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Monday, August 22, 2016

Not Family Attribution Again: Proposed Section 2704 Regulations


On August 2, 2016, the IRS issued Proposed Regulations 2704 in an attempt to reduce/eliminate valuation discounts. There is a 90-day comment period, and the regulations they are not expected to be finalized until 30 days after this, which would be early January 2017.

History appears to be repeating itself with the latest Proposed Section 2704 Regulations. Back in 1981, in Revenue Ruling 81-253, the IRS took the position that where the stock owned by the family unit constituted a controlling interest on a combined basis, no minority discount would generally be available for intra-familial transfers of blocks constituting less than a controlling interest. This attempt was officially unsuccessful with the issuance of Revenue Ruling 93-12, holding that a sole stockholder of a corporation who gave a 20% interest to each of his five children would not be denied a minority discount in valuing those shares solely due to the factor of corporate control in the family.

Without going into the Proposed Section 2704 Regulations in depth, the IRS appears to taking another attempt at family attribution to reduce or eliminate valuation discounts for intra-family transfers, despite the Tax Courts’ repeated rulings against this position. However, the position of the Treasury Department and the IRS is that they are acting under

Section 2704(b) (4) Other Restrictions: “The Secretary may by regulations provide that other restrictions shall be disregarded in determining the value of the transfer of any interest in a corporation or partnership to a member of the transferor’s family if such restriction has the effect of reducing the value of the transferred interest for purposes of this subtitle but does not ultimately reduce the value of such interest to the transferee.”

The Proposed Regulations do not take into account the market-based transactions of similar interests, potential family disagreements and dysfunction, or the legitimate business reasons for parents to make gifts of non-controlling, non-marketable interests to their children. Lastly, the proposed regulations ignore the definition of Fair Market Value in Revenue Ruling 59-60, where the buyer is defined as a hypothetical buyer. 

The Proposed Regulations are construed by many to be an attempt by the IRS to rewrite the tax code, a power specifically provided to Congress, not the Executive branch of the Federal government. 

While the IRS does not appear to have a strong hand with its proposed regulations. However, because of their potential impact, taxpayers may want to consider taking action before year-end if they hold interests in entities which essentially are closely held by the family.

For individuals, we recommend that you contact your Armanino tax advisor to ensure that intra-family gifts are made by December 31, 2106. Family law attorneys can contact Armanino’s experienced Valuations team to support their clients.

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