Monday, August 15, 2016


On August 2, 2016, the Treasury Department issued proposed regulations under the authorization contained in Section 2704(b) of the Code, with a hearing scheduled on December 1, 2016.  The proposed regulations will essentially take away all valuation discounts for interfamily transfers of entities controlled by the transferor and his or her family.

It is likely that the proposed regulations will not take effect until sometime next year, making it necessary to complete any discount-related planning throughout the next several months. Some of the major changes that will be adopted in the proposed regulations are discussed below.

The proposed regulations give a broad definition of control. Specifically, control is holding 50% of equity in an entity (corporation, partnership or LLC). For a limited partnership, control is equivalent to having an interest in the general partner.

Under 2704(a) the lapse of a voting right or liquidation right in a family owned entity is treated as a transfer by the individual holding the right immediately before it lapses. The current regulations exempt such a transfer if the rights with respect to the transferred interest are not restricted or eliminated. The proposed regulations would deny such exemption for transfers occurring within three years of death if the entity is controlled by the transferor and members or his or her family immediately before and after the lapse.

The proposed regulations will significantly change valuations for transfer tax purposes of interests in family owned entities that are subject to restrictions on redemptions or liquidations. Specifically, such restrictions will be disregarded in valuing such an interest for gift/estate tax purposes when the interest in transferred by a family member. The reasoning for this is the fact that after the transfer the restriction will lapse or can be removed by the transferor or a member of his or her family.

The proposed regulations remove nearly all discounts by disregarding the interests held by non-family members as well. Interests held by non-family members that may otherwise give such non-family member the power to prevent the removal of a restriction will be disregarded unless those interests have been held for at least three years; make up at least 10% of the entity; the total combined non-family interests is more than 20% of all interests; or they hold a put interest in the entity to receive a minimum value.

The proposed regulations issued under Section 2704 would, if adopted in final form, have a significant impact on the wealth transfer tax valuation of interests in family controlled entities.  Essentially, almost no minority discounts would be allowed. 

It is essential for anyone interested in reducing their estate taxes by gifting interests in entities, whether operating businesses or investment entities, contact our office immediately as these may disappear before the end of 2016.