The government lost estate and gift tax cases that attracted headlines.
The government lost estate and gift tax cases that attracted headlines. In response, the Department of Treasury (“Treasury”) proposed new regulations in early 2016 that would amend definitions in the 1992 regulations that were problematic in the court cases. In addition, Treasury it added requirements designed to defeat valuation discounts in the estate and gift tax areas.
The 1992 regulation gave IRS the right to disregard certain provisions in shareholder partnership and operating agreements for purposes of estate and gift tax valuation. The 1992 regulations defined an applicable restriction, however, it applied only to a transferor and members of his or her family. An applicable restriction effectively limits the ability to liquidate the entity (in whole or in part) and is more restrictive than a limitation imposed by state law. The law in many states limits the ability of a partner in a partnership or a member in a limited liability company to liquidate the entity. The result was that one could rely upon state law to avoid any problem. A second aspect of the regulation was the definition of a lapse. A liquidation right would lapse when it was eliminated or restricted, so the mere transfer of an interest that held such a right was not a lapse. These rules provided a clear framework for planning and were an obstacle for the government.
The Proposed Regulations
The proposed regulations created a new class of restrictions called disregarded restrictions which are focused on impacting valuation. The first disregarded restrictions is any provision that limits or permits liquidation can be disregarded. Second, any amount received on liquidation or redemption is disregarded if it is less than minimum value. Minimum value is the pro rata share of the enterprise and this prevents discounts. Third, payment is deferred beyond six months after notice of liquidation is given may also be disregarded. Fourth, the agreement permits payment to be in any manner other than cash or property. Debt obligations of the entity are not property for this purpose unless the entity is engaged in an active trade or business.
The proposed regulations address state law restrictions. Only a state or federal law restriction that cannot be changed by the governing documents will not be an applicable restriction. In most states, the statute is the default rule so it is expected that any restrictions would have to be imposed by the written agreement. This change would impact discounts for lack of control and was intended as such.
The 1992 rules only applied to families while the proposed rules would expand coverage beyond the prior definition of family. An interest owned by a non-family member would be disregarded unless: (i) it was held for three years before the transfer under examination; (ii) the interest constituted 10% or more of the equity; (iii) nonfamily members must own 20% or more of the equity; and (iv) the nonfamily member has a put right on the terms specified in the proposed rules.
Additional Changes
There are additional changes, such as an assignee’s interest would be treated as a lapse in order to reduce or eliminate discounts which have haunted the IRS in the past. Finally, there are inconsistencies in the application of the effective date or dates. For example, if the new regulations are effective upon adoption or 30 days thereafter, then how can the rules require that an interest of a non-family member be held for three years? In effect, a blackout period is created by regulation.
What is clear is that Treasury and the IRS want to end discounts. The public hearing on the regulations attracted many negative comments from small business owners and professional organizations. This outcry and a change in the administration may put these regulations on hold. Succession planning faces a major hurdle if these rules are ever adopted in the present form.
Do you have any questions? Would you like to discuss the matter further? If so, please contact me, James McDonough, at 201-806-3364.
Navigating Director and Officer Liability in Times of Financial Distress
Director and officer liability increases sharply when a company is in financial distress. Decisions that would draw little attention in a healthy business can later be challenged by creditors, shareholders, bankruptcy trustees, and regulators as breaches of fiduciary duty, fraudulent transfers, or oversight failures. Understanding where that exposure comes from, and how to manage it, […]
Before You Buy: Managing Real Estate and Permitting Risk for BESS Projects in New York and New Jersey
For developers pursuing battery energy storage system (BESS) projects, finding the right property is only the beginning. BESS site selection is as much a legal and transactional exercise as a real estate decision, with risk analysis central to the project’s ultimate success. Key Takeaways The core questions for BESS site selection in New York and […]
What Business Owners Get Wrong Before Meeting a Litigation Attorney
What should you expect when meeting a litigation attorney about a business dispute? You should expect to describe the dispute in your own words, hand over the most important documents, flag any deadlines or immediate threats, and leave with a clearer picture of the problem, what information is still needed, and the likely next steps. […]
Arbitration vs. Litigation vs. Mediation: What New Jersey Businesses Should Know Before Signing a Contract
Arbitration resolves disputes privately before an arbitrator whose decision is usually final, while litigation resolves them in court with full rights of appeal. Whether a business ends up in arbitration or litigation is often decided when it signs the contract, long before any dispute arises. Key Takeaways When facing a contract dispute, carefully consider your […]
Can You Own Part of a New Jersey Business Without a Written Agreement?
Can you own part of a business in New Jersey without a written agreement? Yes, it is possible. Under New Jersey’s Uniform Partnership Act, a partnership can arise when two or more people carry on a business as co-owners for profit, whether or not they ever intended to form one. Ownership doesn’t necessarily depend on […]
Crisis-Proofing Your New Jersey Business: Building a Crisis Response Plan Before You Need One
For New Jersey businesses, crisis preparedness should be viewed as a legal and operational function, not simply an emergency-management exercise. A well-designed crisis response plan can help preserve evidence, protect confidential communications, meet reporting obligations, limit unnecessary exposure, and prevent an already difficult situation from becoming a larger legal problem. Key Takeaways A serious crisis […]
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
Sign up to get the latest from our attorneys!
Explore What Matters Most to You.
Consider subscribing to our Firm Insights mailing list by clicking the button below so you can keep up to date with the firm`s latest articles covering various legal topics.
Stay informed and inspired with the latest updates, insights, and events from Scarinci Hollenbeck. Our resource library provides valuable content across a range of categories to keep you connected and ahead of the curve.
Let`s get in touch!
Sign up to get the latest from the Scarinci Hollenbeck, LLC attorneys!
