Skip to main content
Estate Planning

Proposed Regulation to Eliminate Estate Planning Discounts

By September 2, 2016September 14th, 2022No Comments

On August 4, 2016, the Treasury Department released Proposed Regulations that seek to eliminate valuation discounts for interests in family-controlled entities. The impact of these new rules is significant and far reaching, and if adopted in their current form, will drastically alter the landscape of wealth transfer planning for family business owners.


The foundation of many estate planning techniques involves the transfer of fractional, non-controlling interests in family-owned business entities from parents to children and grandchildren, or to trusts for their benefit. By transferring only a non-controlling interest, and placing certain restrictions on the rights and abilities to transfer or liquidate the interest, the fair market value for federal gift and estate tax purposes is often discounted to reflect the non-controlling owner’s lack of control (e.g., inability to influence major business decisions, such as whether to compel distributions or liquidate the entity) and lack of marketability (i.e., the degree of difficulty the interest owner would encounter when trying to sell the interest). Generally, the greater the restrictions, the greater the valuation discount for transfer tax purposes.

Current Section 2704

Congress enacted Internal Revenue Code Section 2704 to prevent families from using valuation discounts to artificially reduce the value of interests in family-controlled entities. Under Section 2704, certain restrictions, known as “applicable restrictions,” are disregarded for valuation purposes if the restriction limits the ability of the entity to liquidate under certain circumstances. Existing regulations, however, provide an important exception whereby restrictions on liquidation that are no more restrictive than those allowable under applicable federal or state law may be used to discount the value of the interest. For example, if a state statute provides that liquidation of an entity requires unanimous consent of all owners unless otherwise agreed upon in the operating agreement, a governing instrument of a family-controlled entity that requires unanimous consent for liquidations would not be subject to the Section 2704 rules because the restriction is allowable under state law. An interest in such entity, therefore, could be subject to an appropriate discount reflecting this restriction. Such restrictions tend to generate significant valuation discounts, allowing interests in family-controlled entities to be gifted among family members with reduced gift and estate tax liability.

The Proposed Regulations

According to the IRS and Treasury, Section 2704 has been rendered “substantially ineffective” by the recent trend of states providing restrictive default liquidation provisions. In response, one of the many changes contained in the Proposed Regulations narrows the exception to only those restrictions that are required to be imposed by federal or state law, and not merely those allowable as default provisions. Because state partnership and corporate laws are largely default rules, and not mandatory, this change effectively removes the existing exception, breathing new life into Section 2704 and rendering valuation discounts more difficult to apply. Of the many changes to Section 2704, the most significant change in the Proposed Regulations is the creation of a new class of restrictions, referred to as “disregarded restrictions,” that must be ignored in determining fair market value of an interest in a family-controlled entity. In particular, this new class includes restrictions that: (i) limit the ability of the owner to liquidate the interest; (ii) limit the liquidation proceeds to any amount less than a “minimum value”; (iii) defer payment of liquidation proceeds for more than six months; or (iv) permit payment of the liquidation proceeds in any manner other than cash or property.  In this context, minimum value is essentially the enterprise value multiplied by the ownership percentage. Read as a whole, the Proposed Regulations suggest that an entity’s failure to confer each owner with a “put right” to sell his or her interest within six months for minimum value is a disregarded restriction that must be ignored for valuation purposes. As a result, the right of the owner to liquidate the interest in six months’ time for minimum value will be imputed in valuing the interest even if that right does not actually exist in the governing document. Imputing this right to non-controlling interests would effectively eliminate the minority interest discount.


Suppose an individual owns 100% of a family-controlled LLC with a gross value of US$25 million, and transfers 40% of the company to a trust for the benefit of her children. The undiscounted value of the transfer would be US$10 million. However, since a 40% owner lacks certain valuable rights, such as the ability to force the company to redeem the interest, valuation principles provide that the non-controlling interest transferred to the trust is worth less than the pro-rata value of the underlying business. Under current law, an aggregate discount for minority interest and lack of marketability could equal 40%, producing a gift tax value of US$6 million. After using her federal gift tax exemption of US$5.45 million, she would pay only US$220,000 of gift tax on the transfer. However, if this same transfer takes place after the regulations become final, the interest must be valued as though the owner can redeem the interest for minimum value–or in this case US$10 million–within six months’ notice. Under this assumption, it is likely that any discounts that may still be available could be limited to around 10%, which would produce a gift tax value of US$9 million. In that case, after applying her gift tax exemption, the transfer results in a gift tax bill of US$1.42 million–a staggering difference of US$1.2 million.

Planning for Change

Fortunately, there is still time to act. The new rules do not become effective until the Proposed Regulations are issued in final form, which is expected to occur in late 2016 or early 2017. Note also that the tax and estate planning environment could be further impacted by the result of this November’s election. For family business owners, this presents a closing window of opportunity to make transfers utilizing the full extent of valuation discounts currently available.

*Corey W. Glass also contributed to this advisory. Mr. Glass is admitted only in California; practicing law in the District of Columbia during the pendency of his application for admission to the D.C. Bar and under the supervision of lawyers of the firm who are members in good standing of the D.C. Bar. 

Reposted with permission from Arnold & Porter LLP
The information provided is for educational purposes only and is not intended to be, and should not be construed as investment, legal or tax advice. The information is subject to change and, although based upon information that AdvicePeriod considers reliable, is not guaranteed as to its accuracy or completeness. AdvicePeriod makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information.
In accordance with Treasury Regulations Circular 230, any tax discussions contained in this communication was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matter addressed herein.
Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this article will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. In preparing this article, we have relied upon information provided by third parties. While we believe these sources to be reliable, the accuracy and completeness of the information is not guaranteed. We have provided performance results of certain indices for comparison purposes only. A description of each index is available from us upon request. The historical performance results of each index do not reflect the deduction of transaction and custodial charges, nor the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. It should not be assumed that your account performance or the volatility of any securities held in your account will correspond directly to any comparative benchmark index.
AdvicePeriod, LLC (“AdvicePeriod”) is an SEC registered investment adviser with its principal place of business in the State of California. Any reference to the terms “registered investment adviser” or “registered,” do not imply that AdvicePeriod or any person associated with AdvicePeriod has achieved a certain level of skill or training. AdvicePeriod and its representatives are in compliance with the current registration and notice filing requirements imposed upon registered investment advisers by those states in which AdvicePeriod maintains clients. AdvicePeriod may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from registration/notice filing requirements. This article is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by AdvicePeriod with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of AdvicePeriod, please contact AdvicePeriod or refer to the Investment Adviser Public Disclosure web site (
For additional information about AdvicePeriod, including fees and services, send for our disclosure statement as set forth on Form ADV from AdvicePeriod using the contact information herein. Please read the disclosure statement carefully before you invest or send money.