If you’re a family business owner or you created a family limited partnership (FLP), you may be wondering about the proposed Treasury Regulations that were released earlier this month.  You may have even tried to read an article or two on the topic.  If you’re wondering whether you should care about the proposed regulations and why, please read on.


Valuation discounts for transfers of business interests between family members can be a powerful gift and estate tax planning tool.  Most discounts relevant to this discussion can be put into two general classifications: (1) lack of control, and (2) lack of liquidity.

Lack of control discounts arise most typically when the interest is not large enough to control the entire entity, such as a minority voting interest of 49% or less.  They can also apply when transferring interests that lack control because of the structure of the entity, such as non-voting stock or a limited partnership interest.

Lack of liquidity discounts come from the difficulty in reducing an interest to cash.  This could flow from restrictions on sale, or from an inability of the holder of an interest to compel distributions of cash.

When combined together, these discounts can significantly reduce the tax value of an interest, sometimes by as much as 40-50%.  A parent might have an interest in a $20 million family business, but be able to transfer that interest to children at a value of only $10 million, potentially saving $4 million in gift tax (assuming a 40% gift tax rate on the $10 million of discounted value).

Not surprisingly, however, the IRS examines these types of transfers with closer scrutiny than they do transfers between unrelated parties.  In fact, there are several provisions of the Internal Revenue Code that govern how to value transfers of interests between family members.  They are contained in Chapter 14 (Sections 2701, 2702, 2703 and 2704) of the Code.  These provisions essentially attempt to restrict the use of valuation discounts for certain transfers between family members.  The new proposed regulations relate to section 2704 of the Code and, if adopted in final form, would restrict the use of valuation discounts even further.

In order to know whether the proposed regulations may affect you, the starting point should be whether your net worth is high enough to subject you to an estate tax.  If so, and if you also have a family business or an FLP, or you are considering either of these, the proposed regulations may impact you.

New three-year lookback for gifts affecting control or liquidation rights

Under the proposed regulations, if you transfer an FLP or family business interest[1] to a family member that resulted in the lapse of a voting or liquidation right, and you die within three years, the lapse is treated as having happened at death.  This essentially means that the value of the right that the donor “gave up” is still includible in his estate.   This probably doesn’t mean much without a concrete example, so read on.

Imagine Dad initially owned 60% of the family business, but transferred 10% to his son and 10% to his daughter.  Dad now owns only 40% of the business – a non-controlling interest.  So if Dad dies two years later, the fair market value of that 40% in his estate should be discounted to reflect the fact that he no longer has control, right?  Not under the proposed regulations.  Under the proposed regulations, a minority discount basically cannot be taken into account when valuing the 40% interest in Dad’s estate if he died within three years of the transfer.

In addition, the proposed regulations now capture transfers to an “assignee.”  An assignee is the term for someone who has been transferred an interest in a partnership, but has not yet been admitted as a partner by the other partners.  Because an assignee does not have full partnership rights (such as forcing a liquidation or cash distribution), ensuring that a transferee is merely an assignee is a way of further increasing the discounts on the transfer.  The proposed regulations, however, would apply the new three-year lookback to lapses on transfers to assignees, not just lapses on transfers to full partners.

Use of valuation discounts for liquidation restrictions would be very limited

In general, if a business interest is subject to a restriction on liquidation or redemption, its fair market value would be discounted to take the restriction into account.  But when a transfer of an interest like this is made between family members, the ability to claim a discount is more limited.    The current Chapter 14 provisions regarding discounting on transfers of family-controlled entities contain several technical rules for determining whether a restriction on redemption or liquidation will be respected.  According to the IRS, taxpayers have been able to “game” these rules by incorporating certain restrictions into their partnership agreements that did not run afoul of the rules and, as a result, ostensibly warranted a sizeable discount.

In order to address this, the proposed regulations narrow even further the type of liquidation and redemption restrictions that would permit the use of a valuation discount.  Not surprisingly, the mechanisms for accomplishing this are quite technical.  The proposed regulations, for example, add a new set of esoteric provisions (“disregarded restrictions”) to the existing ones (“applicable restrictions”), in order to expand the class of restrictions that will be disregarded for valuation purposes.  The new rules would completely disregard some of the current discounting techniques used by taxpayers.  In fact, some commenters believe that, if adopted in final form, the proposed regulations are so restrictive that they would sound the death knell for valuation discounts altogether.

By way of illustration, imagine Dad owns a 98% limited partner interest, and his son and daughter each own a 1% general partner interest.  The partnership agreement (“LP”) provides that the partnership will liquidate in 50 years or by earlier agreement of all of the partners, and otherwise prohibits a limited partner from withdrawing.  The approval of all partners is required in order to amend the partnership agreement.  Local law permits an LP to withdraw under the circumstances specified in the partnership agreement, but does not require any of the provisions that Dad, son and daughter have incorporated into their agreement.  Dad transfers a 33% LP interest to each child.  The transferred interests are subject to a restriction on the ability to liquidate the interest, so the value of the interests should be discounted, correct?  Wrong.  An example in the proposed regulations deals directly with this fact pattern.  It concludes that the restriction on liquidation is disregarded for valuation purposes.  The reason for this has to do with one of the technical rules added to the proposed regulations.  A liquidation restriction will be disregarded if it is (i) not required by local law and (ii) can be removed by the transferor’s family.  In this case local law did not require that a partner be prohibited from withdrawing from the partnership.  In addition, the restriction could easily be removed by Dad, son and daughter since they have the ability to amend the partnership agreement.

Effective Date

Is it unlikely that the regulations will become effective before early 2017, and is important to remember that these regulations are still just proposed regulations.  The final regulations may look different than they do now.  There is a 90 day period of public comment on the regulations, after which time a public hearing will be held on December 1st.  They will then be reevaluated in light of the comments received, and final regulations will be issued.  Even then, the final regulations only become effective 30 days after issuance.


It’s still too early to tell whether the proposed regulations will be adopted as is, or if they will be changed before final issuance.  Regardless, since the new rules will only apply to transfers that occur after the effective date, now is a good time to accelerate the gifting of any FLP or family business interests that you’ve been contemplating.  Note, however, that if you make a gift before the regulations are finalized but you die within three years, the three year look-back could affect the availability of a minority discount on the decedent’s remaining interest.

In addition, gifts should not be made in haste.  The transfer of an interest in a family-controlled entity can result in the loss of a basis step-up at death for income tax purposes.  In addition, the transfer is irrevocable.  Even though time is limited, it is nonetheless important to carefully evaluate the pros and the cons of such a transaction before moving forward.


[1] Note that the proposed regulations clarify that they would apply to other entities such as a limited liability company, and not just to corporations and partnerships.

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This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Wealthspire Advisors, LP cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use. © 2019 Wealthspire Advisors

Nicole Hart, J.D.

Nicole Hart is head of our trusts & estates department and works in our Westport, CT office.

Michael Delgass, J.D.

Mike serves as an advisor and head of Wealthspire's Northeast Region.