The IRS is recommending the withdrawal of a proposed regulation change that had been especially dreaded by the owners of some family-held businesses and their heirs.
The IRS last year issued proposed regulations designed to reduce the ability to take valuation discounts on intra-family transfers of interests in privately-held businesses. The regulations aimed to reduce the ability to apply valuation discounts, which can affect future estate and gift tax planning.
The IRS along with the U.S. Department of Treasury issued a report recommending the complete withdrawal of these regulations, known as Section 2704, Restrictions on Liquidation of an Interest for Estate, Gift or Generation-Skipping Transfer Taxes.
This section describes special valuation rules for intrafamily transfers of interests in family-controlled entities. The proposed regulations were intended to reduce the use of such entities to generate artificial valuation discounts (for example, for lack of marketability or control) that depress the value for gift and estate tax purposes.
They specifically address the valuation of interests in corporations and partnerships for estate, gift and generation-skipping transfer tax purposes and the treatment of lapsing rights and restrictions on liquidation when valuing transferred interests.
The regulations narrow well-established exceptions and expand the class of restrictions on the ability to liquidate family-controlled entities that are disregarded under Section 2704 when valuing an interest for transfer tax purposes. They also require an interest in a family entity to be valued as if disregarded restrictions didn’t exist and don’t allow exceptions for interests in active or operating businesses.
The IRS accepted public comment on the proposed change, and commenters complained that it wasn’t reasonable to value an entity interest as if no restrictions on withdrawal or liquidation existed in either the entity’s governing documents or state law.
The Treasury Department and the IRS agreed, deeming the proposed regulations’ approach to the problem of artificial valuation discounts “unworkable.” Among other problems, they found, the regulations could have affected valuation discounts even where factors like lack of control or marketability weren’t created artificially to depress value (for example, where restrictions were created to keep a business in the family).
Notably, the report contained no indication that further guidance on this issue is forthcoming. It states only that the proposed regulations should be withdrawn in their entirety. This is encouraging news for family business owners who wish to pass their businesses to their relatives.
The withdrawal of the Section 2704 regulations should also allow practitioners to breathe a temporary sigh of relief. It is unclear whether Treasury will go back to the drawing board at this time or will wait to see what might happen legislatively with respect to a possible repeal of the estate tax.
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