Baldwin Haspel Burke & Mayer LLC

BHBM Tax Law Alert 8/5/2016


In this newsletter you will find information on recent updates and changes in the law on the state level following the Louisiana Legislative special session. If you have any questions, please feel free to contact John Rouchell or Andrew Sullivan at (504) 569-2900.

The Louisiana Estate Planning Handbook

Our tax and estate planning attorneys have published an update on The Louisiana Estate Planning Handbook: A Guide for the Professional Advisor. Click here to access the order form to secure your copy today. Click here to view the handbook’s table of contents.


Estate Planning Techniques for Closely-Held Family Businesses Under Attack

On August 2, 2016, the Department of the Treasury published Proposed Regulations interpreting Internal Revenue Code (“Code”) Section 2704. Section 2704 was enacted in 1990 as part of new Chapter 14 of the Code providing special valuation rules for transfer tax purposes (gift, estate and generation skipping transfer taxes). After twenty-five years of disappointments in court, the IRS now proposes Regulations which, if made final, would drastically and punitively change planning for generational transfers of closely-held family entities. In brief, the Proposed Regulations are designed to limit valuation discounts on transfers of family-owned entities.

Because of the potential impact the Proposed Regulations would have, if issued as final Regulations, it is essential that taxpayers who own interests in closely-held entities consider potential planning techniques (including making any contemplated gift transfers) prior to the issuance of the final regulations. Failure to take action now could result in the inability to leverage currently available valuation discounts on gift transfers of family-owned entity interests.

A more detailed summary of the background surrounding Section 2704 and the provisions of the Proposed Regulations are set forth below.


Section 2704 was enacted to eliminate perceived valuation abuses related to the lapsing of voting and liquidation rights, as well as certain restrictions on liquidation for transfers of interests in entities controlled by family members. Specifically, Section 2704(b)(1) of the Code provides that if there is a transfer of an interest in a closely-held entity to (or for the benefit of) a member of the transferor’s family, and the transferor and his or her family members hold control of the entity immediately before the transfer, any “applicable restriction” on the transferred interests shall be disregarded in determining the value of said interest.

The Code defines an “applicable restriction” as any restriction that effectively limits the ability of the entity to liquidate where either: (i) the restriction lapses, in whole or in part, after the transfer; or (ii) the transferor or his or her family members (alone or collectively) can remove the restriction, in whole or in part. Nevertheless, an “applicable restriction” does not include: (i) any restriction imposed (or required to be imposed) by federal or state law; or (ii) any commercially reasonable restriction which arises as part of any financing by the entity with an unrelated party. Many states have enacted statutes imposing such transfer restrictions which has historically permitted discounts to be considered in valuing such interests for transfer tax purposes.

Section 2704(b)(4) provides that the IRS has the authority to issue regulations that would disregard other restrictions when determining the value of the transferred interest if such restriction has the effect of reducing the value of the transferred interest, but does not ultimately reduce the value of such interest to the transferee. In essence, Section 2704(b)(4) left the valuation provisions of Section 2704 open to amendment through the issuance of regulations. The Proposed Regulations were issued pursuant to this provision and are designed to eliminate perceived planning abuses.

I Will Not Be Ignored! 

The check-the-box regulations disregard certain entities such as single member limited liability companies for all purposes of the Code.

The Proposed Regulations would make an exception to recognize otherwise disregarded entities, such as single member LLC’s and qualified subchapter S subsidiaries, for purposes of Section 2704 which generally applies to entities where a family (including spouses, ancestors, lineal descendants, brothers and sisters and spouses of the foregoing) hold, directly or indirectly, at least 50% of the equity. In addition to attribution, control is determined by “looking through” tiered entity structures. Almost every family business will be covered under Section 2704, even formerly disregarded entities.

Lapse? What Lapse?

Section 2704(a) provides that when an entity is controlled by the family both before and after a transfer of an interest, a “lapse” of a voting or liquidation right is treated as an additional transfer by gift or at death equal to the excess, if any, of the fair market value of the interest with the lapsing rights over the value without the rights. This provision clearly would apply, for example, where the organizational documents or agreements of the entity would provide that voting rights would be eliminated on transfer of an interest to maintain control within the original equity holders.

The Proposed Regulations now take the position that Section 2704(a) applies whenever there is a transfer of a controlled family entity interest, even where the voting and liquidation rights are not actually eliminated but are transferred as well, unless the transferor survives the transfer by three years. If the transferor does not survive the required three-year period, his or her estate will have an additional taxable asset equal to the excess in value of the interest with and without the “lapsed” rights. It would appear that the voting and liquidation rights attributable to a transferred interest during a donor’s lifetime may be subjected to transfer tax twice. What if the transferred interest was a non-voting interest to begin with?

State Law – Who Cares? 

In order for a federal transfer tax to be valid under the U.S. Constitution, it must be an excise tax on the “privilege” of transferring the property. Otherwise the tax would be a federal property tax which must be apportioned among the states. The U.S. Supreme Court held long ago that state law determines property rights, and transfers of those rights, so determined, are taxed by federal law.

Section 2704(b) provides that certain “applicable restrictions” on a controlled entity’s ability to liquidate will be disregarded in valuing the transferred interest, unless such restriction is “imposed” by federal or state law. The current Regulations exclude from the definition of an “applicable restriction”, those which are no more restrictive than the underlying default state law rules applicable to the entity involved. As a result, a transferred non-marketable, minority interest would be valued taking into consideration the fact that the willing buyer (without a face or name) would not be able to force the entity to liquidate.

The Proposed Regulations would eliminate the exception for default state law provisions and would effectively prevent state legislatures from enacting laws determining the liquidation rights of equity holders of entities having an effect on transfer tax valuation. The logical conclusion to this approach would be the valuation of interests in controlled family entities as if there were no state law limits on liquidation. This would treat every equity owner as if he has an option to put the interest for cash at any time, presumably forcing a proportionate net asset value approach. Of course, this is inconsistent with valuation discounts or adjustments traditionally appropriate for an interest in an entity which is a going concern.

Family Business as an ATM Machine!

Section 2704(b)(4) authorizes the Treasury to create regulations which would provide additional restrictions on liquidation of a controlled family entity to be ignored for transfer tax valuation purposes if such restrictions have the effect of reducing the transfer tax value of the transferred interest but would not “ultimately reduce the value of such interest to the transferee.”

The Proposed Regulations have created a number of new restrictions to be disregarded for transfer tax valuation purposes. Basically, all restrictions inconsistent with the interest holder having the power to liquidate the interest for less than a “minimum” net asset value, payable in cash within six months are ignored for valuation purposes. By process of elimination, all interests in closely-held family entities would be treated as if the holder’s share of the entity’s net asset value is readily available for valuation purposes, regardless of the actual facts and circumstances. The family business is an ATM machine!

Wouldn’t the actual facts and circumstances “ultimately reduce the value of the interest to the transferee”, which would make the Proposed Regulations beyond the provisions of Section 2704(b)(4) and, consequently, invalid?

In order to determine the restrictions on the ability of the family to force a liquidation, the Proposed Regulations disregard the actual ownership of non-family members, including charities, unless the non-family member has previously held at least a 10% interest for a minimum of three years and total interests of all non-family members totals at least 20%.


Closely-held family businesses are the backbone of the economy and account for the vast majority of new job creations. The Proposed Regulations, if finalized and if they survive constitutional and regulatory challenge, will have a negative effect on our clients’ ability to plan for the orderly transition of ownership to the next generation.

A public hearing is scheduled for December 1, 2016, in Washington, D.C. to discuss the Proposed Regulations. If finalized, the Proposed Regulations generally will be effective for lapses of rights occurring on or after the date of publication in the Federal Register.

Owners of closely-held family entities should contact their Congressional Representatives immediately. Owners should consult their tax advisors as soon as possible to review their prior estate planning and to consider moving forward with additional planning transactions before mid-December of this year. Taxpayers who fail to act prior to the issuance of the final regulations will likely be precluded from obtaining historical discounts for lack of marketability or control on transfers of interests in family controlled entities for estate, gift and generation skipping tax planning.


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The information contained within this newsletter does not constitute legal advice and is not intended to create an attorney-client relationship. You should consult an attorney for individual advice regarding your own particular situation.



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