§2704 Proposed Regulations: The Controversy Continues October 5, 2016

By Jonathan C. Wolnik

Early in August, the IRS published proposed regulations regarding valuation discounts on transfers of closely-held business interests to family members.  The proposal has generated varying interpretations of the government’s intent for contemplated transactions occurring in 2016 and going forward.  On September 30th at the American Bar Association’s Section of Taxation meeting in Boston, Ms. Catherine Hughes, an attorney-adviser to the Treasury Office of Tax Legislative Counsel, addressed the Treasury’s intent behind the proposed regulations.

Ms. Hughes stated that the government’s goal was to make §2701 and §2704 relevant in Treasury’s view after years of case law and state legislative developments created perceived escape hatches from the grasp of §2704 (i.e. reduced the Treasury’s tax collections).  According to Ms. Hughes, the government’s perceived abuse of the rules is addressed in the currently proposed regulations by disregarding certain restrictions that, in Treasury’s, view did not affect the value of the transferred interest.  Ms. Hughes believed the government’s intent was clear but she and Treasury were surprised by comments from the practitioner community.  She sought to assuage certain fears surrounding the proposed regulations and emphasized that there was no intent to limit or otherwise restrict typical discounts available for minority interests in closely-held businesses. It should be noted that Ms. Hughes comments on the government’s intent is not binding on the government. Unless the government restates its position to clarify its intent, these regulations may continue to be an area of controversy between practitioners and the government.

Ms. Hughes’ comments also addressed the timing for implementing the proposed regulations, noting that it is unlikely they will become effective by the end of calendar-year 2016.  Given the amount of public commentary, there appears to be a great deal of review required before finalizing the proposed regulations.  While the Treasury continues to actively seek constructive discussion from the practitioner community regarding the §2704 proposal, taxpayers and practitioners are on notice that past valuation practices may be subject to IRS challenge and may not be respected by the government.

The §2704 proposal is also the subject of legislation recently introduced in the House of Representatives to block the Treasury’s proposed changes to the valuation rules. Senate Republican leaders have expressed concerns that the Treasury proposals for such significant changes to the tax regulations in this area requires congressional action to change the underlying law and therefore is beyond the scope of the Treasury’s authority.

Despite the ongoing debate, time is of the essence, so those considering a future transfer of a closely-held business interest to family members are encouraged to actively engage in conversations with your attorney at McCarthy Lebit, Crystal & Liffman.  There may be opportunities to continue building and refining a strategy that provides the best outcome for you, your family and your business.

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