IRS Proposes Regulations to Prevent Perceived Undervaluation
September 29, 2016
The Internal Revenue Service has issued proposed regulations designed to prevent what the IRS believes is the undervaluation of intra-family transfers of interests in corporations and partnerships for estate, gift and generation-skipping transfer tax purposes. Specifically, the proposed regulations address the treatment of discounts related to certain lapsing rights and restrictions on liquidation when determining the value of transferred intra-family interests, including a new three-year look-back rule.
Clarification of 1990 Law
The proposed regulations clarify that Internal Revenue Code Section 2704 applies to corporations, partnerships, and LLCs, as well as other entities and arrangements that are business entities, regardless of whether the entity or arrangement is domestic or foreign, or how the entity or arrangement is classified, or disregarded, for federal tax purposes.
The law dealing with limiting discounts for certain intra-family transfers of partnerships or LLCs was enacted in 1990. The law was concerned with the lapsing of voting or liquidation rights, considering any continuing family control of the subject entity both before and after the lapse as a deemed transfer. The law also provided that any “applicable restriction” be disregarded when an interest in a family controlled corporation or partnership is transferred to a family member.
When the law was enacted, the IRS was given authority to develop regulations to provide its position on how to value transfers of intra-family entity interests, particularly when disregarded restrictions are present in the transaction. The proposed regulations, now issued roughly 26 years after the law was enacted, are the result of this authority.
Proposed regulations do not have an immediate effective date. The proposed regulations, when, and in some ways if, made final as written, will apply only to transactions made 30 days after the regulations become final. However, the effective date could be complicated if the transferor of an intra-family entity interest dies after the effective date of the regulations, but within three years of the date of transfer.
Cutting through all the technical wording, the proposed regulations, when finalized, will significantly reduce, or even eliminate, the ability to apply valuation discounts to intra-family transfers of interests.
The proposed regulations are very controversial. The IRS has asked for and should receive many comments related to the final implementation of the regulations at a hearing scheduled to take place on December 1, 2016. While there is little doubt the IRS will push for early finalization, the controversy and complexity of how the new rules appear to go against years of case law development should slow the finalization process until at least mid to late 2017, if not longer.
Some Could Benefit
But, planning considerations should not wait on the finalization process. And, while it is dependent on the estate tax rules in effect at the time, the new rules may even be of benefit to some taxpayers where basis considerations come into play.
Although there are still many unknowns as to how the proposed regulation finalization process will work its way through, now is the time to consider what planning needs to be done and transactions completed, if any, while the regulations are still in proposed form.