Record number of witnesses testify to fight Sec. 2704 regs

BVWireIssue #171-1
December 7, 2016

An amazing number of speakers descended on the IRS in Washington, D.C., to fight the controversial proposed Section 2704 regulations designed to curb estate valuation discounts for minority interests. Speakers testifying at the December 1 hearing said the rules are so broad and convoluted that they should be withdrawn permanently. If that’s out of the question, the regs should be revised, but they’re so far gone that they are beyond repair, speakers said. The IRS should go back to the drawing board and come out with a new version—and allow for another comment period.

In total, there were 37 witnesses—an “unprecedented” number, said the IRS—more than any other hearing in at least 30 years, an IRS attorney told BVWire. While the format of these hearings is simply for speakers to present their 10 minutes of comments, IRS and Treasury officials on the panel felt compelled to make some remarks in response to the strong concerns of valuation experts, attorneys, wealth planners, and family business owners who testified.

A common issue speakers brought up was the so-called “implied put right” that exists in the proposed regs. This is the ability of each member of the entity to force the company to buy back his or her interest for cash equal to a minimum value within six months of exercising the right. No such right exists in the real world, speakers told the panel, and it should be removed from the regs.

No put right: “It is not our intention for the regs to contain a put right,” said Charlotte Chyr, IRS Special Counsel. This appeared to put this matter to rest and short-circuited some comments by subsequent speakers.

Another recurring theme was the three-year rule, which would nullify discounts taken for certain transfers that occurred within three years of the transferor’s death. Speakers were concerned that the rule would apply to transfers that occurred prior to the regs being finalized. As written, the regs are unclear on this.

Not retroactive: The three-year lookback rule “will not be retroactive,” Chyr told the audience. It would only affect transfers made after the date the final regs are published.

While most of the speakers talked of technical legal and tax issues and appraisers discussed valuation theory and practice, the speakers representing family businesses, farms, and ranches added a poignancy to the proceedings. Clarene Law borrowed her parents’ life savings to open a small motel in 1962. She and her husband struggled to build the business from nothing into a thriving concern with multiple locations run by four generations of family members. Law, now elderly, has “high hopes” to pass on the family legacy to the next generation, some of whom own minority stakes. “The proposed regulations will severely disrupt the plans that are so dear to my heart,” she said, trying to maintain her composure. “We may have to sell out if minority discounts are compromised.” As her voice wavered, she said to the panel: “We had the opportunity to pursue the American Dream. Please let our children have the same chance.”

Discounts will remain: “We will make it clear that these regs will not eliminate minority discounts,” said Catherine Hughes, attorney-advisor at the Treasury. Audience members were happy to hear that, to some extent. Of course, this doesn’t mean that discounts won’t be significantly reduced, which they will be under the regs as written.

While the panel addressed a few issues, many more remain, such as how the regs have redefined long-accepted definitions of fair market value, marketability, and control. For example, the regs remove the hypothetical willing buyer and willing seller assumption from the definition of fair market value—and also the notion of an arm’s-length transaction. Lance Hall (FMV Opinions), in his testimony, said, “That’s like asking Michelangelo to paint the Sistine Chapel without the color blue.”

Not all of the witnesses were against the regs. A speaker from Americans for Tax Fairness fully supports the regs, saying they will close loopholes the wealthy use to avoid estate taxes. Everyone agrees that some abuses are going on that should be stopped, but why not focus the regs on those egregious cases without hurting the family business that was formed for legitimate reasons?

IRS hearings are very serious and formal proceedings, so we were happy that some speakers added a much-needed touch of humor. An owner of a White Castle hamburger franchise said that when he first heard “2704,” he thought it would make a “good price point for a Crave Case of burgers with sides and drinks.”

What’s next: The IRS will “seriously consider” the comments made at the hearing—and those about 10,000 people submitted on the IRS website. It is highly unlikely the IRS will finalize the proposed regs as written because of remarks officials made at the hearing. Some observers think the regs will be tweaked and rushed through before the Trump administration moves in, otherwise they will have little chance to see the light of day. Stay tuned!

BVWire applauds the incredible efforts of the valuation community in coming together to speak in a strong and compelling voice on these controversial regs. More details on the hearing will appear in the January issue of Business Valuation Update.

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