An Update on the Proposed Section 2704 Regulations

New regulations by the Treasury Department proposed earlier this year, formally entitled “Estate, Gift and Generation-Skipping Transfer Taxes; Restrictions on Liquidation of an Interest Regulations” (the Section 2704 regulations”) has business owners, accountants, and estate attorneys considering the best approach to deal with the potential for significantly higher estate tax liabilities.

The Section 2704 regulations, proposed on August 2, 2016, would limit the ability to apply valuation discounts to intra-family transfers of interests in entities such as partnerships and limited liability companies. Such transfers have been a common estate planning strategy to lower gift and estate tax liabilities, and the Section 2704 regulations have many concerned about the resulting tax implications.

Modifying the original regulations (enacted in 1990) the Section 2704 regulations make a number of proposed changes, including, among others, limiting deathbed transfers, modifying the concept of applicable restrictions on liquidation rights, and adding a category of “disregarded restrictions” in connection with interest redemptions and entity liquidations. In the more than four months since the Section 2704 regulations were proposed, thousands of critical comments were submitted, including many calling for the withdrawal of these regulations altogether.
Several hours of testimony against the Section 2704 regulations were provided at a December 1, 2016 hearing before the Treasury Department.

One of those who expressed unhappiness with the Section 2704 regulations was the AICPA. AICPA Representative Michelle Gallagher directly addressed the ambiguity of the language in the Section 2704 regulations and sought clarification on many points while acknowledging the Treasury’s desire to address certain tax abuses the AICPA urges Treasury and the IRS to withdraw the proposed regulations,” said Gallagher. “If that is not pursued, then Treasury and the IRS should take into consideration the points we have raised and issue new, clarified proposed regulations for public comment,” she continued, expressing skepticism about the regulations as they exist in their current format.

The Section 2704 regulations are not a complete surprise and have been anticipated for years. Indeed, changes to the original 1990 regulations have been on the radar for the Treasury Department and IRS since 2003. Last year, following statements hinting at the impending release of the Section 2704 regulations made by Cathy Hughes, a tax lawyer with the Treasury Department’s Office of Tax Policy, at the American Bar Association’s Real Property, Trust and Estate Law Conference, business valuation and estate planning specialists began commenting about what they thought the valuation discount and other related rules in those regulations would look like.

Now that the comment period and the public hearing have passed with considerable objection from taxpayers and practitioners, it is up to the Treasury Department to decide how or if to implement the Section 2704 regulations. Already, accountants and other tax professionals are beginning to make recommendations for how business owners and their families can plan for the Section 2704 regulations. Some suggest transferring interests in those entities that would be impacted should the Section 2704 regulations be finalized largely as proposed, while others discuss increasing the liquidity of estate assets.

Whatever final decision is made regarding the Section 2704 regulations, business owners looking for expert guidance on how best to manage their estate planning needs should call the tax and wealth professionals at MSPC.