Accounting Firm Raises Issues With Proposed Estate Tax Regs

Plante Moran appreciates the opportunity to submit comments as requested by REG-163113-02, regarding the valuation of Estate, Gift, and Generation-skipping Transfer Taxes, namely the Restrictions on Liquidation of an Interest put in place by 26 U.S.C. § 2704 of the Internal Revenue Code.

The Internal Revenue Service ("IRS") has the authority, under 2704(b)(4), to issue regulations that would disregard "other restrictions" if such restrictions have the effect of reducing the value of the transferred interest for valuation purposes but do not reduce value to the transferee. Under this provision, the IRS has issued proposed regulations that impact longstanding valuation principals and change guidance provided under Revenue 59-60 which has been relied upon by taxpayers for a significant number of years. Furthermore, the proposed regulations cause relevant factors to be ignored for purposes of valuation and create economic circumstances that do not exist which must be considered in the valuation of a business interest.

Our comments are specifically focused on three technical areas that we feel require additional clarification. We also comment from our broader perspective as a large public accounting firm that consults with family business owners on successfully transitioning their businesses to both family and non-family member owners. By failing to put forward a clear and compelling argument as to why valuation standards are different for related vs. non-related potential buyers, it is our respectful opinion that the proposed regulations create an inequitable economic environment that threatens succession planning for family owned businesses.

Deemed Six Month Put Right

The proposed regulations effectively values transfers of interest in family-controlled entities as if the interest includes a six month put right for a pro rata share of the net value of the assets. A great deal of legitimate operating family businesses do not have the cash or liquidity to make a deemed six month put right a reasonable expectation. Therefore, Plante Moran recommends that this put right either be a rebuttable presumption or that an exception be added if a taxpayer can show that there is not enough liquidity in the business to fulfill any put right.

Valuation Standards

Minimum Value and Reference to Section 2053 within the Definition of a Disregarded Restriction

Under the proposed Section 2704 regulations, every owner is deemed to have a put right to sell their interest either to the entity or another owner for cash or property equal to the "minimum value."

The term minimum value means the interest's share of the net value of the entity determined on the date of liquidation or redemption. The net value of the entity is the fair market value, as determined under section 2031 or 2512 and the applicable regulations, of the property held by the entity, reduced by the outstanding obligations of the entity. Solely for purposes of determining minimum value, the only outstanding obligations of the entity that may be taken into account are those that would be allowable (if paid) as deductions under section 2053 if those obligations instead were claims against an estate.

Plante Moran requests clarification on how "minimum value" as well as "net value of the entity" are defined and should be calculated. It is very important for the marketplace to understand exactly what valuation principles will apply after the proposed regulations are made final. Without clear guidance, examples, or interpretations, there will be vast differences in how valuations are performed going forward. If valuation is no longer to be performed following the principles of Revenue Ruling 59-60, Plante Moran respectfully requests a clear statement as to any new method of valuing businesses under the final regulations. We urge the IRS to consider the impact of changing the valuation rules without complete and clear guidance as to how valuation will be performed going forward.

We also urge the IRS to provide clear guidance on application of Section 2053 as it is currently unclear as to whether contingent or uncertain obligations are considered for the purposes of calculating "minimum value".

Gift Tax Adequate Disclosures

Treas. Reg. 301.6501(c)-1(f)(2), provides a list of information that must be reported on a gift tax return for the transaction to be considered adequately disclosed. The new valuation principals under the proposed regulations appear to be incompatible with adequate disclosure requirements as it is not fiscally possible for all small businesses to pay for a qualified appraisal every time there is a gift. Therefore, Plante Moran respectfully requests clarification on the impact of the proposed Section 2704 regulations on gift tax adequate disclosure rules. Specifically, Plante Moran requests clarification as to how the minimum value figure will be attained by those businesses that do not own liquid or marketable assets and will not be obtaining a qualified appraisal.

Death Within Three Years of Transfer

Plante Moran respectfully requests clarification as to the date when transfers will be subject to the inclusion of the liquidation or voting value in the transferor's gross estate at death if the transferor dies within three years of the transfer. Plante Moran would specifically like clarification on whether a transfer that occurs before the effective date of the final regulations where the transferor then dies within three years would be subject to the inclusion rule.

Plante Moran recommends that transfers, including sales, gifts, and bequests, that occur prior to the effective date of the final regulations are not retroactively effected by the inclusion rule if the transferor dies within three years of the transfer. Taxpayers have, in some cases, made these transfers before the proposed regulations were issued and a transferee's value should not be retroactively altered by regulations that were not in place when the transfer was made. Requiring the inclusion rule to apply to transfers that occur before the effective date of the final regulations will create a large burden on taxpayers requiring them to file amended returns, alter past purchase agreements, and operating agreements.

Unfair Advantage to Unrelated Parties

The proposed regulations create a situation where an interest in a family-controlled business could not be sold to a family member at the same value as a sale to a non-family member. Plante Moran urges the IRS to consider the full impact the purchasing power advantage held by unrelated parties will have on operating, closely-held family businesses. As Section 2704 currently applies, family members and unrelated parties receive largely the same treatment in terms of value when purchasing an interest in a closely-held business. However, under the proposed regulations, an unrelated party is in a stronger purchasing position, because section 2704(b) will disregard specific restrictions when valuing an interest for gift or estate tax purposes when that interest is transferred to a family member. The unrelated party is not subject to the same applicable and disregarded restrictions as the family member; therefore, due to the inapplicability of Section 2704, it would seem that an unrelated party has a distinct return on investment advantage.

Many business owners have hired professional advisors to help them construct a thoughtful succession plan to increase the probability of success for the overall longevity and health of the business. Often, their plan entails gradually selling their interests to their management team, which is typically comprised of both family and non-family members. Under the proposed regulations, the continuity they desire to achieve will be next to impossible if closely held business stock is priced differently for family and nonfamily member owner/investors. Despite their desire to retain the business, the proposed regulations will create a disincentive for family members to invest if they have to pay more for the business interest than non-family members who are allowed to accurately factor in market discounts such as lack of marketability or lack of liquidation rights into their purchase price. In fact, because unrelated parties will not pay more than the market will dictate, they will always have an investment advantage over family members who are required, under the proposed regulations, to pay an unnaturally inflated price for the same interest. Undoubtedly, the proposed regulations, if passed as final, will create tension between related and unrelated buyers and harm the succession and continuity planning of closely-held family businesses.

Even if a family member is willing to pay the inflated price of an interest in a closely-held family business, it is unlikely that financial institutions will finance the fictitious value above and beyond what the market will bear. The result of the proposed Section 2704 regulations may be far more substantial than a great deal of closely-held family business can survive. As a result, Plante Moran strongly urges the IRS to consider the full impact of the proposed regulations before they are finalized.

Respectfully submitted,