Proposed Regs Aim to Place Restrictions on Valuation Discount Planning

According to the regulations.gov post “Estate, Gift, and Generation-skipping Transfer Taxes: Restrictions on Liquidation of an Interest,” the Treasury Department and the IRS have proposed regulations that would amend §?25.2701-2 to address what constitutes control of an LLC or other entity or arrangement that isn’t a corporation, partnership or limited partnership. 10-14-16

These regs would amend §?25.2704-1 to address deathbed transfers that result in the lapse of a liquidation right and to clarify the treatment of a transfer that results in the creation of an assignee interest. The changes would refine the definition of “applicable restriction.” It eliminates the comparison to the liquidation limitations of state law. It would also add a new section to address restrictions on the liquidation of an individual interest in an entity and the effect of insubstantial interests held by persons who are not members of the family.

If and when finalized, the proposed regulations would do the following:

  • Treat a lapse of voting and liquidation rights for transfers made within three years of death of interests in a family-controlled entity as an additional transfer, eliminating or limiting the lack of control and minority discounts for these transfers;
  • Eliminate discounts based on the transferee’s status as an 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 he or she has held the interest for more than three years, owns a substantial interest in the entity and has the right—with 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 aren’t mandated by law in determining the fair market value of the transferred interest; and
  • Clarify the description of entities covered to include LLCs and other entities and business arrangements—as well as corporations and partnerships.

If these end up being the final regulations, taxpayers will lose an important estate planning technique, and the tax cost of transferring interests in family-owned entities will increase.

Reference: regulations.gov (August 4, 2016) “Estate, Gift, and Generation-skipping Transfer Taxes: Restrictions on Liquidation of an Interest”

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