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New Audit Guidelines for Business Entities: Proposed Regulations Under Section 2704

Posted on: August 25th, 2016
business tax changesThe Internal Revenue Service (IRS) recently issued proposed changes to Section 2704, which details regulations that apply to taxation of business entities. Under the proposed revisions, nearly all discounts for family business entities (including LLCs and partnerships) would be eliminated. Those valuation adjustments that are not removed would be substantially reduced, significantly altering the efficacy of many common planning methods used to gain valuation discounts. 

The proposal clarifies that the potential changes to the application of Section 2704 would affect:
  • Family-controlled businesses
  • Corporations (including S Corporations and qualified subchapter S subsidiaries)
  • Partnerships
  • Limited Liability Companies (LLCs) 
  • Domestic and foreign business entities
 
The proposed terms also clarify how to determine control of an LLC or other entity or arrangement that is not a corporation, partnership, or limited partnership. Control is found where either (a) at least 50 percent of either capital or profits interests is held or (b) any equity interest with the ability to cause full or partial liquidation is held. Control of the entity is a critical factor in evaluating whether a valuation discount is available upon certain transfers.

Many high net worth individuals may wish to explore advance planning options in the immediate future to take advantage of the current valuation discount rules before the new regulations go into effect; this might involve making significant changes to existing plans. The degree of impact these proposed regulations might have is similar to the dramatic last-minute changes at the end of the 2012 tax year when many taxpayers made hasty plan changes to avoid falling off the “fiscal cliff” pending potential legislative revisions to the estate tax exemption. 

If the regulations pass, according to an outline published by tax law information provider CCH Incorporated:
 
The amendments to Proposed Reg. §25.2704-3 are proposed to apply to transfers of property subject to restrictions created after October 8, 1990, occurring 30 days or more after the date that regulations are published as final regulations in the Federal Register.

A public hearing is arranged for December 1, 2016; however, public comments might not influence officials to alter the terms of the proposal, in which case these regulations nonetheless could pass. The regulations would apply to transfers that occur after the regulations are issued in their final form.

Thoughtful asset transfers prior to year’s end might be critical for many individuals with interests in family held businesses. With the essential removal of discounted transfer tax opportunities on the horizon, individuals who own an interest in a family business entity should explore with an estate planning attorney whether immediate action is advisable.
 
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