Proposed changes to Internal Revenue Code (IRC) § 2704, which would impact the valuation of transfers of family business interests at death, come at an interesting time politically given the Trump Administration’s desire to eliminate the federal estate tax altogether.
The regulations proposed in § 2704 will at least be delayed, if not outright halted, in light of President Trump’s executive order mandating that federal agencies eliminate two rules for every new one adopted. A January White House memorandum that put a freeze on all federal rulemaking pending the administration’s review of existing proposals could raise additional roadblocks to the implementation of the Treasury’s proposed regulations.
The proposed regulations, issued in August 2016, seek to limit the ability of family business owners to obtain valuation discounts on transfers of their business interests at death, thereby increasing their potential estate tax burden. Section 2704 sets forth valuation rules for purposes of estate, gift and generation skipping transfer taxes. Until now, restrictions on voting and liquidation rights of business interests passing through decedents’ estates have created discounted valuations for estate tax purposes. This valuation discount comes as the result of a lack of marketability and control of the restricted business interests.
The proposed regulations would allow the IRS to disregard “deathbed” restrictions placed on business interests and the discount that has typically accompanied such restrictions. The IRS would instead treat any termination of voting and liquidation rights occurring within three years of the business owner’s death as a transfer at death for § 2704 valuation purposes. This means the entire value of the business owner’s transferred interest would be included in his or her taxable estate irrespective of any restrictions that take effect at the business owner’s death.
However, the Trump administration’s proposed estate tax repeal could negate the effect of such a proposal (depending on what replaces the estate tax) since the transfer of business interests at death would not cause a taxable event. Speculation abounds over what kind of transfer tax regime might take the place of the estate tax if it is repealed, with some predicting a retention of the gift tax, reimplementation of a carryover basis regime, and/or a tax imposed on unrealized capital gains at death.