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By Daniel T. Jordan, ASA, CBA, CPA, MBA

The proposed regulations under Section 2704 were released on August 2, 2016 and might be finalized in 2017. This would mean no more discounts for family-controlled entities for estate, gift, and generation-skipping transfer tax purposes.

This may seem like game is over for 30%-40% discounts.  However, very few people face federal estate tax.  If they have a partnership interest and there is a 30% discount, the step-up in basis that occurs is going to be limited to 70% of value.  But if the partnership is disregarded for valuation purposes, they are going to get 100% of value.  Thus, for those that do not want the discounts because they do not face much estate tax and instead want the step up in basis, it may be a good thing.

However, if the discounts are important to achieve your financial and estate planning goals, my suggestion is consider transferring now before it is too late.  If you take action now before the regulations are final, you fall under the grandfathering rule.

The Proposed Regulations

The IRS released the section 2704 proposed regulations on August 2, 2016, and they were published in the Federal Register on August 4. 81 Fed. Reg. 51413-51425 (Aug. 4, 2016). If and when finalized, the proposed regulations would:

• Treat as an additional transfer the lapse of voting and liquidation rights for transfers made within three years of death of interests in a family-controlled entity, thereby eliminating or substantially limiting the lack of control and minority discounts for these transfers;
• Eliminate any discount based on the transferee’s status as a mere 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 the nonfamily member has held the interest for more than three years, owns a substantial interest in the entity, and has the right, upon 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 are not mandated by federal or state law in determining the fair market value of the transferred interest; and
• Clarify the description of entities covered to include limited liability companies and other entities and business arrangements, as well as corporations and partnerships.

If the final regulations are similar to the proposed regulations, taxpayers will have lost a significant estate planning technique, and the tax cost of transferring interests in family-owned entities will increase.

UPDATE

The IRS backpedaled from what most perceived as the harsh tack of the Proposed Regs. Treasury officials suggested that all valuation discounts would not be eliminated and that the Regs were unlikely to be finalized until well into 2017, or later.