The elimination of the proposed Section 2704(b) tax regulations re-opens significant opportunities for taxpayers to transfer substantial investment interests to family members at reduced gift tax costs.
The checkered history of the proposed Section 2704(b) regulations finally has come to a close. The proposed regulations were intended to severely limit the use of valuation discounts, and to crack down on “non-substantial” transactions; that is, transactions that the IRS considered to be motivated solely by tax considerations. The proposed regulations have now been officially rescinded, by the Second Report to the President on Identifying and Reducing Tax Regulatory Burdens, after a contentious public hearing for which over 28,000 comments criticizing their overreach and onerousness were filed.
The Second Report, issued by the Department of the Treasury under the authority of Treasury Secretary Steve Mnuchin, described the proposed Section 2704(b) regulations as “unworkable,” citing their complexity, lack of clarity, and burdensome effect on legitimate transactions. For these reasons, the Second Report concluded, the proposed regulations should be discarded.
The demise of the proposed Section 2704(b) regulations is excellent news for families with farms, small businesses, or other closely-held interests to pass on to younger generations. There is no longer a reason to hesitate when selling or gifting interests in such entities, now that the specter of disallowed discounts has vanished.
The demise of the proposed regulations also provides the opportunity for families to use family limited partnerships and limited liability companies, funded with marketable assets, as vehicles to take advantage of valuation discounts. However, tax planners are strongly cautioned to plan carefully in this arena. A valid business purpose must be present when implementing such a plan to prevent a possible successful challenge by the IRS of “form over substance.” Thus, taxpayers should always seek guidance from qualified tax and legal counsel before pursuing this tax planning strategy.
Charles F. Schultz III is a partner at FGMK LLC in Chicago, who leads FGMK's Estate and Succession Planning practice.
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