The Future of Discount Planning

Assuming the proposed Internal Revenue Code Section 2704 regulations (see my prior article on what these regulations provide) are eventually finalized and upheld in substantially their current form, at first blush it would appear that future estate and gift tax discount planning should return to its original form of creating marketability and minority interest discounts for transferred and retained interests. That’s because the proposed regulations imply that the Internal Revenue Service will continue to honor the minority and lack of marketability discounts, as long as the transfers are made more than three years prior to the decedent’s death. The Conference Committee Report that accompanied the passage of Section 2704 in 1990 also makes it abundantly clear that “[t]hese rules do not affect minority discounts or other discounts available under present law.”¹

The open question, however, will be determining the level of these discounts in the future.  Because family members could always agree, even as shareholders in a corporation, to liquidate the entity, would the general state law majority and supermajority shareholder voting requirements for liquidation now constitute “applicable restrictions” or “disregarded restrictions?” The proposed regulations for both applicable restrictions and disregarded restrictions imply that this is the case: “The manner in which the restriction may be removed is irrelevant for [the purpose of determining whether the ability to remove the restriction is held by any one or more family members], whether by voting, taking other action authorized by the governing documents or applicable local law, . . .  terminating the entity, or otherwise.”²

It would thus appear that the only type of entity that will benefit significantly from a lack of marketability or minority interest discount in the future will be one that is engaged in an active operation, that is, where the going concern value of the interest is significantly greater than its liquidation value. The entity’s “liquidation value per unit” may be its future floor estate and gift tax value, or its “minimum value,” employing the IRS’ new term.

Note, however, the arguments which are advanced in my article, "Portions of Proposed 2704 Regulations Exceed IRS' Authority," for the invalidity of two elements of the proposed regulations  -  the "three-year rule" and the "and/or addition."  If the three-year rule is ultimately rejected as constituting an invalid exercise of the IRS' regulatory authority, lifetime gifts of minority interests in a closely-held entity, at a time when only the transferor holds an interest in the entity, should continue to fully qualify  for lack of marketability and minority interest discounts, even if made within three years of the donor's death.  If the gifts are made more than three years before the transferor's death, but again at a time when only the transferor holds an interest in the entity, the discounts should continue regardless of the validity of the proposed regulations.

Endnotes

1. Conference Committee Report at p. 157.
2. Proposed Regulations Sections 25.2704-2(b)(3), 25.2704-3(b)(3) (emphasis supplied).