Proposed Regulations for Section 2704 of the Internal Revenue Code

Today, valuation discounts are permitted for interests in closely held family entities for transfer tax purposes. However, proposed regulations under Section 2704 of the Internal Revenue Code were released on August 3, 2016 to curtail this use of valuation discounts.

By way of background, a closely held family entity may be in the form of a corporation, limited liability company, limited partnership, or other entity.  US transfer taxes include the estate, gift and generation skipping transfer taxes, and are generally applicable when interests in a closely held family entity are gifted (or sold at less than fair market value) or pass upon death either outright or in trust.

For transfer tax purposes, the value of a minority interest in a closely held entity is often discounted for lack of control. A discount is also permitted by reason of the inherent lack of marketability of an interest in a closely held entity. These discounts have been applied to interests in closely held family entities as well. The transfer tax value of an interest in a closely held family entity can be substantially reduced through application of theses discounts.  This reduction in value can result in a reduction or elimination of the transfer tax cost of transfers between family members. This is what the proposed regulations are trying to stop.

A public hearing on the proposed regulations is scheduled for December 1, 2016. Generally, the final regulations won’t become effective until at least 30 days after they become final. Accordingly, valuation discounts will continue to be available for transfers of interests in closely held family entities made before the date the regulations become final.  It is not too late to take advantage of this opportunity.

Commonwealth Trust Company is pleased to provide this article as a guide. Commonwealth Trust Company is not engaged in the practice of law and is not providing legal advice by the provision of these materials. Commonwealth Trust Company recommends that clients seek the opinion of their attorney regarding the specific legal and tax issues addressed in this article.