Proposed Section 2704 Regulations Would Impose Major Restrictions on Valuation Discount Planning

The Department of Treasury released proposed regulations under Section 2704 of the Internal Revenue Code, which if enacted, are likely to mean a higher tax bill if you transfer shares of family-controlled entities.  The new rules appear to spell the end of minority or marketability discounts for family-controlled companies, family limited partnerships and limited liability companies for gift, estate or generation skipping tax.  

The primary intention of the long awaited, proposed regulations is to address the treatment of lapsing rights and restrictions on liquidation in determining the value of transferred interests.  Some of the key provisions of the proposed regulations include: 

• Clarification that section 2704 applies to corporations, partnerships, limited liability corporations and other business entities and arrangements.

• Amendment of section 2704 to address deathbed transfers that result in the lapse of a liquidation right and to clarify the treatment of a transfer that results in the creation of an assignee interest. 

• Defines control of an entity as 50 percent of the equity, capital or profits interest. For purposes of determining control, Reg. section 25.2701-6’s attribution rules will treat an individual, the individual’s estate and members of the individual’s family as owners of interests held through an entity.

• Refines the definition of the term “applicable restriction” by eliminating the comparison to the liquidation limitations of state law. 

• Disregards liquidation restrictions for family-controlled entities that:

  • Limit the ability of the holder of the interest to liquidate the interest,

  • Limit the liquidation proceeds to an amount that is less than a minimum value,

  • Defers the payment of the liquidation proceeds for more than six months, or

  • Permits the payment of the liquidation proceeds in any manner other than in cash or other property, or other than certain notes.

• Disregards a non-family member interest if the interest is not economically substantial, which is defined as:

  • An interest held by the non-family member for at least three years immediately before the transfer,

  • The non-family member interest constitutes at least 10 percent of the value of all of the equity, capital or profits interest,

  • The total non-family equity, capital or profits interest constitutes at least 20 percent of the value of all of the equity, capital or profits interest, or

  • Each non-family member has a put right.

The IRS has invited the public to submit comments on the proposed regulations by Nov. 2, 2016 and a public hearing is scheduled for December 1, 2016.  The final form of the regulations may change as a result.  The new rules will not apply to interests transferred as gifts (or in estate settlement) within 30 days after the publication of final regulations.  This means it may very well be a great tax move to step up estate planning to include gifting, before detrimental tax treatment kicks in.

BCC Advisers has seven full-time business valuation analysts with significant experience valuing closely-held entities for gifting purposes.  Visit our Business Valuation page for information regarding our Experience, Approach and Staff.  

If you’d like to discuss further or get the gifting process started, please give us a call.