Anticipated 2704 Valuation Discount Regulations

Authored by: Dana L. Mark

In 1990 Chapter 14 (Special Valuation Rules) was added to the Internal Revenue Code to prevent the manipulation of the transfer tax value of a proprietary interest in certain entities in the context of transfers between related parties. In other words, what discounts ought to be taken into account in valuing the transferred interest if control of the entity remains within the family. Included among the new rules was Section 2704 dealing with the treatment of certain lapsing rights and restrictions. Essentially, in the context of a family held entity, if the interest in the entity is transferred to or for the benefit of a member of the transferor’s “family” the value of any “applicable restriction” is disregarded.

Family for this purpose means an individual’s ancestors, lineal descendants, siblings, and spouses of all of them.

An applicable restriction is a limitation (i) on the ability to liquidate the entity that is more restrictive than the default rule under state law, and (ii) which lapses at any time after the transfer or where members of the transferor’s family can remove it after the transfer. The bottom line in disregarding the restriction is that the transferred interest is valued as if the restriction does not exist.

Section 2704(b)(4) provides that the Secretary may by regulations provide that other restrictions shall be disregarded in determining the value of any interest in a corporation or partnership to a member of the transferor’s family if such restriction has the effect of reducing the value of the transferred interest but does not ultimately reduce the value of such interest to the transferee.

For most years since 2003 the Treasury Department, in its Priority Guidance Plan, called for guidance under Section 2704 regarding such restrictions on liquidations. Finally, this past Spring Cathy Hughes, an Estate and Gift Tax Attorney Advisor in Treasury’s Office of Tax Policy, indicated that the proposed regulations should be expected in early Fall 2015.
So what will the regulations cover? At this point, there are no clear answers. Potentially, the regulations could:

  • Limit the application of discounts applied for lack of control (minority interest) and lack of marketability.
  • Apply only to passive entities, e.g., those holding cash and marketable securities, and leave operating businesses for another day.
  • Add restrictions in addition to restrictions on liquidation.
  • Provide safe harbors for drafting the entity’s governing documents to avoid the application of Section 2704.
  • Provide a de minimus rule with respect to non-family ownership in determining who can remove a restriction.

Also uncertain is the effective date of the regulations – although regulations are generally effective when finalized, it would not be surprising if they are immediately effective. Transfers already effectuated should be protected from the new regulations; however, the fact that the entity already exists would likely not insulate post-effective date transfers.

For more information, please contact Dana Mark.

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