TALKING POINTS OF NEW PROPOSED 2704 REGULATIONS Denver Estate - - PowerPoint PPT Presentation

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TALKING POINTS OF NEW PROPOSED 2704 REGULATIONS Denver Estate - - PowerPoint PPT Presentation

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CPAs & ADVISORS experience direction // TALKING POINTS OF NEW PROPOSED 2704 REGULATIONS Denver Estate Planning Council Meeting November 17, 2016 Presented by: Carol Lewis, CPA, ABV AGENDA Introduction Background Proposed regulations

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experience direction //

CPAs & ADVISORS

TALKING POINTS OF NEW PROPOSED §2704 REGULATIONS

Denver Estate Planning Council Meeting – November 17, 2016 Presented by: Carol Lewis, CPA, ABV

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AGENDA Introduction Background Proposed regulations Talking points Planning opportunities

2 // experience direction

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CAROL LEWIS, CPA/ABV

3 // experience direction

  • Firm wide leader of BKD’s business valuation services practice
  • 30 plus years of experience in valuation, accounting, tax & litigation support
  • Performed business valuation services for more 20 years, including valuations for

the purpose of financial reporting, estate and gift tax, employee stock ownership plans, divorce, shareholder disputes and mergers and acquisitions

  • Served as an expert witness and has provided testimony regarding business

valuation and damages

  • Accredited in Business Valuation (ABV) by the American Institute of CPAs.
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KEY TERMS & CONCEPTS Unified transfer tax system

  • Estate tax: transfers by reason of death
  • Gift tax: transfers during life
  • Generation-skipping transfer tax: transfers to skip persons

// Value transferred = fair market value of property passing from transferor

4 // experience direction

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KEY TERMS & CONCEPTS Fair market value (Rev. Rul. 59-60)

  • Price at which subject equity ownership interest would change hands between a

willing buyer & a willing seller when the former is under no compulsion to buy & the latter is under no compulsion to sell & both parties have reasonable knowledge of relevant facts

5 // experience direction

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POLLING QUESTION 1 Which of the following factors are provided by Rev. Rul. 59-60 as requiring careful analysis in determining fair market value? Type of business & its history since inception Economic outlook of general economy Book value & financial condition of a business All of the above Not sure

6 // experience direction

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KEY TERMS & CONCEPTS Valuation discounts

  • Adjustments to FMV in entity interest for
  • Lack of control/minority interest
  • Lack of marketability
  • Selling large blocks of stock
  • Fractional ownership interests
  • Impact of losing key person

7 // experience direction

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KEY TERMS & CONCEPTS Family limited partnership

  • Enable families to hold & manage wealth
  • Must have legitimate & significant nontax purpose
  • Often result in valuation discounts
  • Senior generation establishes FLP with

general & limited partner interests

  • Transfer LP units to trusts for descendants
  • Transfers discounted to reflect applicable

valuation discounts

8 // experience direction

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BACKGROUND Chapter 14 – §§2701-2704

  • Enacted to curtail perceived abuse of techniques to discount transfers for transfer

tax purposes

  • Disregards FMV concepts for certain transfer tax purposes

9 // experience direction

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CHAPTER 14 OVERVIEW

10 // experience direction

§2701 = Estate freeze §2702 = Trusts with retained interests §2703 = Options & buy-sell agreements §2704 = Lapses of voting & liquidation rights treated as transfers; disregards certain restrictions on liquidation of family entities

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WHAT IS §2704? §2704

  • Lapsing rights & restrictions can be used to lower value of interest in entity
  • Addresses perceived abusive structures in family-owned entities
  • Statutory framework
  • (a) Treatment of lapsed voting/liquidation rights
  • (b) Certain restrictions on liquidation disregarded

11 // experience direction

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KEY TERMS & CONCEPTS §2704(a) = Lapses

  • Lapse of any voting/liquidation right deemed as transfer for transfer tax purposes

if individual holding such right immediately before lapse & members of such individual’s family hold control of entity both before & after lapse

  • Value of deemed transfer = value of transferee’s units before lapse less value of

units after

  • See Estate of Harrison v. Commissioner (T.C. Memo 1987-8)

12 // experience direction

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KEY TERMS & CONCEPTS Voting right

  • Right to vote with respect to any matter of entity. Right of general partner to

participate in partnership management is a voting right

13 // experience direction

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KEY TERMS & CONCEPTS Liquidation right

  • Right or ability, including by reason of aggregate voting power, to compel entity to

acquire all/portion of holder’s equity interest whether or not exercise would result in complete liquidation of entity

14 // experience direction

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KEY TERMS & CONCEPTS Family member

  • Individual’s spouse
  • Ancestors
  • Lineal descendants
  • Siblings
  • Spouse of any such ancestor, lineal descendant or sibling

§2704(c)(2)

15 // experience direction

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POLLING QUESTION 2 Is transferor’s niece or nephew considered family member for purposes of §2704?

Yes No Not sure

16 // experience direction

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KEY TERMS & CONCEPTS Control

  • For corporations, holding at least 50% of total voting

power or total FMV of equity interests in corporation

  • For partnerships, holding at least 50% of either capital

interest or profits interest in partnership

17 // experience direction

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KEY TERMS & CONCEPTS §2704(b) = Liquidation rights

  • Any applicable restriction is disregarded in determining value of transfer of

interest in corporation/partnership to or for benefit of member of transferor’s family if transferor & members of transferor’s family hold control of the entity immediately before transfer

18 // experience direction

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KEY TERMS & CONCEPTS §2704(b) = Liquidation rights

  • Value determined for transfer tax purposes to be computed without

consideration of certain applicable restrictions

  • If restrictions are disregarded, transferred interest valued as if transferor’s rights

were determined under state law default provisions

  • Reg. §25.2704-2(c)

19 // experience direction

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KEY TERMS & CONCEPTS §2704(b) = Liquidation rights

  • Value determined using subtraction method
  • See Estate of Kerr v. Commissioner 113 T.C. 449 (1999)

20 // experience direction

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KEY TERMS & CONCEPTS Transfer of interest

  • Contribution to capital of new/existing entity
  • Capital structure transaction
  • Termination of indirect holding in entity if interest is held in grantor trust or

includable in gross estate of indirect holder before termination

  • Reg. §25.2701-1(b)(2))

21 // experience direction

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KEY TERMS & CONCEPTS Applicable restriction

  • Any restriction that
  • Effectively limits ability of corporation/partnership to liquidate
  • Restriction lapses (entirely or partially) after transfer OR transferor or family members can remove

restriction (entirely or partially)

§2704(b)(2)

22 // experience direction

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KEY TERMS & CONCEPTS

Applicable restriction

  • Except does not include
  • Any restriction imposed, or required to be imposed, by any federal or state law
  • Commercially reasonable restrictions imposed by unrelated persons in a financing transaction

§2704(b)(2)

23 // experience direction

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REASON FOR REGS

24 // experience direction

Current regulations substantially ineffective

  • Many states modified their

law to become more “taxpayer friendly”

  • Subsequent developments

Proposal to modify statute appeared in Treasury’s Green Book from 2010– 2013

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REASON FOR REGS

25 // experience direction

Proposed statutory changes dropped in favor

  • f Treasury issuing regulations

Statute grants broad authority for Treasury to issue regulations

  • 2704(a)(3): similar rights
  • 2704(b)(4): other restrictions
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POLLING QUESTION 3 New proposed regulations under §2704 have potential to impact all taxpayers holding interest in family-controlled entities

True False Not sure

26 // experience direction

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NEW PROPOSED REGULATIONS

27 // experience direction

Proposed regulations apply to all entities under state law regardless of classification for federal tax purposes Clarify control of entity = 50% Confirm assignee interest is treated as a lapse within meaning of §2704(a)

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NEW PROPOSED REGULATIONS

28 // experience direction

Extend §2704(a) to deathbed transfers – new three-year rule Refine definition of applicable restriction by eliminating comparison to liquidation limitations of state law

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NEW PROPOSED REGULATIONS

29 // experience direction

Provide bright-line test to disregard interest held by nonfamily member if any of the following apply Held less than three years before date of transfer Constitutes < 10% of value of all interests

Constitutes < 20% of value of all interests when combined with interests of other nonfamily members

Lacks right to put interest in entity & receive minimum value

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NEW PROPOSED REGULATIONS

Minimum value (Prop. Reg. §25.2704-3(b)(1))

  • Interest’s share of net value of entity on date of liquidation/redemption
  • FMV determined under §2031 & §2512 – property held by entity reduced by outstanding
  • bligations allowable as deductions under §2053

30 // experience direction

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NEW PROPOSED REGULATIONS

31 // experience direction

Adds new disregarded restrictions Limit ability of holder to liquidate interest Limit liquidation proceeds to an amount less than minimum value Defers payment of liquidation proceeds for more than six months Permits payment of liquidation proceeds in any manner other than cash/property (not inform of notes except in certain situations)

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NEW PROPOSED REGULATIONS New disregarded restrictions effectively value transfer of interests in family- controlled entities as if holder has a put right to sell interest to entity within six months for a value at least equal to a minimum value

32 // experience direction

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NEW PROPOSED REGULATIONS

33 // experience direction

Exceptions to safe harbor put right for commercially reasonable restrictions

  • Every owner has enforceable put right to sell interest to entity or other
  • wners
  • Payment must be made within six months of exercise of put right
  • Payment not in form of a note except for certain types
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NEW PROPOSED REGULATIONS

34 // experience direction

§2704(b) generally applies in computing marital deduction §2704(b) does not apply to transfers to charity or nonfamily members

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NEW PROPOSED REGULATIONS

35 // experience direction

Effective dates

  • Generally effective on & after date regulations are finalized
  • New disregarded restrictions effective 30 or more days after date

regulations are finalized (Prop. Reg. §25.2704-3)

Comments due November 2, 2016 Public hearing December 1, 2016

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POLLING QUESTION 4 What is the soonest the proposed regulations could be finalized? August 2, 2016 November 2, 2016 December 1, 2016 January 2, 2017 Not sure

36 // experience direction

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TALKING POINTS Far-reaching & broad Intended to largely eliminate use of valuation discounts on interests in family

  • owned

entities

37 // experience direction

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TALKING POINTS Reduce ability to apply valuation discounts to intrafamily transfers of interests in entities Apply to active trade/business entities

38 // experience direction

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TALKING POINTS Create uncertainty

  • Validity of proposed regulations
  • Application of new three-year rule
  • Valuation impact

Act now before effective date

39 // experience direction

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TALKING POINTS Action plan depends on estate tax exposure – Facing estate tax: discuss & potentially execute plans to transfer interests in family-

  • wned entities before effective date of proposed regs

– Not facing estate tax: consider modifications to ownership structure as undiscounted values in family-owned entities may provide income tax benefit

40 // experience direction

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POLLING QUESTION 5 What percentage of people in the United States would have no federal estate tax if they died today?

75% 88.8% 99.8% 100% Not sure

41 // experience direction

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PLANNING POINTS IF REGS ARE FINALIZED

42 // experience direction

Grantor Retained Annuity Trusts (GRATs) Promissory notes

  • §2701 affects estate freeze transactions
  • Senior generation keeps common interest & gives away preferred

Reverse freeze

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PLANNING POINTS IF REGS ARE FINALIZED

43 // experience direction

  • Ex-spouse
  • Unmarried couple

Nonfamily members Undivided interests in real estate

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CONCLUDING THOUGHTS

44 // experience direction

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QUESTIONS?

45 // experience direction

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THANK YOU

FOR MORE INFORMATION // For a complete list

  • f our offices and subsidiaries, visit bkd.com or contact:

Carol Lewis, Partner // clewis@bkd.com // 303.861.4545