On August 4, 2016, after months of speculation and delay, the IRS proposed new regulations under Section 2704 of the Internal Revenue Code that will severely limit the valuation discounts previously available for certain intrafamily transfers of interest in family-controlled entities.
The proposed regulations, while complex, would essentially eliminate minority and lack-of-control discounts for intrafamily transfers of interest in family-controlled entities. These new rules would apply to both active and passive family-controlled entities.
Section 2704 of the Internal Revenue Code, enacted in 1990, was designed to combat valuation discounts in two ways:
- Section 2704(a) provides that a taxable transfer occurs when liquidation or voting rights lapse
- Section 2704(b) provides that certain restrictions on the ability of an entity to liquidate are ignored (disregarded) when valuing property for estate and gift tax purposes.
Despite the enactment of Section 2704, taxpayers seemed to be able to find ways around the rules. After years of litigation with taxpayers (which was often resolved in the favor of the taxpayer) the Treasury Department sought to tighten the rules. Section 2704(b) gives the Treasury Department the authority to issue regulations interpreting Section 2704, and they have now exercised that authority by issuing the proposed new regulations.
Be aware that these proposed regulations, if finalized, will severely restrict, if not eliminate, the opportunity to claim valuation discounts upon the intrafamily transfer of interests in family-controlled entities, e.g., corporations, partnerships, LLCs, etc. The good news is that most of these rules will not become effective before the end of 2016. The IRS has scheduled a public hearing regarding the proposed regulations for Dec. 1, 2016, and they will not become effective until at least 30 days after they are finalized, which cannot happen until after this hearing. There may be some planning opportunities between now and when the proposed regulations become effective.