{"id":1607,"date":"2017-10-06T02:54:00","date_gmt":"2017-10-06T06:54:00","guid":{"rendered":"https:\/\/actec.matrixdev.net\/?post_type=capital-letter&p=1607"},"modified":"2024-01-07T19:49:09","modified_gmt":"2024-01-08T00:49:09","slug":"proposed-section-2704-regulations-to-be-withdrawn","status":"publish","type":"capital-letter","link":"https:\/\/actec.matrixdev.net\/capital-letter\/proposed-section-2704-regulations-to-be-withdrawn\/","title":{"rendered":"Proposed Section 2704 Regulations to be Withdrawn"},"content":{"rendered":"\n
Treasury\u2019s second response to White House directives announces the pending withdrawal of the controversial proposed regulations under section 2704.<\/strong><\/em> Dear Readers Who Follow Washington Developments:<\/p>\n\n\n\n In a second Report in response to Executive Order 13789, the Treasury Department and the Internal Revenue Service have announced that they will withdraw the controversial Proposed Regulations about disregarded restrictions and lapsing rights under section 2704. The Report says nothing about revisions, further study, or any other additional consideration of these Proposed Regulations. There are lessons to be learned, but some implications of Treasury\u2019s Report are still uncertain. Reports of the death of the Proposed Regulations may now have been confirmed, or may still be premature.<\/p>\n\n\n\n As discussed in\u00a0Capital Letter Number 40<\/a>,\u00a0Executive Order 13789<\/a>\u00a0(April 21, 2017) directed the Treasury Department to identify tax regulations issued on or after January 1, 2016, \u201cthat (i) impose an undue financial burden on United States taxpayers; (ii) add undue complexity to the Federal tax laws; or (iii) exceed the statutory authority of the Internal Revenue Service.\u201d\u00a0 It directed that such regulations be identified in an interim report to the President within 60 days, or by June 20, 2017.<\/p>\n\n\n\n Treasury\u2019s initial response, dated June 22 and released July 7, 2017 as\u00a0Notice 2017-38<\/a>,\u00a02017-30 I.R.B. 147<\/a>, identified eight regulations that it said \u201cmeet at least one of the first two criteria specified by \u2026 Executive Order 13789\u201d \u2013 that is, undue financial burden or undue complexity.\u00a0 These eight regulations included six sets of regulations that were already in effect (three final, one final and temporary, and two temporary) and two sets of regulations that were only proposed (the section 2704 Proposed Regulations and a set of proposed regulations tightening the requirements a political subdivision must meet to be qualified to issue tax-exempt bonds under section 103). \u00a0The Notice said this about the Proposed Regulations:<\/p>\n\n\n\n \u201cCommenters expressed concern that the proposed regulations would eliminate or restrict common discounts, such as minority discounts and discounts for lack of marketability, which would result in increased valuations and transfer tax liability that would increase financial burdens. Commenters were also concerned that the proposed regulations would make valuations more difficult and that the proposed narrowing of existing regulatory exceptions was arbitrary and capricious.\u201d<\/p>\n\n\n\n Now, in its second response to Executive Order 13789, Treasury has issued an 11-page\u00a0Report<\/a>, dated October 2 and released October 4, 2017, announcing the action it will take regarding the eight regulations identified in Notice 2017-38, including withdrawal of the Proposed Regulations.\u00a0 Here is the full discussion of the Proposed Regulations in the Report:<\/p>\n\n\n\n \u201cSection 2704 addresses the valuation, for wealth transfer tax purposes, of interests in family-controlled entities. In limited cases, Section 2704 disregards restrictions on the ability to liquidate family-controlled entities when determining the fair market value of an interest for estate, gift, and generation-skipping transfer tax purposes. Also in limited cases, Section 2704 treats lapses of voting or liquidation rights as if they were transfers for gift and estate tax purposes. The proposed regulations, through a web of dense rules and definitions, would have narrowed longstanding exceptions and dramatically expanded the class of restrictions that are disregarded under Section 2704. In addition, the proposed regulations would have required an entity interest to be valued as if disregarded restrictions did not exist, either in the entity\u2019s governing documents or under state law. No exceptions would have been allowed for interests in active or operating businesses.<\/p>\n\n\n\n \u201cThe goal of the proposed regulations was to counteract changes in state statutes and developments in case law that have eroded Section 2704\u2019s applicability and facilitated the use of family-controlled entities to generate artificial valuation discounts, such as for lack of control and marketability, and thereby depress the value of property for gift and estate tax purposes. Commenters warned, however, that the valuation requirements of the proposed regulations were unclear and that their effect on traditional valuation discounts was uncertain. In particular, commenters argued that it was not feasible to value an entity interest as if no restrictions on withdrawal or liquidation existed in either the entity\u2019s governing documents or state law. A legal vacuum in which there is no law relevant to an interest holder\u2019s right to withdraw or liquidate is impossible, commenters asserted, and, therefore, cannot meaningfully be applied as a valuation assumption. Commenters also argued that the proposed regulations could have produced unrealistic valuations. For example, the lack of a market for interests in family-owned operating businesses is a reality that, commenters argued, should continue to be taken into account when determining fair market value.<\/p>\n\n\n\n \u201cAfter reviewing these comments, Treasury and the IRS now believe that the proposed regulations\u2019 approach to the problem of artificial valuation discounts is unworkable. In particular, Treasury and the IRS currently agree with commenters that taxpayers, their advisors, the IRS, and the courts would not, as a practical matter, be able to determine the value of an entity interest based on the fanciful assumption of a world where no legal authority exists. Given that uncertainty, it is unclear whether the valuation rules of the proposed regulations would have even succeeded in curtailing artificial valuation discounts. Moreover, merely to reach the conclusion that an entity interest should be valued as if restrictions did not exist, the proposed regulations would have compelled taxpayers to master lengthy and difficult rules on family control and the rights of interest holders. The burden of compliance with the proposed regulations would have been excessive, given the uncertainty of any policy gains. Finally, the proposed regulations could have affected valuation discounts even where discount factors, such as lack of control or lack of a market, were not created artificially as a value-depressing device.<\/p>\n\n\n\n \u201cIn light of these concerns, Treasury and the IRS currently believe that these proposed regulations should be withdrawn in their entirety. Treasury and the IRS plan to publish a withdrawal of the proposed regulations shortly in the Federal Register.\u201d<\/p>\n\n\n\n In general, the Report is rather noncommittal.\u00a0 The second paragraph, for example, mentions that \u201cthe goal of the proposed regulations was to counteract changes in state statutes and developments in case law.\u201d\u00a0 That reflects the statement in the Preamble to the\u00a0Proposed Regulations\u00a0that \u201cthe Treasury Department and the IRS have determined that the current regulations have been rendered substantially ineffective in implementing the purpose and intent of the statute by changes in state laws and by other subsequent developments,\u201d giving as examples case law like\u00a0Kerr v. Commissioner<\/em>, 113 T.C. 449 (1999),\u00a0aff\u2019d<\/em>, 292 F.3d 490 (5th Cir. 2002), changes in state partnership statutes, the practice of transferring partnership interests to assignees rather than to partners, and the practice of transferring \u201ca nominal partnership interest to a nonfamily member, such as a charity or an employee.\u201d\u00a0 Then the Report, mirroring the two sentences in Notice 2017-38 quoted above, summarizes the concerns about which \u201ccommenters warned,\u201d \u201ccommenters argued,\u201d and \u201ccommenters asserted.\u201d\u00a0 Treasury and the IRS do not state whether they agree or disagree with those commenters, although they do appear to distance their own motivating goal from the views of those commenters by use of the word \u201chowever.\u201d<\/p>\n\n\n\n In the third paragraph, Treasury and the IRS concede that, in view of the comments, the approach of the Proposed Regulations is \u201cunworkable.\u201d\u00a0 \u201cIn particular,\u201d the Report continues, \u201cTreasury and the IRS currently agree with commenters that taxpayers, their advisors, the IRS, and the courts would not, as a practical matter, be able to determine the value of an entity interest based on the fanciful assumption of a world where no legal authority exists.\u201d\u00a0 They stop short of admitting that their draft was based on their own fanciful assumptions, but neither do they accuse the commenters of making fanciful assumptions.\u00a0 They seem to state, matter-of-factly, that if the Proposed Regulations assume \u201ca world where no legal authority exists,\u201d that indeed would be a \u201cfanciful\u201d assumption.\u00a0 Is that dismissing as \u201cfanciful\u201d the view that the Proposed Regulations would produce such a result (the \u201cbroad view\u201d discussed and rejected in\u00a0Capital Letter Number 41<\/a>)?\u00a0 There is no reason to think that the Report intended to go that far.<\/p>\n\n\n\n It is in the first paragraph that the Report uses the most surprising wording. Without attribution to \u201ccommenters,\u201d the Report states that \u201cthe proposed regulations, through a web of dense rules and definitions<\/em>, would have narrowed longstanding exceptions and dramatically<\/em> expanded the class of restrictions that are disregarded under Section 2704. It is true that the Proposed Regulations \u201cwould have narrowed longstanding exceptions\u201d \u2013 for example, the exception from the disregard of \u201capplicable restrictions\u201d under section 2704(b) of restrictions imposed by mere default law and the exception of certain lapses from deemed gift treatment under section 2704(a) if the transferor dies within three years. It is also true that some observers might characterize these rules as \u201ca web of dense rules and definitions.\u201d But that is a much more subjective and gratuitous characterization, which is odd for the Report to use.<\/p>\n\n\n\n It is also true that the Proposed Regulations would have \u201cexpanded the class of restrictions that are disregarded under Section 2704(b),\u201d namely by the addition of \u201cdisregarded restrictions.\u201d Describing that expansion as \u201cdramatic\u201d is a subjective label some observers might use, but again is odd for the Report to use.<\/p>\n\n\n\n It is almost as if these aspersions on Treasury\u2019s own work come from sources outside<\/em> Treasury. Or possibly sources who were<\/em> outside Treasury when the Proposed Regulations were published in August 2016. If so, we may have witnessed, to a degree unusual for estate tax regulations, the direct influence of the political tone, and possibly the political appointees, of the Trump Administration. The Report, after all, is a response to Executive Order 13789.<\/p>\n\n\n\n The withdrawal of the Proposed Regulations is not a surprise. Another option might have been to identify specific fixes to address the concerns that public comments expressed and to promise to make those fixes. But the 90 days allowed by Executive Order 13789 between the first Report (Notice 2017-38) and this second Report was simply not enough time to fix the Notice of Proposed Rulemaking that itself took 14 years to draft. So simple withdrawal was the most likely expected response.<\/p>\n\n\n\n
<\/p>\n\n\n\nBACKGROUND<\/strong><\/h2>\n\n\n\n
TREASURY\u2019S SECOND REPORT<\/strong><\/h2>\n\n\n\n
PARSING THE REPORT<\/strong><\/h2>\n\n\n\n
ANALYSIS OF THE REPORT<\/strong><\/h2>\n\n\n\n
Withdrawal of the Proposed Regulations<\/strong><\/h3>\n\n\n\n