Proposed §2704 Regulations and Closely Held Family-Controlled Business Interests August 24, 2016

By Jonathan C. Wolnik

Many individuals have successfully built thriving enterprises that greatly contribute to the economic prosperity of their community and family.  Significant numbers of these businesses are structured as closely held or family-controlled businesses.  Interests in such entities can be extremely valuable.  Succession planning concerning these interests, whether for business continuity purposes or as part of an overall gift and estate tax planning strategy, has provided opportunities for transferring ownership at discounted values.  This is accomplished by using well-established valuation discounts.

The IRS is well aware of discounting techniques used to legally lower the fair market value of the transferred interest.  As such, on August 2, 2016, the IRS released proposed regulations that, if finalized in their current proposed form, will considerably restrict the availability and deployment of valuation discounts.  The proposed regulations undermine these favorable tax planning techniques by limiting or eliminating many of the discounts that are currently available.  Examples of areas affected by the proposed regulations include minority interest discounts, lack of control and marketability discounts, transferee status discounts, and discounts associated with liquidation that are not otherwise mandated by federal or state law.  The IRS is seeking to be all-inclusive in removing these discounts as the proposed regulations are broadly written to explicitly apply to corporations, partnerships, limited liability companies, and other business entities.  Given the scope and severity of this proposal, it is very likely that the final rules will result in sweeping changes to this tax planning area.

The proposed regulations will likely need to be adjusted for certain ambiguities that exist in the current form.  For example, it remains unclear whether the proposed regulations, if adopted, will affect transfers contemplated and completed between the date of the proposed regulations and when they are finalized.  Further, the IRS has scheduled a hearing on December 1, 2016, that may also result in additional changes.  Once the public comment period passes and the public hearings conclude, the IRS will issue the proposed regulations in their final form.  Once finalized, these regulations will become effective thirty days thereafter.  However, that is no reason to delay progress on your 2016 tax planning.

Given both the impact of the proposal and the inherent uncertainties, we strongly encourage you to contact us as soon as possible to discuss the ramifications that the proposed §2704 regulations may have on your business succession plan and your overall estate plan.  This proposal is broad sweeping, covering all forms and types of family-controlled businesses whether active operating businesses or passive holding businesses.  There may be opportunities to review and execute a strategy that produces the optimal result for your specific family and business needs.

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