IRC Section 2704 Proposed Regulations

Treasury published long-awaited proposed revisions to the existing I.R.C. Section 2704 regulations on August 4, 2016. 81 Fed. Reg. 51413. If published as final regulations in current form, the revisions will inhibit transfers of closely-held business interests to family members. Treasury provided a reprieve by postponing the effective date of the proposed regulations until such time as they are published as final regulations, with the proposed regulations setting forth disregarded restrictions specifically applying only to transfers occurring 30 or more days after the regulations become final. Prop. Treas. Reg. § 25.2704-4(b).

Proposed regulations acknowledge that Congress enacted I.R.C. Section 2704 to curtail the planning strategy successfully used by the decedent's estate in Estate of Harrison v. Commissioner, T.C. Memo 1987-8. The proposed regulations, however, seek to interpret the parameters of I.R.C. Section 2704 more broadly to curtail current planning strategies upheld by courts and allowed by current regulations. The proposed regulations attack the viability of estate planning strategies where the transferor and the transferor's family control the corporation before and after the transfer.

The proposed regulations target estate planning strategies used prior to publication of the proposed regulations in five ways:

(1)   Transfers made within three years of death that cause a lapse of a voting or liquidation right with respect to the entity interest passing from the hands of the transferor to the transferee will trigger gross estate inclusion of the lost value attributable to a minority or similar discount.

(2)   The lapse of a voting or liquidation will be deemed to occur on the transfer of an assignee interest. Transfers of partnership interests typically cause the transferee to hold the interest as an assignee without any voting or management rights and the proposed regulations will deem this to be a lapse.

(3)   Liquidation restrictions imposed by state and federal law will generally fall within the definition of "applicable restriction" despite the exception specifically provided by statute because of a new and more narrow reading of what it means for a restriction to be "imposed, or required to be imposed" by law.

(4)   A newly minted category of "disregarded restrictions" will apply; specifically, a disregarded restriction will be one that limits the transferee's ability to liquidate the interest, limits liquidation proceeds to less than a "minimum" value; defers payment of liquidation proceeds beyond six months, or permits payment of the liquidated amount in other than cash, property or certain notes. As defined in the proposed regulations, liquidation value will in almost all cases be required

(5)   In determining whether the transferor and the transferor's family can remove a liquidation restriction, certain interests of non-family members will be disregarded. In addition, for valuation purposes the regulations will treat the interest passing to family members as separate from that of nonfamily members.

Proposed regulations change the rules as set forth in I.R.C. Section 2704(a) and its interpretation in current regulations and by the courts. The proposed regulations apply a newly constructed three-year rule to deem a lapse on the transfer of a minority interest by a transferor who prior to the transfer held a majority interest. The proposed regulations also "confirm" the transfer of an interest that in the hands of the transferee converts to an assignee interest constitutes a lapse. 

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