§2704 — Treatment of certain lapsing rights and restrictions
9 citing cases
Statute Text — 26 U.S.C. §2704
For purposes of this subtitle, if—
there is a lapse of any voting or liquidation right in a corporation or partnership, and
the individual holding such right immediately before the lapse and members of such individual’s family hold, both before and after the lapse, control of the entity,
such lapse shall be treated as a transfer by such individual by gift, or a transfer which is includible in the gross estate of the decedent, whichever is applicable, in the amount determined under paragraph (2).
For purposes of paragraph (1), the amount determined under this paragraph is the excess (if any) of—
the value of all interests in the entity held by the individual described in paragraph (1) immediately before the lapse (determined as if the voting and liquidation rights were nonlapsing), over
the value of such interests immediately after the lapse.
The Secretary may by regulations apply this subsection to rights similar to voting and liquidation rights.
For purposes of this subtitle, if—
there is a transfer of an interest in a corporation or partnership to (or for the benefit of) a member of the transferor’s family, and
the transferor and members of the transferor’s family hold, immediately before the transfer, control of the entity,
any applicable restriction shall be disregarded in determining the value of the transferred interest.
For purposes of this subsection, the term “applicable restriction” means any restriction—
which effectively limits the ability of the corporation or partnership to liquidate, and
with respect to which either of the following applies:
The restriction lapses, in whole or in part, after the transfer referred to in paragraph (1).
The transferor or any member of the transferor’s family, either alone or collectively, has the right after such transfer to remove, in whole or in part, the restriction.
The term “applicable restriction” shall not include—
any commercially reasonable restriction which arises as part of any financing by the corporation or partnership with a person who is not related to the transferor or transferee, or a member of the family of either, or
any restriction imposed, or required to be imposed, by any Federal or State law.
The Secretary may by regulations provide that other restrictions shall be disregarded in determining the value of the transfer of any interest in a corporation or partnership to a member of the transferor’s family if such restriction has the effect of reducing the value of the transferred interest for purposes of this subtitle but does not ultimately reduce the value of such interest to the transferee.
For purposes of this section—
The term “control” has the meaning given such term by section 2701(b)(2).
The term “member of the family” means, with respect to any individual—
such individual’s spouse,
any ancestor or lineal descendant of such individual or such individual’s spouse,
any brother or sister of the individual, and
any spouse of any individual described in subparagraph (B) or (C).
The rule of section 2701(e)(3) shall apply for purposes of determining the interests held by any individual.
Treasury Regulations
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Treas. Reg. §25.2704-1Lapse of certain rights
(a) Lapse treated as transfer—(1) In general. The lapse of a voting right or a liquidation right in a corporation or partnership (an “entity”) is a transfer by the individual directly or indirectly holding the right immediately prior to its lapse (the “holder”) to the extent provided in paragraphs (b) and (c) of this section. This section applies only if the entity is controlled by the holder and members of the holder's family immediately before and after the lapse. The amount of the transfer is determined under paragraph (d) of this section. If the lapse of a voting right or a liquidation right occurs during the holder's lifetime, the lapse is a transfer by gift. If the lapse occurs at the holder's death, the lapse is a transfer includible in the holder's gross estate.
(2) Definitions. The following definitions apply for purposes of this section.
(i) Control. Control has the meaning given it in § 25.2701-2(b)(5).
(ii) Member of the family. Member of the family has the meaning given it in § 25.2702-2(a)(1).
(iii) Directly or indirectly held. An interest is directly or indirectly held only to the extent the value of the interest would have been includible in the gross estate of the individual if the individual had died immediately prior to the lapse.
(iv) Voting right. Voting right means a right to vote with respect to any matter of the entity. In the case of a partnership, the right of a general partner to participate in partnership management is a voting right. The right to compel the entity to acquire all or a portion of the holder's equity interest in the entity by reason of aggregate voting power is treated as a liquidation right and is not treated as a voting right.
(v) Liquidation right. Liquidation right means a right or ability to compel the entity to acquire all or a portion of the holder's equity interest in the entity, including by reason of aggregate voting power, whether or not its exercise would result in the complete liquidation of the entity.
(vi) Subordinate. Subordinate has the meaning given it in § 25.2701-3(a)(2)(iii).
(3) Certain temporary lapses. If a lapsed right may be restored only upon the occurrence of a future event not within the control of the holder or members of the holder's family, the lapse is deemed to occur at the time the lapse becomes permanent with respect to the holder, i.e. either by a transfer of the interest or otherwise.
(4) Source of right or lapse. A voting right or a liquidation right may be conferred by and may lapse by reason of a State law, the corporate charter or bylaws, an agreement, or other means.
(b) Lapse of voting right. A lapse of a voting right occurs at the time a presently exercisable voting right is restricted or eliminated.
(c) Lapse of liquidation right—(1) In general. A lapse of a liquidation right occurs at the time a presently exercisable liquidation right is restricted or eliminated. Except as otherwise provided, a transfer of an interest that results in the lapse of a liquidation right is not subject to this section if the rights with respect to the transferred interest are not restricted or eliminated. However, a transfer that results in the elimination of the transferor's right or ability to compel the entity to acquire an interest retained by the transferor that is subordinate to the transferred interest is a lapse of a liquidation right with respect to the subordinate interest.
(2) Exceptions. Section 2704(a) does not apply to the lapse of a liquidation right under the following circumstances.
(i) Family cannot obtain liquidation value—(A) In general. Section 2704(a) does not apply to the lapse of a liquidation right to the extent the holder (or the holder's estate) and members of the holder's family cannot immediately after the lapse liquidate an interest that the holder held directly or indirectly and could have liquidated prior to the lapse.
(B) Ability to liquidate. Whether an interest can be liquidated immediately after the lapse is determined under the State law generally applicable to the entity, as modified by the governing instruments of the entity, but without regard to any restriction described in section 2704(b). Thus, if, after any restriction described in section 2704(b) is disregarded, the remaining requirements for liquidation under the governing instruments are less restrictive than the State law that would apply in the absence of the governing instruments, the ability to liquidate is determined by reference to the governing instruments.
(ii) Rights valued under section 2701. Section 2704(a) does not apply to the lapse of a liquidation right previously valued under section 2701 to the extent necessary to prevent double taxation (taking into account any adjustment available under § 25.2701-5).
(iii) Certain changes in State law. Section 2704(a) does not apply to the lapse of a liquidation right that occurs solely by reason of a change in State law. For purposes of this paragraph, a change in the governing instrument of an entity is not a change in State law.
(d) Amount of transfer. The amount of the transfer is the excess, if any, of—
(1) The value of all interests in the entity owned by the holder immediately before the lapse (determined immediately after the lapse as if the lapsed right was nonlapsing); over
(2) The value of the interests described in the preceding paragraph immediately after the lapse (determined as if all such interests were held by one individual).
(e) Application to similar rights. [Reserved]
(f) Examples. The following examples illustrate the provisions of this section:
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Treas. Reg. §25.2704-1(a)Lapse treated as transfer—(1) In general.
Lapse treated as transfer—(1) In general. The lapse of a voting right or a liquidation right in a corporation or partnership (an “entity”) is a transfer by the individual directly or indirectly holding the right immediately prior to its lapse (the “holder”) to the extent provided in paragraphs (b) and (c) of this section. This section applies only if the entity is controlled by the holder and members of the holder's family immediately before and after the lapse. The amount of the transfer is determined under paragraph (d) of this section. If the lapse of a voting right or a liquidation right occurs during the holder's lifetime, the lapse is a transfer by gift. If the lapse occurs at the holder's death, the lapse is a transfer includible in the holder's gross estate.
(2) Definitions. The following definitions apply for purposes of this section.
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Treas. Reg. §25.2704-1(b)Lapse of voting right.
Lapse of voting right. A lapse of a voting right occurs at the time a presently exercisable voting right is restricted or eliminated.
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Treas. Reg. §25.2704-1(c)Lapse of liquidation right—(1) In general.
Lapse of liquidation right—(1) In general. A lapse of a liquidation right occurs at the time a presently exercisable liquidation right is restricted or eliminated. Except as otherwise provided, a transfer of an interest that results in the lapse of a liquidation right is not subject to this section if the rights with respect to the transferred interest are not restricted or eliminated. However, a transfer that results in the elimination of the transferor's right or ability to compel the entity to acquire an interest retained by the transferor that is subordinate to the transferred interest is a lapse of a liquidation right with respect to the subordinate interest.
(2) Exceptions. Section 2704(a) does not apply to the lapse of a liquidation right under the following circumstances.
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Treas. Reg. §25.2704-1(d)Amount of transfer.
Amount of transfer. The amount of the transfer is the excess, if any, of—
(1) The value of all interests in the entity owned by the holder immediately before the lapse (determined immediately after the lapse as if the lapsed right was nonlapsing); over
(2) The value of the interests described in the preceding paragraph immediately after the lapse (determined as if all such interests were held by one individual).
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Treas. Reg. §25.2704-1(e)Application to similar rights.
Application to similar rights. [Reserved]
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Treas. Reg. §25.2704-1(f)Examples.
Examples. The following examples illustrate the provisions of this section:
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Treas. Reg. §25.2704-1(i)Family cannot obtain liquidation value—(A) In general.
Family cannot obtain liquidation value—(A) In general. Section 2704(a) does not apply to the lapse of a liquidation right to the extent the holder (or the holder's estate) and members of the holder's family cannot immediately after the lapse liquidate an interest that the holder held directly or indirectly and could have liquidated prior to the lapse.
(B) Ability to liquidate. Whether an interest can be liquidated immediately after the lapse is determined under the State law generally applicable to the entity, as modified by the governing instruments of the entity, but without regard to any restriction described in section 2704(b). Thus, if, after any restriction described in section 2704(b) is disregarded, the remaining requirements for liquidation under the governing instruments are less restrictive than the State law that would apply in the absence of the governing instruments, the ability to liquidate is determined by reference to the governing instruments.
(ii) Rights valued under section 2701. Section 2704(a) does not apply to the lapse of a liquidation right previously valued under section 2701 to the extent necessary to prevent double taxation (taking into account any adjustment available under § 25.2701-5).
(iii) Certain changes in State law. Section 2704(a) does not apply to the lapse of a liquidation right that occurs solely by reason of a change in State law. For purposes of this paragraph, a change in the governing instrument of an entity is not a change in State law.
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Treas. Reg. §25.2704-1(v)Liquidation right.
Liquidation right. Liquidation right means a right or ability to compel the entity to acquire all or a portion of the holder's equity interest in the entity, including by reason of aggregate voting power, whether or not its exercise would result in the complete liquidation of the entity.
(vi) Subordinate. Subordinate has the meaning given it in § 25.2701-3(a)(2)(iii).
(3) Certain temporary lapses. If a lapsed right may be restored only upon the occurrence of a future event not within the control of the holder or members of the holder's family, the lapse is deemed to occur at the time the lapse becomes permanent with respect to the holder, i.e. either by a transfer of the interest or otherwise.
(4) Source of right or lapse. A voting right or a liquidation right may be conferred by and may lapse by reason of a State law, the corporate charter or bylaws, an agreement, or other means.
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Treas. Reg. §25.2704-2Transfers subject to applicable restrictions
(a) In general. If an interest in a corporation or partnership (an “entity”) is transferred to or for the benefit of a member of the transferor's family, any applicable restriction is disregarded in valuing the transferred interest. This section applies only if the transferor and members of the transferor's family control the entity immediately before the transfer. For the definition of control, see § 25.2701-2(b)(5). For the definition of member of the family, see § 25.2702-2(a)(1).
(b) Applicable restriction defined. An applicable restriction is a limitation on the ability to liquidate the entity (in whole or in part) that is more restrictive than the limitations that would apply under the State law generally applicable to the entity in the absence of the restriction. A restriction is an applicable restriction only to the extent that either the restriction by its terms will lapse at any time after the transfer, or the transferor (or the transferor's estate) and any members of the transferor's family can remove the restriction immediately after the transfer. Ability to remove the restriction is determined by reference to the State law that would apply but for a more restrictive rule in the governing instruments of the entity. See § 25.2704-1(c)(1)(B) for a discussion of the term “State law.” An applicable restriction does not include a commercially reasonable restriction on liquidation imposed by an unrelated person providing capital to the entity for the entity's trade or business operations whether in the form of debt or equity. An unrelated person is any person whose relationship to the transferor, the transferee, or any member of the family of either is not described in section 267(b) of the Internal Revenue Code, provided that for purposes of this section the term “fiduciary of a trust” as used in section 267(b) does not include a bank as defined in section 581 of the Internal Revenue Code. A restriction imposed or required to be imposed by Federal or State law is not an applicable restriction. An option, right to use property, or agreement that is subject to section 2703 is not an applicable restriction.
(c) Effect of disregarding an applicable restriction. If an applicable restriction is disregarded under this section, the transferred interest is valued as if the restriction does not exist and as if the rights of the transferor are determined under the State law that would apply but for the restriction. For example, an applicable restriction with respect to preferred stock will be disregarded in determining the amount of a transfer of common stock under section 2701.
(d) Examples. The following examples illustrate the provisions of this section:
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Treas. Reg. §25.2704-2(a)In general.
In general. If an interest in a corporation or partnership (an “entity”) is transferred to or for the benefit of a member of the transferor's family, any applicable restriction is disregarded in valuing the transferred interest. This section applies only if the transferor and members of the transferor's family control the entity immediately before the transfer. For the definition of control, see § 25.2701-2(b)(5). For the definition of member of the family, see § 25.2702-2(a)(1).
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Treas. Reg. §25.2704-2(b)Applicable restriction defined.
Applicable restriction defined. An applicable restriction is a limitation on the ability to liquidate the entity (in whole or in part) that is more restrictive than the limitations that would apply under the State law generally applicable to the entity in the absence of the restriction. A restriction is an applicable restriction only to the extent that either the restriction by its terms will lapse at any time after the transfer, or the transferor (or the transferor's estate) and any members of the transferor's family can remove the restriction immediately after the transfer. Ability to remove the restriction is determined by reference to the State law that would apply but for a more restrictive rule in the governing instruments of the entity. See § 25.2704-1(c)(1)(B) for a discussion of the term “State law.” An applicable restriction does not include a commercially reasonable restriction on liquidation imposed by an unrelated person providing capital to the entity for the entity's trade or business operations whether in the form of debt or equity. An unrelated person is any person whose relationship to the transferor, the transferee, or any member of the family of either is not described in section 267(b) of the Internal Revenue Code, provided that for purposes of this section the term “fiduciary of a trust” as used in section 267(b) does not include a bank as defined in section 581 of the Internal Revenue Code. A restriction imposed or required to be imposed by Federal or State law is not an applicable restriction. An option, right to use property, or agreement that is subject to section 2703 is not an applicable restriction.
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Treas. Reg. §25.2704-2(c)Effect of disregarding an applicable restriction.
Effect of disregarding an applicable restriction. If an applicable restriction is disregarded under this section, the transferred interest is valued as if the restriction does not exist and as if the rights of the transferor are determined under the State law that would apply but for the restriction. For example, an applicable restriction with respect to preferred stock will be disregarded in determining the amount of a transfer of common stock under section 2701.
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Treas. Reg. §25.2704-2(d)Examples.
Examples. The following examples illustrate the provisions of this section:
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Treas. Reg. §25.2704-3Effective date
Section 25.2704-1 applies to lapses occurring after January 28, 1992, of rights created after October 8, 1990. Section 25.2704-2 applies to transfers occurring after January 28, 1992, of property subject to applicable restrictions created after October 8, 1990. In determining whether a voting right or a liquidation right has lapsed prior to that date, and for purposes of determining whether the lapse is subject to section 2704(a), taxpayers may rely on any reasonable interpretation of the statutory provisions. For transfers of interests occurring before January 28, 1992, taxpayers may rely on any reasonable interpretation of the statutory provisions in detemining whether a restriction is an applicable restriction that must be disregarded in determining the value of the transferred interest. For these purposes, the provisions of the proposed regulations and the final regulations are considered a reasonable interpretation of the statutory provisions.
9 Citing Cases
See DenHollander, Note, “Minority Interest Discounts and the Effect of the Section 2704 Regulations”, 45 Tax Law.
See DenHollander, Note, “Minority Interest Discounts and the Effect of the Section 2704 Regulations”, 45 Tax Law.
We must decide whether, as respondent contends, the restrictions on the right to liquidate the partnership contained in the partnership agreement are applicable restrictions within the meaning of section 2704 and are accordingly to be disregarded when valuing the shares of the partnership.
Respondent determined in pertinent part that the restrictions on liquidation set forth in section 10.01 of the KFLP and KILP partnership agreements constitute “applicable restrictions” within the meaning of section 2704(b), and that these restrictions should have been disregarded in valuing the limited partnership interests. Procedural History After petitioners filed a timely joint petition for redetermination, and respondent filed an answer to the petition, petitioners filed the motion for part
Eastland further advised petitioners that the partnerships should include a charity as a partner in light of the recent enactment of section 2704 and to “make sure that traditional valuation rules apply to the partnerships.” Kerr Issue GST Trust On December 29, 1993, petitioners, as grantors, and their children, as trustees, executed a document entitled “Agreement Creating the Kerr Issue GST Trusts”.