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Proposed Regulations will Place Limit on Discounts for Intra-family Transfers

 

Proposed Regulations for IRC. § 2704

Proposed regulations would place far-reaching limitations on valuation discounts for transfers of interest in family-controlled entities.

Big Picture:

  • The general purpose of § 2704, which is part of a group of sections collectively known as Chapter 14, is to prevent taxpayers from using various strategies to reduce their exposure to federal taxes, generally known as “wealth transfer taxes”.
  • For purposes of this regulation, taxpayers may be using a wealth transfer strategy of using business entities to produce lower asset values than might otherwise exist.
  • This proposed regulation is intended to prevent undervaluation of transferred interests.
  • While widely anticipated for quite some time, if enacted, this may be the biggest change in estate planning in the last 25 years.

Specifically:

  • Section 2704 concerns intra-family transfers and is intended to eliminate valuation discounts for interests in family controlled entities, when one family member holding a majority interest transfers an interest to another family member. The donor’s interest thereby becomes a minority interest and under current law, he is able to take a deduction based on his new minority interest.
  • Currently, there is a valuation discount given to those who hold a minority interest, the enactment of this regulation will eliminate such discount.
  • While the enactment is predicted to be prospective and will not retroactively affect transfers, there will be a three-year look back period for transfers that happen within three years of death. The IRS will look at the transfer as if it happened “on the deathbed”.

In practice, for example:

  • Let’s say Dad owns 60% of the voting stock in our family held enterprise. He gifts 15% of my voting stock to his two children, 50% equally to each of them. The current regulation values the children’s 15% interest as a minority interest valued with a minority discount. Likewise, Dad’s remaining shares (45%) are now considered a minority interest and would be valued with a minority discount, under current law. However, under the proposed §2704, the regulations would now require the donor (Dad) to survive 3 years after the gift is made; but, if death occurs within 3 years then the value of a lapse right that gave rise to the discount will have to be included in his estate for estate tax purposes.
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