The effect of proposed IRS regulations on estate planning


In August, the Internal Revenue Service (IRS) issued proposed regulations that will have a substantial effect on estate planning techniques often utilized by family-controlled entities. The proposed regulations, under Internal Revenue Code (IRC) sections 2701 and 2704, curtail the ability to use certain lapsing rights and restrictions on liquidations, when determining the value of transferred interests. 

 

The new rules provide clarification that family-controlled entities — to which IRC section 2704 is applicable — include corporations, partnerships, limited liability companies and any other business entities. They also govern valuation methods for intra-family transfers of interests in those family-controlled entities that are subject to certain lapsing voting or liquidation rights and restrictions. The rules now generally apply that, if there is a lapse of a voting or liquidation right in a family-controlled entity, — and the person holding that right immediately before that lapse, and their family members hold, before and after the lapse control of the family-controlled entity — the lapse will be considered a gift transferred by that person, or a transfer to be included in the gross estate, whichever is applicable. In determining control of the entity, the IRS defines control as 50 percent or more of the equity, capital or profits.  Attribution rules will also have an effect on determining control.  One example of how the proposed regulations impact estate planning techniques: Parents gift their child with a non-voting, minority interest in the operating family business.  Prior to the new rules taking effect, the value of the interest gifted could be discounted due to it being a minority interest and due to the fact that the interest was a non-voting interest. When the new rules take effect these discounts will no longer be allowed.

 

These proposed regulations are intended to be finalized on December 1st of this year; however, a great deal of feedback from tax professionals is expected, especially since these regulations apply to active trades or businesses. 

 

We will continue to monitor the progression of these regulations, and are committed to keeping you informed.