to provide for granting comparable benefits to any future employees.

As under present law, the qualified pension plans covering self-employed individuals could be funded through contributions to a trust or by purchase of an annuity contract directly from an insurance company. Self-employed individuals establishing such plans for themselves and their employees could, if they choose to do so, use associations to pool their separate funds for investment purposes.

In order to simplify administration from the standpoint of not only the individuals concerned but also the Internal Revenue Service, consideration should be given to permitting self-employed individuals to invest their pension funds directly in special nonnegotiable Federal Government retirement bonds without the use of a trust. This would make possible the investment of pension funds with a minimum of complexity and expense. It would also be likely to reduce abuses in the misuse of pension funds and attendant complexity in the application of so-called prohibited transaction rules.

Need for limitations

Historically, pension and profit-sharing plans have been accorded special tax treatment on the premise that they are for the exclusive benefit of employees. As we have already noted, the statute confines this special treatment to qualified pension plans which meet certain tests as to nondiscrimination in favor of shareholders, executives or highly paid employees. Moreover, from the outset, the regulations have provided that a pension plan which is so designed as to amount to a subterfuge for the distribution of profits to shareholders will not qualify as a plan for the exclusive benefit of employees.

Though a self-employed person cannot now be covered by a qualified pension plan, an owner-manager of a corporation may be covered by such a plan. This is because technically the latter is an employee of the corporation even though he owns it. This means that an owner-manager of a corporation may now arrange to secure all the tax advantages associated with coverage in a qualified plan despite the fact that, as the owner, he can establish the plan and arrange the conditions including the size of the contributions and benefits for covered individuals.

As a practical matter, where there are a substantial number of employees beside the owner, there are limits to the amounts that an owner-manager can afford to have contributed for himself under a qualified plan. Since qualified pension plans must not discriminate in regard to coverage and benefits, an owner-manager of a corporation with many employees generally can receive substantial pension benefits only by going to the considerable expense of providing other employees pension benefits on a comparable basis.

However, owner-managers of corporations who have no employees or a relatively small number of employees earning modest salaries can now provide themselves with substantial pensions under qualified plans without incurring considerable extra costs to pay for comparable pension benefits for others. Under such conditions, therefore, the contributions under the plan in effect may benefit only or mainly the owner of an enterprise. The tax avoidance possibilities in this type of situation can be substantial.

In an effort to deal with this problem, the Service, in 1944, ruled as follows: "A pension or profit-sharing plan shall not generally be considered to be for the benefit of shareholders if contributions which are required to provide benefits for employees, each of whom owns, directly or indirectly, more than 10 percent of the voting stock of the corporation, do not exceed, in the aggregate, 30 percent of the contributions for all participants under the plan. For the purpose of determining stock ownership, an individual shall be considered as owning the stock owned by the spouse and minor lineal descendants of such individual." (I.T. 3674, C.B. 1944, 315)

However, this 30 percent rule, which was designed to prevent owner-managers of closely held corporations from using pension plans as a device to provide benefits principally for themselves, was held invalid by the Tax Court in Volkening Inc. (1949-13 T.Č. 723) since there was no specific statutory authority for the rule.

The House version of H.R. 8300, the bill which was adopted into law as the Internal Revenue Code of 1954, would have restored, in modified form, the 30 percent limitation on contributions made for stockholders as part of a thoroughgoing revision of the pension provisions. However, in view of the very fundamental changes involved in the House bill, at the recommendation of the Treasury Department, your committee decided to postpone them pending further study. Accordingly, quite apart from the extension of coverage under qualified pension plans to self-employed individuals, legislative provisions are now required to prevent owner-managers of corporations from securing unwarranted advantages by establishing pension plans providing benefits mainly for themselves.

For similar reasons it would be essential to impose similar limitations on the pension contributions or benefits that self-employed individuals would be permitted to provide for themselves if they are permitted to be covered by qualified pension plans. Moreover, in order to provide equal tax treatment it is necessary to apply the same limitations to pension contributions on behalf of owner-managers of corporations and self-employed people. Unless there is such equal treatment of both groups, there will be a continuation of the very troublesome problems that now result from attempts on the part of partners to be treated as corporations in order to secure pension advantages. The result would be to grant owners different tax treatment with regard to retirement savings depending upon the form of doing business.

Proposed limitations

Under Secretary Scribner's letter of April 1, 1960, indicates the kinds of limitation that should be placed on pension contributions on behalf of self-employed individuals and owner-managers of corporations in order to prevent unwarranted tax advantages from accruing to such individuals under qualified plans.

The Treasury Department believes that these limitations should be put into effect immediately for pension plans covering self-employed individuals and corporate owner-managers which are established after the effective date of the legislation. To allow a transition period, existing plans covering owner-managers which were established before the effective date of the legistalion should be allowed a two-year grace period before being required to comply on a prospective basis with the new rules. Such action would permit, if found necessary, further extension of the grace period and in the meantime focus adequate continuous attention to the problem to insure that the soundest possible solution is developed. We do not believe that legislation that does nothing more than grant benefits to the self-employed is justified at this time in terms of either competing priorities for tax relief or sound budgetary requirements. Legislation may be justified, notwithstanding loss in revenue, if it accomplishes needed reforms and points the way to equalization in the pension area on a sound basis.

Under the Treasury's approach, deductible contributions to a qualified pension plan for self-employed individuals or owner-managers with an ownership interest of 10 percent or more would be permitted up to 10 percent of earned income but not more than $2,500 a year. This basic allowance is the same as under H.R. 10 except that (a) consistent with the treatment of employees under pension plans, the allowance under the Treasury approach is based on earned income rather than on self-employment income which may include earnings from investment; (b) H.R. 10 limits the total lifetime deductions for any self-employed person to $50,000 (the Treasury alternative does not impose any lifetime ceiling on deductions); and (c) H.R. 10 allows all self-employed individuals over 50 on the effective date of the legislation to invest and deduct extra amounts.

The 10 percent-$2,500 limits are intended to provide a basic allowance for contributions to a pension plan on behalf of owners who do not provide substantial contributions for employees. However, it would be consistent with the purpose of pension plans to allow deductible contributions for owners to exceed these basic limits where the plan provides substantial contributions for other employees. Accordingly, we have suggested that a self-employed person or an owner-manager of a corporation should not be bound by the 10 percent-$2,500 limits otherwise applying to deductible contributions on his own behalf if the deductible contributions vested in employees are at least twice the amount he contributes for himself. This does not mean all contributions must be immediately vested. The test

could be met under a graduated vesting plan. Under such conditions the owners would be permitted to make contributions exceeding the basic amounts without any special limitation provided all contributions and benefits are nondiscriminatory.

*

Two additional limitations recommended in our letter of April 1, 1960, are intended to give more concrete statutory backing for administrative positions in the pension-plan area which thus far have not been seriously challenged but which, if upset in future litigation, would create serious additional problems.

First, where the pension plan does not provide all covered employees with vested rights, forfeitable contributions made on behalf of employees should not be permitted to accrue eventually to the self-employed person establishing the plan. Instead, as under present Income Tax Regulations relating to pension plans, any forfeitures resulting under the pension plan should be used to reduce the employer's contributions and should not be used to increase benefits for the remaining participants.

Second, to reduce the amounts reverting to an employer on termination of a pension plan, all employees covered at the time of termination should be given vested rights to benefits, as under present administrative rules.

Under the statute, employers may establish pension plans geared to social security benefits and in so doing take credit for social security benefits relating to the first $4,800 of salaries. However, we take the position that if only the owner of the business is covered by the private contributions and all or almost all employees are in reality deprived of benefits under the plan because they earn $4,800 or less or small amounts in excess of $4,800, the plan is inherently discriminatory. While this is generally the present administrative position, it is not as firmly defined as the rules on forfeiture and termination. Accordingly, we recommend that the pension plan should not take credit for social security benefits if the total amount of the contributions for self-employed persons and corporate-ownermanagers exceeds one-half of the total annual deductible contributions vested in all employees who are neither owners nor close relatives of the owner. Further recommendations pertaining to the integration of pension plans with social security are suggested in our letter of April 1, 1960, for future consideration.

In our letter of April 1, 1960, we did not suggest that covered employees be granted vested rights where the contributions under the plan for owners do not exceed the basic 10 percent-$2,500 limitation. If vesting were required for all plans subject to this limitation, it is possible that some hardships might arise. It may be possible that where there are several owners of a business, contributions made on their behalf could be made truly forfeitable. By and large, however, where there is a single owner of a business, whether or not the business is incorporated, amounts set aside on behalf of the owner are as a practical matter vested. It would seem, therefore, that contributions on behalf of such an employer's employees should be similarly vested if we are to keep faith with the requirement that the plan is not to be discriminatory and that the employees must receive benefits comparable to those accorded the owner. From the point of view of administration, the simplest rule is one which would require immediate vesting, at least in the area where the owner of the business, by reason of his controlling position, has in substance vested rights under the plan.

As stated in our letter of April 1, 1960, we recommend, but with appropriate safeguards, that self-employed individuals might be permitted to participate in a form of retirement plan which would allow them to set aside funds in profitable years but would not require them to do so in nonprofitable years. This suggestion, described in more detail in our letter of April 1, would, in effect, tighten the rules of existing law applicable to profit-sharing plans for the owners of a corporate enterprise, at least to the extent that the bulk of the benefits go to such owners. While profit-sharing plans are often lumped together with pension plans, there are a number of problems in the profit-sharing area that call for special attention. Particularly in the case of an owner of a business or a self-employed individual without substantial employees, profit-sharing plans may in operation be highly discriminatory in favor of the owner because of the timing of contributions and the fact that forfeitures increase benefits to remaining employees.

Profit-sharing may be an appropriate device for permitting employees to share more in the profits of an enterprise than would be the case if the total compensa

tion were based on commitments regardless of profits. In the case of an owner of a business or a self-employed individual without substantial employees, profitsharing is more in the nature of a tax-saving device since such persons in any event are entitled to all of the profits of the enterprise.

Even with respect to the larger plans where the bulk of the benefits go to the employees, future consideration should be given to restoring the rule that a qualified profit-sharing plan must set forth a definite formula for determining the profits of the employer to be shared and for distributing such profits among his employees or their beneficiaries.

Additional recommendations

The foregoing highlights the major proposed limitations recommended by the Treasury with the exception of those items which, due to insufficient time, have been postponed for future consideration. In addition, the April 1, 1960, letter contains recommendations pertaining to contributory plans, premature withdrawals, and prohibited transactions. While important, these recommendations should not require further elaboration in the context of these hearings.

In our letter of April 1, 1960, it was suggested that pension contributions on behalf of each self-employed individual or owner-manager of a corporation could be as much as the largest annual deductible contribution vested in any employee who is neither an owner nor a close relative of an owner. On further examination, this recommendation appears troublesome and we recommend against its adoption.

We appreciate the committee affording us an opportunity to discuss the alternative approach and more particularly that part of the approach which on a transition basis would make it possible to cope with the pressing problems in the corporate area.

EXHIBIT 29.-Statement by Assistant to the Secretary Glasmann, February 1, 1960, before the House Committee on Ways and Means on the taxation of cooperatives

MR. CHAIRMAN AND MEMBERS OF THE COMMITTEE: I appreciate this opportunity to appear before your committee to present the Treasury's views on the troublesome problem of taxation of cooperatives.

In the President's budget message last year and again this year, the President recommended amendments to the Internal Revenue Code to provide equitable taxation of cooperatives. As you know, during the past five years the Treasury has several times called to the attention of the committee the fact that a series of court decisions have made largely ineffective the 1951 legislation which was intended to assure that all cooperative income would be taxed either to the cooperative or to its members as earned.

Corrective legislation is clearly needed because under existing law it is possible for a cooperative to exclude from its taxable income certain noncash patronage dividends paid to its members which, at the same time, are not taxable to the members who receive them. As Secretary Anderson stated in testimony before your committee on January 16, 1958, the Treasury Department, while fully aware of the importance of cooperatives to our agricultural and farming communities, believes that the cooperative's income should be taxed currently at either the cooperative or patron level and that legislation which is fair and reasonable, both from the standpoint of the availability of retained earnings for expansion and tax benefits to cooperative members, should be developed.

During the last session of the Congress, the Secretary of the Treasury submitted to the Congress a legislative proposal which was intended to insure the ultimate payment of a single tax on cooperative income and which, at the same time, would limit the cooperative's ability to expand from retained earnings that have not been taxed at the cooperative level.

The Treasury recommendations in this area were released to the public by your committee last February and are embodied in H.R. 7875, a bill introduced last session by the late Representative Simpson of Pennsylvania. Under the Treasury's proposal, cooperatives would be permitted to deduct amounts paid to the patron during the taxable year if paid (1) in cash, or (2) in the form of "qualified" patronage certificates which bear interest at the rate of at least four percent and are redeemable in cash within three years. The patron would include in his income only the cash amounts received. At the time Secretary Anderson submitted this suggested method of taxing cooperative income, he also