Proposed Regulations Issued Impacting Valuation Of Interests In Family Entities

Author:Mr Louis A. Mezzullo
Profession:Withers LLP

On August 2nd, the Internal Revenue Service (IRS) and the Treasury Department (Treasury) issued proposed regulations dealing with the special valuation rules under Internal Revenue Code Section 2704. The proposed regulations modify the existing regulation dealing with lapsing (i.e., disappearing) voting and liquidation rights under Section 2704(a) and restrictions on the ability to force a liquidation of an entity under 2704(b), and add a new set of regulations under Section 2704(b) that establish a new type of restriction that will be ignored for valuation purposes, referred to as “disregarded restrictions.” The proposed regulations, if adopted in their present form, would significantly reduce the amount of minority and lack of marketability discounts that could apply when valuing interests in family controlled entities for gift, estate and generation-skipping transfer tax purposes (collectively referred to as "transfer taxes").

Although the regulations would not be effective until the final regulations are published (and in some cases, 30 days after the final regulations are published), they will apply to lapses of rights and transfers of property subject to restrictions created after October 8, 1990. Therefore, simply creating an entity before the effective date of the proposed regulations will not be sufficient to avoid the application of the new rules. Rather, actual transfers of property before the effective date will be necessary to avoid the application of the new rules.

Because the public hearing on the proposed regulations will not be held until December 1, 2016, it is likely that the final regulations will not be published until after the end of 2016. This gives those clients who would otherwise desire to make transfers of interests in entities to family members the opportunity to create the entity if not already created and then to make gifts or sales of the interests in the entity before the end of 2016.

The first significant change relates to the rules that apply to lapsing voting and liquidation rights. Under existing regulations, a transfer of an interest that reduces the interest below an amount needed to force the liquidation of an entity will not be considered a lapse under Section 2704(a) provided that those interests have been "transferred" rather than "restricted or eliminated." Consequently, under the current rules the transferor can transfer a small portion of their ownership interest during their lifetime so as to...

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