Reich," and who has now spent as much time writing a history of the French Third Republic. Since the "Rise and Fall of the Third Reich," which was almost 6 years ago, he has thus been at work on one book, which will be published, I think, this year. If it succeeds he will have in 1 or 2 years the fruit of approximately 6 years of labor. The CHAIRMAN. Well, you could say, I guess, the same thing about someone who is an inventor who works over a period of many years, perhaps even longer than 7 years. Let us assume for the sake of argument some fellow-and usually this is done in a big research organization-but if some individual person who was working on an invention, suppose something, for example, he is trying to find a cure for cancer, and he worked on it over a period of 15 years, and eventually he did come up with it, it would stand to reason that he should not be taxed all of that in 1 or 2 years, but that he should have it spread over a longer period of time. Inventors, I guess, would be an example, too; wouldn't they? Mr. KARP. Yes; inventors would be covered by this, as they are now; lawyers, doctors, any self-employed person or any person who is an employee for that matter, who had this concentrated income. That is how the law works today. We are just suggesting a change to add two additional base periods. It is not confined to authors or inventors. The CHAIRMAN. Well, I was trying to recall-I believe when I was on the Interior Committee-a lawyer pleading one of these Indian claims cases, was told if a lawyer is going to take one of these old Indian claims cases he ought to be a young lawyer, otherwise he would not live long enough to see it to a conclusion. So that that type of thing justifies an even broader averaging than just the 5 years. Mr. KARP. Yes, sir. The CHAIRMAN. All right. Thank you. Senator Miller. I am going to leave this with Senator Miller. Senator MILLER. I have no further questions. The CHAIRMAN. Senator Miller usually has a depth of intellectual curiosity that makes him want to delve into some of these things more deeply, so I thought he might have been intrigued by your testimony here today. Senator MILLER. Mr. Chairman, I was impressed by the testimony, and I think that this is the kind of testimony that we like to get where not only do we receive some criticism of a bill but we receive some suggestions, and not just one but we are given some options. I was only going to make this point, and that is that it seems to me that the longer we go back beyond the years the more difficulty we have from an administration standpoint. The average taxpayer does pretty well to save his tax records back 3 years, and he does wonderfully well to save them for 5 years, but if we keep pushing it back we won't have the kind of information we need to have to substantiate tax returns, and my instinctive reaction, looking at the administrative side of it, would be to go with the 3-year approach to it. Mr. KARP. I think that could be possible, although, with an incentive, I think many people would save their tax returns a little longer. Senator MILLER. Especially authors. Senator MILLER. Yes. We appreciated your testimony very much. Thank you. (Mr. Karp's prepared statement follows:) STATEMENT OF IRWIN KARP, COUNSEL, THE AUTHORS LEAGUE OF AMERICA Sec. 802-The 50% tax limit SUMMARY 1. The 50% tax limit would not apply to authors, dramatists and composers under the present definition of "earned income", which is restrcited to income from "personal service". 2. The 50% limit was intended to apply to income earned by a taxpayer's personal efforts-as distinguished from income produced by the use of capital. An author's income is "earned income". 3. "Earned income" should be defined to include income derived by an author from the disposition of rights to use his works [as in Sec. 401 (c) (2) (C) (IRC)]. 4. The 50% limit would provide a more equitable tax rate and would eliminate a formidable deterrent to independent creative work. Sec. 311-Income averaging 1. Sec. 1301 (IRC) does not provide equitable taxation of an author when his income from one or two works, resulting from the creative effort of several years, is concentrated in the upper brackets of one or two tax years. 2. Section 1301 should be revised to permit the use of 3 alternative base periods for "income averaging"; the extent to which current income must exceed the average of a given period to increase in relation to the length of the period. My name is Irwin Karp. I am counsel of The Authors League of America, a national society of professional writers and dramatists and submit this statement on its behalf. The Authors League urges the Committee to extend the protection of the proposed 50% tax limit to authors, composers and dramatists. It also requests the Committee to consider revisions in the "tax-averaging" provisions which are described below. Sec. 802-The 50% limit Section 802 would limit the maximum tax rate on earned income to 50%. The Authors League believes that this maximum rate should be adopted. However, the proposed new section od the Code (Sec. 1438, IRC) would notas written apply the 50% limit to writers, dramatists, poets, composers, artists and persons in other creative occupations. They would continue to pay taxes ranging up to 70%, if their earnings were substantial. These individuals should not be taxed at higher rates than corporate executives and employees, lawyers and doctors, actors or professional athletes. Yet that would be the result, unless 802 is amended to include a more reasonable definition of "earned income". We believe that the exclusion of authors from the 50% limit was inadvertent. The limit was intended to apply to income earned by a taxpayer's personal efforts and not to income produced by the use of capital. However, to draw the line, a definition of "earned income" was incorporated from Sec. 911(b) of the Code. But that definition was formulated to serve the particular purposes of Sec. 911 which exempts income earned by certain non-resident citizens from tax. The Sec. 911 definition consequently limited "earned income" to salaries and other income from "personal services"-to confine the exemption to those citizens who are required tolive abroad, i.e., those who earn their living by rendering services in other countries. The Sec. 911 definition does not include other forms of income earned by a taxpayer's work and personal efforts, such as income earned by writing, composing and other creative occupatons. Thus, while the Internal Revenue Service (and the Code) recognize that a self-employed author earns income by creating a book or play, it contends that this does not constitute income from "personal services" as that term is used in Sec. 911. Consequently, if Sec. 802 only applies to income falling with the Sec. 911 defintion, authors will not be protected by the 50% limit. A Congress resolved the same dilemma in 1966 when it amended Sec. 401 (IRC) which permits self-employed taxpayers to make deductible contributions to retirement plans based on their "earned income". That section originally defined "earned income" by incorporating the definition of Sec. 911(b). As this Committee noted, IRS took the position that a free-lance author's income was not compensation for personal services and therefore not "earned income". (Sen. Rep. No. 1707, 89th Cong. 2nd Sess.) The Committee said: The intent of the Congress in adopting the 'earned income' concept was to limit the applicability of these provisions to the portion of a self-employed person's income which was a result of his individual efforts as distinguished from a return on capital. Your committee does not believe that for this purpose the classification of income from an author's writing (or an inventor's invention), which is so clearly a result of his individual efforts, as 'earned' or 'not earned' should depend upon the terms of the contract under which the author (or inventor) is to be compensated." Similarly, self-employed authors' income should be recognized as "earned income" under Sec. 802. It as as much earned by his work and personal efforts as are the fees paid to a lawyer or doctor, or the salary paid to a corporate executive, or the writer who works as an employee. The only difference is that the free-lance author translates his creative work into earnings by licensing or selling rights in his book or play, rather than by doing the work under a professional retainer, or an employment relationship. The Internal Revenue Code classifies an author's earnings as income produced by his personal efforts; not as income derived from the use of capital. Sec. 1221 prohibits an author from treating his book or play as a capital asset; and denies him the right to claim a capital gain on any disposition of his work. Congress enacted this provision in 1950 on ground that an author's income was the result of his personal efforts and should therefore be taxed as ordinary income. (House Report No. 2319, 81st Cong. 2nd Sess.) We respectfully urge that Sec. 802 be amended to apply the 50% limit to income earned by self-employed authors (and by composers, artists and other creative persons)-i.e., the income they derive by licensing, selling or otherwise disposing of the works they create. This could be accomplished by inserting in Section 802 the additional definition of “earned income" contained in Section 401: "(C)-Income from disposition of Certain Property. For purposes of this section, the term 'earned income' includes gains (other than any gain which is treated under any provision of this chapter as gain from the sale or exchange of a capital asset) and net earnings derived from the sale or other disposition of, the transfer of any interest in, or the licensing of the use of property (other than good will) by an individual whose personal efforts created such property." The Authors League believes that the 50% limit should be adopted. The present upper-bracket rates are "extremely high” and “unrealistic" (H. Rep. 91-413, page 208); and patently unfair to the individual who earns his income rather than derives it from "capital gains" investments. The rates impose a particularly heavy penalty on individuals such as authors and artists whose few years of high income are the result of many years of poorly compensated work. The tax averaging provisions of the Code, even improved as the Reform Act proposes (or as we suggest) cannot, in many instances, mitigate the confiscatory effect of these rates. Furthermore, the present rates deter authors from independent creative work. Writing a book or play requires the self-employed author to expend a great deal of time (months or years) and money, to support himself and his family. If the work fails he loses everything; he has no loss deduction. The odds against success are high; free-lance writing is a high-risk occupation. Add to this the fact that if the book succeeds, as much as 70% of its earnings will go to the federal government in taxes (plus an additional slice for state tax), and it is understandable that some very talented writers frequently decide not to enter the contest. It is much safer for an author to hire out to a motion picture company, magazine or other employer. He cannot write the book or play he would have created as a free-lance. But his writing is guaranteed to produce salaried income, whether the work succeeds or fails. And the money he would have used to finance a freelance work can be invested in securities. Even in today's market, the risk is less; and any gain would cost him 25% (plus surtax) rather than 70%. What we lose is the book or play he might have created had the tax rates not made risk of independent work so exorbitant, a book or play that might have enriched our culture. The Authors League believes that the 50% maximum tax rate would remove this formidable obstacle to independent writing and provide a more equitate tax system. Sec. 311-Income averaging Section 1301 of the Code was designed to eliminate unfair taxation of indivi duals whose compensation for several years of work is concentrated in one of two comparatively high income years. For example, the author who spends years with little return, writing a book which produces substantial income in the year it is published. Or, the dramatist who creates several plays over a period of years. sees some score artistic success, but only has one that produces substantial income for a year or two. When the return for several years of work is concentrated in one or two years, it becomes high-backet income, taxed much more heavily than if it had been received gradually over the period of work. Section 311 of the Bill would liberalize Sec. 1301 by permitting current income to be “averaged" when it was 20% (rather than 33%) greater than average income in the prior 4 years. However, this improvement would not reach twe areas of difficulty under the present section. The averaging formula imposes a tax on an individual's "concentrated income" which approximates the tax be would have paid had it been received ratably during the previous four years and the current year. But for some taxpayers, including many authors, the concer trated income represents the result of a much longer period of work. Limiting "averaging" to a five year period still produces harsh results: it does not leave such an individual with a fair share of "after-tax" income to compensate him for his years of work. Had the income been spread over the period of work, it would have been taxed at lower rates (often much lower than the 50% maximum of Sec. 802). On the other hand an author may over a period of many years have only two successful works; but be unfortunate enough to have the second success occur within four years of the first. The income from the first work raises his four-year average to the point where he cannot apply Section 1301 to the windfall income of the second work and he is taxed at the high-bracket rates of the year in which the income was received. To meet both problems, we respectfully suggest that Sec. 1301 be revised to allow an individual to elect one of three alternative "base periods": (i) if his current year's income exceeds his average annual income for the three (3) previous years by at least 20%, he may compute the tax on the excess as if it had been received ratably during the prior 3 years and the current year; (ii) if his current year's income exceeds his average annual income for the preceding four (4) years by at least 33%, he may compute the tax on the excess as if it had been received ratably during the prior 4 years and the current year; and (iii) if his current year's income exceeds his average annual income for the preceding six (6) years by at least 40%, he may compute the tax on the excess as if it had been received ratably during the prior 6 years and the current year. The length of the base period would depend on the extent to which current income exceeded the average for prior years. Since a greater increase is more likely to be the result of a longer period of work, this formula would produce a closer approximation of the tax that would have been paid had the income been received ratably during that period. In each case, the method of computation provided in Sec. 1301 would apply, adjusted for the number of years in the applicable base period. Other sections of the Internal Revenue Code allow a taxpayer to choose between alternative methods of “receiving" income, and taking deductions, amortization and depreciation-thus affecting the amount of tax to be paid. For Example: under Section 167 a corporate or individual taxpayer may select various methods of depreciation; under Section 451, they may report income on a completed contract or percentage of completion method; under Section 453, they may report income in the year a sale is made or over a period of years, on an installment basis. We believe this change would provide more equitable taxation of self-employed authors, composers and artists, athletes, actors, musicians and others engaged in occupations where income fluctuates widely over a period of years. after Sec. 331-Minimum tax on deferred compensation Sec. 331 of the Bill would place a minimum tax on deferred compensation for personal services. By its terms, the Section does not apply to periodic payments to authors under the "spread forward" provisions of publishing contracts; nor does the tax formula appear to have been drawn with any intention that it apply to such payments. However, if any changes are to be made in the Section which would effect payments under these contracts, we respectfully request the opportunity to submit a statement. The circumstances involved in such contracts are quite different from those involved in provisions for deferred compensation of employees; and imposition of the minimum tax on payments under these contracts would produce substantial inequities. (The following communications were received by the committee expressing an interest in the subject of income averaging:) THE AUTHORS LEAGUE OF AMERICA, INC., Hon. RUSSELL B. LONG, Washington, D.C. New York, N.Y., July 31, 1969. DEAR CHAIRMAN LONG: The Authors League of America respectfully submits the following suggestion for revision of the “averaging provisions" of the Internal Revenue Code (Sec. 1301). We understand that changes in the Section are being considered by the House Ways and Means Committee. Section 1301 was designed to eliminate unfair taxation of individuals whose compensation for several years of work is concentrated in one or two comparatively high income years. For example, the author who spends years, with little return, writing a book which produces substantial income the year it is published. Or, the dramatist who creates several plays over a period of years, sees some score artistic success, but only has one that produces substantial income for a year or two. When the return for several years of work is concentrated in one or two years, it becomes high-bracket income, taxed much more heavily than if it had been received gradually over the period of work. While Section 1301 has reduced this inequity, it has not produced fair tax results in many instances. The House Ways and Means Committee, recognizing this, is considering various revisions to make the Section more equitable. We understand that one contemplated change would permit an individual to compute his tax under the "averaging" formula when his current income is at least 25% above his averaging income for the four preceding years. At present, "averaging" is only allowed if current income is at least 33% % higher than the average of the prior four years. While this is an improvement, it would not eliminate inequities in two areas. The averaging formula of Sec. 1301 is designed to impose a tax on an individual's "concentrated income" (the amount exceeding 133% % of his four year average) which approximates the taxes he would have paid had it been received ratably during the previous four years and the current year. But for some taxpayers, including many authors, the concentrated income truly represents the result of a much longer period of work. Limiting "averaging" to a five year period still produces harsh results; it does not leave such an individual with a fair share of "after-tax" income to compensate him for his years of work. On the other hand an author may over a period of many years have only two successful works; but be unfortunate enough to have the second success occur within four years of the first. The income from the first work raises his fouryear average to the point where he cannot apply Section 1301 to the windfall income of the second work and he is taxed at the high-bracket rates of the year in which the income was received. To meet both problems, we respectfully suggest that Sec. 1301 be revised to allow an individual to elect one of three alternative "base periods": (i) if his current year's income exceeds his average annual income for the three (3) years by at least 25%, he may compute the tax on the excess as if it had been received ratably during the prior 3 years and the current year. (ii) if his current year's income exceeds his average annual income for the preceding four (4) years by at least 33% %, he may compute the tax on the excess as if it had been received ratably during the prior 4 years and the current year. |