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IRS Proposed Changes to IRC 2704 Affect Business Succession and Estate Planning Valuation Discounts

The IRS stands poised to take definitive action respecting its long-standing aversion to valuation discounts utilized in business succession and estate planning. On August 2, 2016, the United States Treasury Department issued proposed regulations under Section 2704(b). The proposed regulations, if enacted, stand to severely limit valuation discounts associated with transfers of intra-family interests held in family limited partnerships (“FLPs”) and limited liability companies (“Family LLCs”).

Since 1990, when the Internal Revenue Code (“IRC”) Section 2704 that deals with the treatment of limited voting rights and other restrictions became effective, attorneys have counseled their clients with respect to the formation of family owned partnerships and limited liability companies as an effective family wealth management and estate planning vehicle. Traditionally, the entities would be created to hold family investments or business interests. In addition to the centralization of management that these entities afford, the FLP and Family LLC structures facilitate estate planning by permitting distribution of participatory interests in the entities rather than portions of individual assets. Traditionally, under IRC Section 2704, if the transferred interests were fractional shares or were otherwise encumbered by restrictions on transfer and voting or control, the limitations supported discounts in the value of the transferred interest. The lower valuation would, in turn, result in reduced estate and gift taxes.

The IRS has long sought to curtail these valuation discounts. Prior to the new proposed regulations, IRC Section 2704(b) had disregarded restrictions affecting marketability in only certain and very defined circumstances. The proposed regulations, however, go much further. Newly proposed regulation §25.2704-3 provides that restrictions on marketability or control will, in most cases, be disregarded in assessing fair market value for valuation purposes.

The proposed regulations are complex. Most practitioners in the trusts and estates field are opining that the proposed regulations extend too far. For example, rather than targeting only closely held family entities, the proposed regulations infringe on intra-family transfers in well-established businesses where business succession and active participation are part of a family business succession plan.

Certainly, the proposed regulations are not law as of yet. There is a hearing on the proposed regulations on December 1, 2016 and the proposed regulations do not become law until 30 days after the regulations become final. Until the hearing, the IRS is inviting the public to submit their commentary. However, if changes implemented as proposed, they stand to have a dramatic impact on business succession, gift and estate planning. As with any significant change, it is important to revisit your estate plan in light of the impending change and discuss with your financial and estate planning professionals how these changes may impact your estate plan.

For more information on the topic discussed, contact Yolanda Kanes, Chair of Tannenbaum Helpern’s Trusts & Estates practice, at kanes@thsh.com or at 212.508-6721.


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