These long-awaited proposed regulations, released on August 2, 2016, would make sweeping and very significant changes to the valuation of interests in many family-controlled entities for estate, gift, and generation-skipping transfer tax purposes. The primary focuses of the proposed regulations are treating the lapse of voting or liquidation rights as an additional transfer and disregarding certain restrictions on liquidation in determining the fair market value of a transferred interest.
When finalized, the proposed regulations would:
- Treat as an additional transfer the lapse of voting and liquidation rights for transfers made within three years of death of interests in a family-controlled entity, thereby eliminating or substantially limiting the lack of control and minority discounts for these transfers;
- Eliminate any discount based on the transferee’s status as a mere assignee and not a full owner and participant in the entity;
- Disregard the ability of most nonfamily member owners to block the removal of covered restrictions unless the nonfamily member has held the interest for more than three years, owns a substantial interest in the entity, and has the right, upon six months’ notice, to be redeemed or bought out for cash or property, not including a promissory note issued by the entity, its owners, or anyone related to the entity or its owners;
- Disregard restrictions on liquidation that are not mandated by federal or state law in determining the fair market value of the transferred interest; and
- Clarify the description of entities covered to include limited liability companies and other entities and business arrangements, as well as corporations and partnerships.
Where the Final Regulations are
Similar to the Prop. Regs., Taxpayers Will Have Lost a Significant
Estate Planning Tool and the Estate Tax Cost of Transferring Interests in
Family Owned Entities Will Increase!
The Overall Effect of Section 2704(b) is that Specified Restrictions are Disregarded in Valuing such an Interest for Gift or Estate Tax Purposes when that Interest is Transferred to a "Family Member".
The Provisions of the Prop. Regs. Applicable to Voting and Liquidation Rights are Proposed to Apply to Rights and Restrictions Created After October 8, 1990, but Only to Transfers Occurring AFTER the Date the Regulations are Published as Final Regulations.
The new rules regarding “Disregarding Certain Restrictions on Redemption or Liquidation” will not take effect until 30 days after the date the regulations are published as final regulations.
Taxpayers who are considering transferring interests in family-controlled entities that are not controlling interests and do not have liquidation rights should consider making the transfers as soon as possible.
It is possible, however, that if the client dies within three years of the transfer and after the date that the proposed regulations become final, the client may be caught by the final regulations.
The proposed regulations would also apply to determine and measure any gift component of transfers otherwise structured as sales. So clients who have recently made transfers and die after the regulations are finalized but within three years of the transfer may be caught by the final regulations.
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Estate planners have used defined value and formula clauses for many years. Recent cases such as McCord and Wandry have provided guidance on how to use them and withstand IRS scrutiny. Planning before the proposed section 2704 regulations become effective is increasing workload for estate planners and appraisers. The flexibility of defined value and formula clauses can be an important tool in doing this planning.
ReplyDeleteLast week, Rep. James Sensenbrenner, R-Wis., introduced H.R. 6042 to nullify the proposed regulations and any other substantially similar regulations that the IRS may float.
ReplyDelete“The IRS proposal is basically an attempt to sidestep congressional oversight,” Nicole Tieman, a representative for the congressman’s office, told Law360 in an email. “If new rules of this breadth are to be implemented, it should be done with congressional participation. … Further, this rulemaking is widely unknown to the very people the changes would affect — an indication that the process should be more transparent.”
Experts say Sensenbrenner’s bill is remarkable in that it is unusual for Congress to try to curtail an agency’s specific rule-making power instead of addressing possible deficiencies in the underlying statute.