United States

Treasury releases proposed regulations to section 2704


On Aug. 2, 2016, the IRS issued proposed regulations to section 2704. The long awaited and much speculated regulations are intended to address perceived shortcomings that have developed in the effectiveness of section 2704 to prevent taxpayers from using structural artifices to discount the value of interests for gift, estate and generation-skipping transfer tax purposes.

There is much to absorb (and parse) in the proposed regulations. The IRS invited the public to submit comments on the proposed regulations by Nov. 2, 2016, and will hold a public hearing on Dec. 1, 2016. The regulations will not be effective until they are final.

As issued, the proposed regulations expand the scope and reach of section 2704 to preclude use of various structural techniques to artificially suppress the value of interests in entities transferred by taxpayers or owned by them at death. In summary, 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. This precludes a hyper-technical narrow reading of the kinds of entities to which section 2704 applies.
  • 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.
  • Disregards liquidation restrictions of a family-controlled entity if the restrictions will lapse at any time after the transfer or if the transferor, or the transferor and family members without regard to certain interests held by nonfamily members, may remove or override the restrictions.
  • Disregards liquidation restrictions for family-controlled entities that:

o   Limit the ability of the holder of the interest to liquidate the interest

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

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

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

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

o   An interest held by the nonfamily member for at least three years immediately before the transfer

o   The nonfamily member interest constitutes at least 10 percent of the value of all of the equity, capital or profits interest

o   The total nonfamily equity, capital or profits interest constitutes at least 20 percent of the value of all of the equity, capital or profits interest

o   Each nonfamily member has a put right

The IRS is likely to receive a great deal of commentary from the estate planning and valuation communities, respectively. Therefore, the final form of these regulations is difficult to predict at best. In the meanwhile, taxpayers who are considering wealth transfer have ever more reason to put their plans into motion.


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