[Federal Register Volume 81, Number 150 (Thursday, August 4, 2016)]
[Proposed Rules]
[Pages 51413-51425]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-18370]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 25

[REG-163113-02]
RIN 1545-BB71


Estate, Gift, and Generation-Skipping Transfer Taxes; 
Restrictions on Liquidation of an Interest

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations concerning the 
valuation of interests in corporations and partnerships for estate, 
gift, and generation-skipping transfer (GST) tax purposes. 
Specifically, these proposed regulations concern the treatment of 
certain lapsing rights and restrictions on liquidation in determining 
the value of the transferred interests. These proposed regulations 
affect certain transferors of interests in corporations and 
partnerships and are necessary to prevent the undervaluation of such 
transferred interests.

DATES: Written and electronic comments must be received by November 2, 
2016. Outlines of topics to be discussed at the public hearing 
scheduled for December 1, 2016, must be received by November 2, 2016.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-163113-02), Room 
5203, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions also may be hand delivered Monday 
through Friday between the hours of 8 a.m. and 5 p.m. to: CC:PA:LPD:PR 
(REG-163113-02), Courier's Desk, Internal Revenue

[[Page 51414]]

Service, 1111 Constitution Avenue NW., Washington, DC 20224, or sent 
electronically via the Federal eRulemaking portal at 
www.regulations.gov (IRS REG-163113-02). The public hearing will be 
held in the Auditorium, Internal Revenue Service Building, 1111 
Constitution Avenue NW., Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
John D. MacEachen, (202) 317-6859; concerning submissions of comments, 
the hearing, and/or to be placed on the building access list to attend 
the hearing, Regina L. Johnson at (202) 317-6901 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION: 

Background

    Section 2704 of the Internal Revenue Code provides special 
valuation rules for purposes of subtitle B (relating to estate, gift, 
and GST taxes) for valuing intra-family transfers of interests in 
corporations and partnerships subject to lapsing voting or liquidation 
rights and restrictions on liquidation. Lapses of voting or liquidation 
rights are treated as a transfer of the excess of the fair market value 
of all interests held by the transferor, determined as if the voting or 
liquidation rights were nonlapsing, over the fair market value of such 
interests after the lapse. Certain restrictions on liquidation are 
disregarded in determining the fair market value of the transferred 
interest. The legislative history of section 2704 states that the 
provision is intended, in part, to prevent results similar to that in 
Estate of Harrison v. Commissioner, T.C. Memo. 1987-8. Informal S. Rep. 
on S. 3209, 136 Cong. Rec. S15629-4 (October 18, 1990); H.R. Conf. Rep. 
No. 101-964, 2374, 2842 (October 27, 1990).
    In Harrison, the decedent and two of his children each held a 
general partner interest in a partnership immediately before the 
decedent's death. The decedent also held all of the limited partner 
interests in the partnership. Because any general partner could 
liquidate the partnership during life, each general partner could cause 
all partners to obtain the full value of such partner's partnership 
interests. A general partner's right to liquidate the partnership 
lapsed on the death of that partner. In determining the estate tax 
value of the decedent's limited partner interest, the court concluded 
that the right of the decedent to liquidate the partnership (and thus 
readily obtain the full value of the limited partner interest) could 
not be taken into account because that right lapsed at death. As a 
result, the Court determined the value for transfer tax purposes of the 
limited partner interest to be less than its value either in the hands 
of the decedent immediately before death or in the hands of his family 
(the other general partners) immediately after death.
    Section 2704(a)(1) provides generally that, if there is a lapse of 
any voting or liquidation right in a corporation or a 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, whichever is applicable. The amount of the transfer is 
the fair market value of all interests held by the individual 
immediately before the lapse (determined as if the voting and 
liquidation rights were nonlapsing) over the fair market value of such 
interests after the lapse.
    Section 25.2704-1(a)(2)(v) of the current Gift Tax Regulations 
defines a liquidation right as the right or ability, including by 
reason of aggregate voting power, to compel the entity to acquire all 
or a portion of the holder's equity interest in the entity, whether or 
not its exercise would result in the complete liquidation of the 
entity.
    Section 25.2704-1(c)(1) provides a rule that a lapse of a 
liquidation right occurs at the time a presently exercisable 
liquidation right is restricted or eliminated. However, under Sec.  
25.2704-1(c)(1), a transfer of an interest that results in the lapse of 
a liquidation right generally is not subject to this rule if the rights 
with respect to the transferred interest are not restricted or 
eliminated. The effect of this exception is that the inter vivos 
transfer of a minority interest by the holder of an interest with the 
aggregate voting power to compel the entity to acquire the holder's 
interest is not treated as a lapse even though the transfer results in 
the loss of the transferor's presently exercisable liquidation right.
    The Treasury Department and the IRS, however, believe that this 
exception should not apply when the inter vivos transfer that results 
in the loss of the power to liquidate occurs on the decedent's 
deathbed. Cf. Estate of Murphy v. Commissioner, T.C. Memo. 1990-472 
(rejecting ``attempts to avoid taxation of the control value of stock 
holdings through bifurcation of the blocks''). Such transfers generally 
have minimal economic effects, but result in a transfer tax value that 
is less than the value of the interest either in the hands of the 
decedent prior to death or in the hands of the decedent's family 
immediately after death. See Harrison, supra. The enactment of section 
2704 was intended to prevent this result. See Informal S. Rep. on S. 
3209, supra; H.R. Conf. Rep. No. 101-964, supra. See also section 
2704(a)(3) (conferring on the Secretary broad regulatory authority to 
apply section 2704(a) to the lapse of rights similar to voting and 
liquidation rights). The Treasury Department and the IRS have concluded 
that the regulatory exception created in Sec.  25.2704-1(c)(1) should 
apply only to transfers occurring more than three years before death, 
where the loss of control over liquidation is likely to have a more 
substantive effect. A bright-line test will avoid the fact-intensive 
inquiry underlying a determination of a donor's subjective motive which 
is administratively burdensome for both taxpayers and the IRS. Cf. 
section 2035(a) (replacing the contemplation of death presumption of 
prior law with a bright-line, three-year test). Accordingly, the 
proposed regulations treat transfers occurring within three years of 
death that result in the lapse of a liquidation right as transfers 
occurring at death for purposes of section 2704(a).
    Section 2704(b)(1) provides generally that, if a transferor 
transfers 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'' is 
disregarded in valuing the transferred interest. Under section 
2704(b)(2), an applicable restriction is defined as a restriction that 
effectively limits the ability of the entity to liquidate, but which, 
after the transfer, either in whole or in part, will lapse or may be 
removed by the transferor or the transferor's family, either alone or 
collectively. Section 2704(b)(3)(B) excepts from the definition of an 
applicable restriction any restriction ``imposed, or required to be 
imposed, by any Federal or State law.''
    Section 2704(b)(4) provides that the Secretary may by regulations 
provide that other restrictions shall be disregarded in determining the 
value of any interest in a corporation or a partnership transferred to 
a member of the transferor's family if the restriction has the effect 
of reducing the value of the transferred interest for transfer tax 
purposes but does not ultimately reduce the value of the interest to 
the transferee.
    Section 25.2704-2(b) provides, in part, that 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

[[Page 51415]]

generally applicable to the entity in the absence of the restriction.''
    The 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. First, courts have concluded 
that, under the current regulations, section 2704(b) applies only to 
restrictions on the ability to liquidate an entire entity, and not to 
restrictions on the ability to liquidate a transferred interest in that 
entity. Kerr v. Commissioner, 113 T.C. 449, 473 (1999), aff'd, 292 
F.3rd 490 (5th Cir. 2002). Thus, a restriction on the ability to 
liquidate an individual interest is not an applicable restriction under 
the current regulations.
    Second, as noted above, the current regulations except from the 
definition of an applicable restriction a restriction on liquidation 
that is no more restrictive than that of the state law that would apply 
in the absence of the restriction. The Tax Court viewed this as a 
regulatory expansion of the statutory exception to the application of 
section 2704(b) contained in section 2704(b)(3)(B) that excepts ``any 
restriction imposed, or required to be imposed, by any Federal or State 
law.'' Kerr, 113 T.C. at 472. Since the promulgation of the current 
regulations, many state statutes governing limited partnerships have 
been revised to allow liquidation of the entity only on the unanimous 
vote of all owners (unless provided otherwise in the partnership 
agreement), and to eliminate the statutory default provision that had 
allowed a limited partner to liquidate his or her limited partner 
interest. Instead, statutes in these jurisdictions typically now 
provide that a limited partner may not withdraw from the partnership 
unless the partnership agreement provides otherwise. See, e.g., Tex. 
Bus. Orgs. Ann. Sec.  153.110 (West 2016) (limited partner may withdraw 
as specified in the partnership agreement); Uniform Limited Partnership 
Act (2001) Sec.  601(a), 6A U.L.A. 348, 448 (Supp. 2015) (limited 
partner has no right to withdraw before completion of the winding up of 
the partnership). Further, other state statutes have been revised to 
create elective restrictions on liquidation. See, e.g., Nev. Rev. Stat. 
Sec.  87A.427 (2016) (limited partnership electing to be restricted 
limited partnership may not make any distributions for a 10-year 
period). Each of these statutes is designed to be at least as 
restrictive as the maximum restriction on liquidation that could be 
imposed in a partnership agreement. The result is that the provisions 
of a partnership agreement restricting liquidation generally fall 
within the regulatory exception for restrictions that are no more 
restrictive than those under state law, and thus do not constitute 
applicable restrictions under the current regulations.
    Third, taxpayers have attempted to avoid the application of section 
2704(b) through the transfer of a partnership interest to an assignee 
rather than to a partner. Again relying on the regulatory exception for 
restrictions that are no more restrictive than those under state law, 
and the fact that an assignee is allocated partnership income, gain, 
loss, etc., but does not have (and thus may not exercise) the rights or 
powers of a partner, taxpayers argue that an assignee's inability to 
cause the partnership to liquidate his or her partnership interest is 
no greater a restriction than that imposed upon assignees under state 
law. Kerr, 113 T.C. at 463-64; Estate of Jones v. Commissioner, 116 
T.C. 121, 129-30 (2001). Taxpayers thus argue that the assignee status 
of the transferred interest is not an applicable restriction.
    Finally, taxpayers have avoided the application of section 2704(b) 
through the transfer of a nominal partnership interest to a nonfamily 
member, such as a charity or an employee, to ensure that the family 
alone does not have the power to remove a restriction. Kerr, 292 F.3rd 
at 494.
    As the Tax Court noted in Kerr, Congress granted the Secretary 
broad discretion in section 2704(b)(4) to promulgate regulations 
identifying restrictions not covered by section 2704(b) that 
nevertheless should be disregarded for transfer tax valuation purposes. 
113 T.C. at 474. The Treasury Department and the IRS have concluded 
that, as was recognized by Congress when enacting section 2704(b), 
there are additional restrictions that may affect adversely the 
transfer tax value of an interest but that do not reduce the value of 
the interest to the family-member transferee, and thus should be 
disregarded for transfer tax valuation purposes. H.R. Conf. Rep. No. 
101-964, supra, at 1138. The Treasury Department and the IRS have 
determined that such restrictions include: (a) A restriction on the 
ability to liquidate the transferred interest; and (b) any restrictions 
attendant upon the nature or extent of the property to be received in 
exchange for the liquidated interest, or the timing of the payment of 
that property.
    Further, the Treasury Department and the IRS have concluded that 
the grant of an insubstantial interest in the entity to a nonfamily 
member should not preclude the application of section 2704(b) because, 
in reality, such nonfamily member interest generally does not constrain 
the family's ability to remove a restriction on the liquidation of an 
individual interest. Cf. Kerr, 292 F.3rd at 494 (noting that a charity 
receiving a partnership interest would ``convert its interests into 
cash as soon as possible, so long as it believed the transaction to be 
in its best interest and that it would receive fair market value for 
its interest''). The interest of such nonfamily members does not affect 
the family's control of the entity, but rather, when combined with a 
requirement that all holders approve liquidation, is designed to reduce 
the transfer tax value of the family-held interests while not 
ultimately reducing the value of those interests to the family member 
transferees. The enactment of section 2704 was intended to prevent this 
result. See section 2704(b)(4) (conferring on the Secretary broad 
regulatory authority to apply section 2704(b) to other restrictions if 
the restriction has the effect of reducing the value of the transferred 
interest for transfer tax purposes but does not ultimately reduce the 
value of the interest to the transferee). The Treasury Department and 
the IRS have concluded that the presence of a nonfamily-member interest 
should be recognized only where the interest is an economically 
substantial and longstanding one that is likely to have a more 
substantive effect. A bright-line test will avoid the fact-intensive 
inquiry underlying a determination of whether the interest of the 
nonfamily member effectively constrains the family's ability to 
liquidate the entity. Accordingly, the proposed regulations disregard 
the interest held by a nonfamily member that has been held less than 
three years before the date of the transfer, that constitutes less than 
10 percent of the value of all of the equity interests, that when 
combined with the interests of other nonfamily members constitutes less 
than 20 percent of the value of all of the equity interests, or that 
lacks a right to put the interest to the entity and receive a minimum 
value.
    Finally, since the promulgation of Sec. Sec.  301.7701-1 through 
301.7701-3 of the Procedure and Administration Regulations (the check-
the-box regulations), an entity's classification for federal tax 
purposes may differ substantially from the entity's structure or form 
under local law. In addition, many taxpayers now utilize a limited 
liability company (LLC) as the preferred entity to hold family assets 
or business

[[Page 51416]]

interests. The Treasury Department and the IRS have concluded that the 
regulations under section 2704 should be updated to reflect these 
significant developments.

Explanation of Provisions

    The proposed regulations would amend Sec.  25.2701-2 to address 
what constitutes control of an LLC or other entity or arrangement that 
is not a corporation, partnership, or limited partnership. The proposed 
regulations would amend Sec.  25.2704-1 to address deathbed transfers 
that result in the lapse of a liquidation right and to clarify the 
treatment of a transfer that results in the creation of an assignee 
interest. The proposed regulations would amend Sec.  25.2704-2 to 
refine the definition of the term ``applicable restriction'' by 
eliminating the comparison to the liquidation limitations of state law. 
Further, the proposed regulations would add a new section, Sec.  
25.2704-3, to address restrictions on the liquidation of an individual 
interest in an entity and the effect of insubstantial interests held by 
persons who are not members of the family.

Covered Entities

    The proposed regulations would clarify, in Sec. Sec.  25.2704-1 
through 25.2704-3, that section 2704 applies to corporations, 
partnerships, LLC's, and other entities and arrangements that are 
business entities within the meaning of Sec.  301.7701-2(a), regardless 
of whether the entity or arrangement is domestic or foreign, regardless 
of how the entity or arrangement is classified for other federal tax 
purposes, and regardless of whether the entity or arrangement is 
disregarded as an entity separate from its owner for other federal tax 
purposes.

Classification of the Entity

    Section 2704 speaks in terms of corporations and partnerships. 
Under the proposed regulations, a corporation is any business entity 
described in Sec.  301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8), 
an S corporation within the meaning of section 1361(a)(1), and a 
qualified subchapter S subsidiary within the meaning of section 
1361(b)(3)(B). For this purpose, a qualified subchapter S subsidiary is 
treated as a corporation that is separate from its parent owner. For 
most purposes under the proposed regulations, a partnership would be 
any other business entity within the meaning of Sec.  301.7701-1(a), 
regardless of how the entity is classified for federal tax purposes.
    However, these proposed regulations address two situations in which 
it is necessary to go beyond this division of entities into only the 
two categories of corporation and partnership. These situations 
(specifically, the test to determine control of an entity, and the test 
to determine whether a restriction is imposed under state law) require 
consideration of the differences among various types of business 
entities under the local law under which those entities are created and 
governed. As a result, for purposes of the test to determine control of 
an entity and to determine whether a restriction is imposed under state 
law, the proposed regulations would provide that in the case of any 
business entity or arrangement that is not a corporation, the form of 
the entity or arrangement would be determined under local law, 
regardless of how it is classified for other federal tax purposes, and 
regardless of whether it is disregarded as an entity separate from its 
owner for other federal tax purposes. For this purpose, local law is 
the law of the jurisdiction, whether domestic or foreign, under which 
the entity or arrangement is created or organized. Thus, in applying 
these two tests, there would be three types of entities: Corporations, 
partnerships (including limited partnerships), and other business 
entities (which would include LLCs that are not S corporations) as 
determined under local law.

Control of the Entity

    Section 2704(c)(1) incorporates the definition of control found in 
section 2701(b)(2). Control of a corporation, partnership, or limited 
partnership is defined in sections 2701(b)(2)(A) and (B). The proposed 
regulations would clarify, in Sec.  25.2701-2, that control of an LLC 
or of any other entity or arrangement that is not a corporation, 
partnership, or limited partnership would constitute the holding of at 
least 50 percent of either the capital or profits interests of the 
entity or arrangement, or the holding of any equity interest with the 
ability to cause the full or partial liquidation of the entity or 
arrangement. Cf. section 2701(b)(2)(B)(ii) (defining control of a 
limited partnership as including the holding of any interest as a 
general partner). Further, for purposes of determining control, under 
the attribution rules of existing Sec.  25.2701-6, an individual, the 
individual's estate, and members of the individual's family are treated 
as holding interests held indirectly through a corporation, 
partnership, trust, or other entity.

Lapses Under Section 2704(a)

    The proposed regulations would amend Sec.  25.2704-1(a) to confirm 
that a transfer that results in the restriction or elimination of any 
of the rights or powers associated with the transferred interest (an 
assignee interest) is treated as a lapse within the meaning of section 
2704(a). This is the case regardless of whether the right or power is 
exercisable by the transferor after the transfer because the statute is 
concerned with the lapse of rights associated with the transferred 
interest. Whether the lapse is of a voting or liquidation right is 
determined under the general rules of section 25.2704-1.
    The proposed regulations also would amend Sec.  25.2704-1(c)(1) to 
narrow the exception in the definition of a lapse of a liquidation 
right to transfers occurring three years or more before the 
transferor's death that do not restrict or eliminate the rights 
associated with the ownership of the transferred interest. In addition, 
the proposed regulations would amend Sec.  25.2704-1(c)(2)(i)(B) to 
conform the existing provision for testing the family's ability to 
liquidate an interest with the proposed elimination of the comparison 
with local law, to clarify that the manner in which liquidation may be 
achieved is irrelevant, and to conform with the proposed provision for 
disregarding certain nonfamily-member interests in testing the family's 
ability to remove a restriction in proposed Sec.  25.2704-3 regarding 
disregarded restrictions.

Applicable Restrictions Under Section 2704(b)

    The proposed regulations would remove the exception in Sec.  
25.2704-2(b) that limits the definition of applicable restriction to 
limitations that are more restrictive than the limitations that would 
apply in the absence of the restriction under the local law generally 
applicable to the entity. As noted above, this exception is not 
consistent with section 2704(b) to the extent that the transferor and 
family members have the power to avoid any statutory rule. The proposed 
regulations also would revise Sec.  25.2704-2(b) to provide that an 
applicable restriction does include a restriction that is imposed under 
the terms of the governing documents, as well as a restriction that is 
imposed under a local law regardless of whether that restriction may be 
superseded by or pursuant to the governing documents or otherwise. In 
applying this particular exception to the definition of an applicable 
restriction, this proposed rule is intended to ensure that a 
restriction that is not imposed or required to be imposed by federal or 
state law is disregarded without regard to its source.
    Further, with regard to the exception for restrictions ``imposed, 
or required to

[[Page 51417]]

be imposed, by any Federal or State law,'' in section 2704(b)(3)(B), 
the proposed regulations would clarify that the terms ``federal'' and 
``state'' refer only to the United States or any state (including the 
District of Columbia (see section 7701(a)(10)), but do not include any 
other jurisdiction.
    A restriction is imposed or required to be imposed by law if the 
restriction cannot be removed or overridden and it is mandated by the 
applicable law, is required to be included in the governing documents, 
or otherwise is made mandatory. In addition, a restriction imposed by a 
state law, even if that restriction may not be removed or overridden 
directly or indirectly, nevertheless would constitute an applicable 
restriction in two situations. In each situation, although the statute 
itself is mandatory and cannot be overridden, another statute is 
available to be used for the entity's governing law that does not 
require the mandatory restriction, thus in effect making the 
purportedly mandatory provision elective. The first situation is that 
in which the state law is limited in its application to certain narrow 
classes of entities, particularly those types of entities most likely 
to be subject to transfers described in section 2704, that is, family-
controlled entities. The second situation is that in which, although 
the state law under which the entity was created imposed a mandatory 
restriction that could not be removed or overridden, either at the time 
the entity was organized or at some subsequent time, that state's law 
also provided an optional provision or an alternative statute for the 
creation and governance of that same type of entity that did not 
mandate the restriction. Thus, an optional provision is one for the 
same category of entity that did not include the restriction or that 
allowed it to be removed or overridden, or that made the restriction 
optional, or permitted the restriction to be superseded, whether by the 
entity's governing documents or otherwise. For purposes of determining 
whether a restriction is imposed on an entity under state law, there 
would be only three types of entities, specifically, the three 
categories of entities described in Sec.  25.2701-2(b)(5) of the 
proposed regulations: Corporations; partnerships (including limited 
partnerships); and other business entities. A similar proposed rule 
applies to the additional restrictions discussed later in this 
preamble.
    If an applicable restriction is disregarded, the fair market value 
of the transferred interest is determined under generally applicable 
valuation principles as if the restriction does not exist (that is, as 
if the governing documents and the local law are silent on the 
question), and thus, there is deemed to be no such restriction on 
liquidation of the entity.

Disregarded Restrictions

    A new class of restrictions is described in the proposed 
regulations that would be disregarded, described as ``disregarded 
restrictions.'' This class of restrictions is identified pursuant to 
the authority contained in section 2704(b)(4). Note that, although it 
may appear that sections 2703 and 2704(b) overlap, they do not. While 
section 2703 and the corresponding regulations currently address 
restrictions on the sale or use of individual interests in family-
controlled entities, the proposed regulations would address 
restrictions on the liquidation or redemption of such interests.
    Under Sec.  25.2704-3 of the proposed regulations, in the case of a 
family-controlled entity, any restriction described below on a 
shareholder's, partner's, member's, or other owner's right to liquidate 
his or her interest in the entity will be disregarded if the 
restriction will lapse at any time after the transfer, or if the 
transferor, or the transferor and family members, without regard to 
certain interests held by nonfamily members, may remove or override the 
restriction. Under the proposed regulations, such a disregarded 
restriction includes one that: (a) Limits the ability of the holder of 
the interest to liquidate the interest; (b) limits the liquidation 
proceeds to an amount that is less than a minimum value; (c) defers the 
payment of the liquidation proceeds for more than six months; or (d) 
permits the payment of the liquidation proceeds in any manner other 
than in cash or other property, other than certain notes.
    ``Minimum value'' is the interest's share of the net value of the 
entity on the date of liquidation or redemption. The net value of the 
entity is the fair market value, as determined under section 2031 or 
2512 and the applicable regulations, of the property held by the 
entity, reduced by the outstanding obligations of the entity. Solely 
for purposes of determining minimum value, the only outstanding 
obligations of the entity that may be taken into account are those that 
would be allowable (if paid) as deductions under section 2053 if those 
obligations instead were claims against an estate. For example, and 
subject to the foregoing limitation on outstanding obligations, if the 
entity holds an operating business, the rules of Sec.  20.2031-2(f)(2) 
or 20.2031-3 apply in the case of a testamentary transfer and the rules 
of Sec.  25.2512-2(f)(2) or 25.2512-3 apply in the case of an inter 
vivos transfer. The minimum value of the interest is the net value of 
the entity multiplied by the interest's share of the entity. For this 
purpose, the interest's share is determined by taking into account any 
capital, profits, and other rights inherent in the interest in the 
entity.
    A disregarded restriction includes limitations on the time and 
manner of payment of the liquidation proceeds. Such limitations include 
provisions permitting deferral of full payment beyond six months or 
permitting payment in any manner other than in cash or property. For 
this purpose, the term ``property'' does not include a note or other 
obligation issued directly or indirectly by the entity, other holders 
of an interest in the entity, or persons related to either. An 
exception is made for the note of an entity engaged in an active trade 
or business to the extent that (a) the liquidation proceeds are not 
attributable to passive assets within the meaning of section 
6166(b)(9)(B), and (b) the note is adequately secured, requires 
periodic payments on a non-deferred basis, is issued at market interest 
rates, and has a fair market value (when discounted to present value) 
equal to the liquidation proceeds. A fair market value determination 
assumes a cash sale. See Section 2 of Rev. Rul. 59-60, 1959-1 C.B. 237 
(defining fair market value and stating that ``[c]ourt decisions 
frequently state in addition that the hypothetical buyer and seller are 
assumed to be able, as well as willing to trade . . .''). Thus, in the 
absence of immediate payment of the liquidation proceeds, the fair 
market value of any note falling within this exception must equal the 
fair market value of the liquidation proceeds on the date of 
liquidation or redemption.
    Exceptions that apply to applicable restrictions under the current 
and these proposed regulations also apply to this new class of 
disregarded restrictions. One of the exceptions applicable to the 
definition of a disregarded restriction applies if (a) each holder of 
an interest in the entity has an enforceable ``put'' right to receive, 
on liquidation or redemption of the holder's interest, cash and/or 
other property with a value that is at least equal to the minimum value 
previously described, (b) the full amount of such cash and other 
property must be paid within six months after the holder gives notice 
to the entity of the holder's intent to liquidate any part or all of 
the holder's interest and/or withdraw from the entity, and (c) such 
other property does not include a note or other obligation issued 
directly or

[[Page 51418]]

indirectly by the entity, by one or more holders of interests in the 
entity, or by a person related either to the entity or to any holder of 
an interest in the entity. However, in the case of an entity engaged in 
an active trade or business, at least 60 percent of whose value 
consists of the non-passive assets of that trade or business, and to 
the extent that the liquidation proceeds are not attributable to 
passive assets within the meaning of section 6166(b)(9)(B), such 
proceeds may include a note or other obligation if such note is 
adequately secured, requires periodic payments on a non-deferred basis, 
is issued at market interest rates, and has a fair market value on the 
date of the liquidation or redemption equal to the liquidation 
proceeds. A similar exception is made to the definition of an 
applicable restriction in proposed Sec.  25.2704-2(b)(4).
    In determining whether the transferor and/or the transferor's 
family has the ability to remove a restriction included in this new 
class of disregarded restrictions, any interest in the entity held by a 
person who is not a member of the transferor's family is disregarded 
if, at the time of the transfer, the interest: (a) Has been held by 
such person for less than three years; (b) constitutes less than 10 
percent of the value of all of the equity interests in a corporation, 
or constitutes less than 10 percent of the capital and profits 
interests in a business entity described in Sec.  301.7701-2(a) other 
than a corporation (for example, less than a 10-percent interest in the 
capital and profits of a partnership); (c) when combined with the 
interests of all other persons who are not members of the transferor's 
family, constitutes less than 20 percent of the value of all of the 
equity interests in a corporation, or constitutes less than 20 percent 
of the capital and profits interests in a business entity other than a 
corporation (for example, less than a 20-percent interest in the 
capital and profits of a partnership); or (d) any such person, as the 
owner of an interest, does not have an enforceable right to receive in 
exchange for such interest, on no more than six months' prior notice, 
the minimum value referred to in the definition of a disregarded 
restriction. If an interest is disregarded, the determination of 
whether the family has the ability to remove the restriction will be 
made assuming that the remaining interests are the sole interests in 
the entity.
    Finally, if a restriction is disregarded under proposed Sec.  
25.2704-3, the fair market value of the interest in the entity is 
determined assuming that the disregarded restriction did not exist, 
either in the governing documents or applicable law. Fair market value 
is determined under generally accepted valuation principles, including 
any appropriate discounts or premiums, subject to the assumptions 
described in this paragraph.

Coordination With Marital and Charitable Deductions

    Section 2704(b) applies to intra-family transfers for all purposes 
of subtitle B relating to estate, gift and GST taxes. Therefore, to the 
extent that an interest qualifies for the gift or estate tax marital 
deduction and must be valued by taking into account the special 
valuation assumptions of section 2704(b), the same value generally will 
apply in computing the marital deduction attributable to that interest. 
The value of the estate tax marital deduction may be further affected, 
however, by other factors justifying a different value, such as the 
application of a control premium. See, e.g., Estate of Chenoweth v. 
Commissioner, 88 T.C. 1577 (1987).
    Section 2704(b) does not apply to transfers to nonfamily members 
and thus has no application in valuing an interest passing to charity 
or to a person other than a family member. If part of an entity 
interest includible in the gross estate passes to family members and 
part of that interest passes to nonfamily members, and if (taking into 
account the proposed rules regarding the treatment of certain interests 
held by nonfamily members) the part passing to the decedent's family 
members is valued under section 2704(b), then the proposed regulations 
provide that the part passing to the family members is treated as a 
property interest separate from the part passing to nonfamily members. 
The fair market value of the part passing to the family members is 
determined taking into account the special valuation assumptions of 
section 2704(b), as well as any other relevant factors, such as those 
supporting a control premium. The fair market value of the part passing 
to the nonfamily member(s) is determined in a similar manner, but 
without the special valuation assumptions of section 2704(b). Thus, if 
the sole nonfamily member receiving an interest is a charity, the 
interest generally will have the same value for both estate tax 
inclusion and deduction purposes. If the interest passing to nonfamily 
members, however, is divided between charities and other nonfamily 
members, additional considerations (not prescribed by section 2704) may 
apply, resulting in a different value for charitable deduction 
purposes. See, e.g., Ahmanson Foundation v. United States, 674 F.2d 761 
(9th Cir. 1981).
Effective Dates
    The amendments to Sec.  25.2701-2 are proposed to be effective on 
and after the date of publication of a Treasury decision adopting these 
rules as final regulations in the Federal Register. The amendments to 
Sec.  25.2704-1 are proposed to apply to lapses of rights created after 
October 8, 1990, occurring on or after the date these regulations are 
published as final regulations in the Federal Register. The amendments 
to Sec.  25.2704-2 are proposed to apply to transfers of property 
subject to restrictions created after October 8, 1990, occurring on or 
after the date these regulations are published as final regulations in 
the Federal Register. Section 25.2704-3 is proposed to apply to 
transfers of property subject to restrictions created after October 8, 
1990, occurring 30 or more days after the date these regulations are 
published as final regulations in the Federal Register.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. Pursuant to the Regulatory Flexibility Act (5 U.S.C. 
chapter 6), it is hereby certified that this regulation will not have a 
significant economic impact on a substantial number of small entities. 
The proposed regulations affect the transfer tax liability of 
individuals who transfer an interest in certain closely held entities 
and not the entities themselves. The proposed regulations do not affect 
the structure of such entities, but only the assumptions under which 
they are valued for federal transfer tax purposes. In addition, any 
economic impact on entities affected by section 2704, large or small, 
is derived from the operation of the statute, or its intended 
application, and not from the proposed regulations in this notice of 
proposed rulemaking. Accordingly, a regulatory flexibility analysis is 
not required. Pursuant to section 7805(f) of the Internal Revenue Code, 
this regulation has been submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8)

[[Page 51419]]

copies) or electronic comments that are submitted timely (in the manner 
described in ADDRESSES) to the IRS. The Treasury Department and the IRS 
request comments on all aspects of the proposed regulations. All 
comments will be available at www.regulations.gov, or upon request.
    A public hearing on these proposed regulations has been scheduled 
for December 1, 2016, beginning at 10 a.m. in the Auditorium, Internal 
Revenue Building, 1111 Constitution Avenue NW., Washington, DC 20224. 
Due to building security procedures, visitors must enter at the 
Constitution Avenue entrance. In addition, all visitors must present 
photo identification to enter the building. Because of access 
restrictions, visitors will not be admitted beyond the immediate 
entrance area more than 30 minutes before the hearing starts. For 
information about having your name placed on the building access list 
to attend the hearing, see the FOR FURTHER INFORMATION CONTACT section 
of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit comments by 
November 2, 2016, and submit an outline of the topics to be discussed 
and the time to be devoted to each topic (signed original and eight (8) 
copies) by November 2, 2016.
    A period of 10 minutes will be allotted to each person for making 
comments. Copies of the agenda will be available free of charge at the 
hearing.

Drafting Information

    The principal author of these proposed regulations is John D. 
MacEachen, Office of the Associate Chief Counsel (Passthroughs and 
Special Industries). Other personnel from the Treasury Department and 
the IRS participated in their development.

List of Subjects in 26 CFR Part 25

    Gift taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 25 is proposed to be amended as follows:

PART 25--GIFT TAX; GIFTS MADE AFTER DECEMBER 31, 1954

0
Paragraph 1. The authority citation for part 25 is amended by adding 
entries in numerical order to read in part as follows:

    Authority:  26 U.S.C. 7805. * * *
    Section 25.2701-2 also issued under 26 U.S.C. 2701(e).
    Section 25.2704-1 also issued under 26 U.S.C. 2704(a).
    Sections 25.2704-2 and 25.2704-3 also issued under 26 U.S.C. 
2704(b).
* * * * *

0
Par. 2. Section 25.2701-2 is amended as follows:
0
1. In paragraph (b)(5)(i), the first sentence is revised and five 
sentences are added before the last sentence.
0
2. Paragraph (b)(5)(iv) is added.
    The revision and additions read as follows:


Sec.  25.2701-2  Special valuation rules for applicable retained 
interests.

* * * * *
    (b) * * *
    (5) * * *
    (i) * * * For purposes of section 2701, a controlled entity is a 
corporation, partnership, or any other entity or arrangement that is a 
business entity within the meaning of Sec.  301.7701-2(a) of this 
chapter controlled, immediately before a transfer, by the transferor, 
applicable family members, and/or any lineal descendants of the parents 
of the transferor or the transferor's spouse. The form of the entity 
determines the applicable test for control. For purposes of determining 
the form of the entity, any business entity described in Sec.  
301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) of this chapter, an S 
corporation within the meaning of section 1361(a)(1), and a qualified 
subchapter S subsidiary within the meaning of section 1361(b)(3)(B) is 
a corporation. For this purpose, a qualified subchapter S subsidiary is 
treated as a corporation separate from its parent corporation. In the 
case of any business entity that is not a corporation under these 
provisions, the form of the entity is determined under local law, 
regardless of how the entity is classified for federal tax purposes or 
whether it is disregarded as an entity separate from its owner for 
federal tax purposes. For this purpose, local law is the law of the 
jurisdiction, whether domestic or foreign, under whose laws the entity 
is created or organized. * * *
* * * * *
    (iv) Other business entities. In the case of any entity or 
arrangement that is not a corporation, partnership, or limited 
partnership, control means the holding of at least 50 percent of either 
the capital interests or the profits interests in the entity or 
arrangement. In addition, control means the holding of any equity 
interest with the ability to cause the liquidation of the entity or 
arrangement in whole or in part.
* * * * *
0
 Par. 3. Section 25.2701-8 is amended as follows:
0
1. The existing text is designated as paragraph (a).
0
2. The first sentence of newly designated paragraph (a) is revised and 
paragraph (b) is added.
    The revision and addition reads as follows:


Sec.  25.2701-8  Effective dates.

    (a) Except as provided in paragraph (b) of this section, Sec. Sec.  
25.2701-1 through 25.2701-4 and Sec. Sec.  25.2701-6 and 25.2701-7 are 
effective as of January 28, 1992. * * *
    (b) The first six sentences of Sec.  25.2701-2(b)(5)(i) and (iv) 
are effective on the date these regulations are published as final 
regulations in the Federal Register.
0
Par. 4. Section 25.2704-1 is amended as follows:
0
1. In paragraph (a)(1), the first two sentences are revised and four 
sentences are added before the third sentence.
0
2. In paragraph (a)(2)(i), a sentence is added at the end.
0
3. Paragraph (a)(2)(iii) is removed.
0
4. Paragraphs (a)(2)(iv) through (vi) are redesignated as paragraphs 
(a)(2)(iii) through (v), respectively.
0
5. In newly designated paragraph (a)(2)(iii), a sentence is added 
before the third sentence.
0
6. Paragraph (a)(4) is revised.
0
7. Paragraph (a)(5) is added.
0
8. In paragraph (c)(1), the second sentence is revised and a sentence 
is added at the end.
0
9. Paragraph (c)(2)(i)(B) is revised.
0
10. In paragraph (f) Example 4, the third and fourth sentences are 
revised and a sentence is added at the end.
0
11. In paragraph (f) Example 6, the third sentence is removed.
0
12. In paragraph (f) Example 7, the third and fourth sentences are 
revised and a sentence is added at the end.
    The revisions and additions read as follows:


Sec.  25.2704-1   Lapse of certain rights.

    (a) * * *
    (1) * * * For purposes of subtitle B (relating to estate, gift, and 
generation-skipping transfer taxes), the lapse of a voting or a 
liquidation right in a corporation or a partnership (an entity), 
whether domestic or foreign, 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/or members of the holder's family immediately before and 
after the lapse. For purposes of this section, a

[[Page 51420]]

corporation is any business entity described in Sec.  301.7701-2(b)(1), 
(3), (4), (5), (6), (7), or (8) of this chapter, an S corporation 
within the meaning of section 1361(a)(1), and a qualified subchapter S 
subsidiary within the meaning of section 1361(b)(3)(B). For this 
purpose, a qualified subchapter S subsidiary is treated as a 
corporation separate from its parent corporation. A partnership is any 
other business entity within the meaning of Sec.  301.7701-2(a) of this 
chapter regardless of how that entity is classified for federal tax 
purposes. Thus, for example, the term partnership includes a limited 
liability company that is not an S corporation, whether or not it is 
disregarded as an entity separate from its owner for federal tax 
purposes. * * *
    (2) * * *
    (i) * * * For purposes of determining whether the group consisting 
of the holder, the holder's estate and members of the holder's family 
control the entity, a member of the group is also treated as holding 
any interest held indirectly by such member through a corporation, 
partnership, trust, or other entity under the rules contained in Sec.  
25.2701-6.
* * * * *
    (iii) * * * In the case of a limited liability company, the right 
of a member to participate in company management is a voting right. * * 
*
* * * * *
    (4) Source of right or lapse. A voting right or a liquidation right 
may be conferred by or lapse by reason of local law, the governing 
documents, an agreement, or otherwise. For this purpose, local law is 
the law of the jurisdiction, whether domestic or foreign, that governs 
voting or liquidation rights.
    (5) Assignee interests. A transfer that results in the restriction 
or elimination of the transferee's ability to exercise the voting or 
liquidation rights that were associated with the interest while held by 
the transferor is a lapse of those rights. For example, the transfer of 
a partnership interest to an assignee that neither has nor may exercise 
the voting or liquidation rights of a partner is a lapse of the voting 
and liquidation rights associated with the transferred interest.
    (c) * * *
    (1) * * * Except as otherwise provided, a transfer of an interest 
occurring more than three years before the transferor's death that 
results in the lapse of a voting or liquidation right is not subject to 
this section if the rights with respect to the transferred interest are 
not restricted or eliminated. * * * The lapse of a voting or 
liquidation right as a result of the transfer of an interest within 
three years of the transferor's death is treated as a lapse occurring 
on the transferor's date of death, includible in the gross estate 
pursuant to section 2704(a).
    (2) * * *
    (i) * * *
    (B) Ability to liquidate. Whether an interest can be liquidated 
immediately after the lapse is determined under the local law generally 
applicable to the entity, as modified by the governing documents of the 
entity, but without regard to any restriction (in the governing 
documents, applicable local law, or otherwise) described in section 
2704(b) and the regulations thereunder. The manner in which the 
interest may be liquidated is irrelevant for this purpose, whether by 
voting, taking other action authorized by the governing documents or 
applicable local law, revising the governing documents, merging the 
entity with an entity whose governing documents permit liquidation of 
the interest, terminating the entity, or otherwise. For purposes of 
making this determination, an interest held by a person other than a 
member of the holder's family (a nonfamily-member interest) may be 
disregarded. Whether a nonfamily-member interest is disregarded is 
determined under Sec.  25.2704-3(b)(4), applying that section as if, by 
its terms, it also applies to the question of whether the holder (or 
the holder's estate) and members of the holder's family may liquidate 
an interest immediately after the lapse.
* * * * *
    (f) * * *

    Example 4.  * * * More than three years before D's death, D 
transfers one-half of D's stock in equal shares to D's three 
children (14 percent each). Section 2704(a) does not apply to the 
loss of D's ability to liquidate Y because the voting rights with 
respect to the transferred shares are not restricted or eliminated 
by reason of the transfer, and the transfer occurs more than three 
years before D's death. However, had the transfers occurred within 
three years of D's death, the transfers would have been treated as 
the lapse of D's liquidation right occurring at D's death.
* * * * *
    Example 7.  * * * More than three years before D's death, D 
transfers 30 shares of common stock to D's child. The transfer is 
not a lapse of a liquidation right with respect to the common stock 
because the voting rights that enabled D to liquidate prior to the 
transfer are not restricted or eliminated, and the transfer occurs 
more than three years before D's death. * * * However, had the 
transfer occurred within three years of D's death, the transfer 
would have been treated as the lapse of D's liquidation right with 
respect to the common stock occurring at D's death.

0
Par. 5. Section 25.2704-2 is amended as follows:
0
1. Paragraphs (a) and (b) are revised.
0
2. Paragraphs (c) and (d) are designated as paragraphs (e) and (g), 
respectively.
0
3. New paragraphs (c), (d), and (f) are added.
0
4. The first sentence of newly designated paragraph (e) is revised.
0
5. The third sentences of newly designated paragraph (g) Example 1. and 
Example 3. are removed.
0
6. The third sentence of newly designated paragraph (g) Example 5. is 
revised.
    The revisions and additions read as follows:


Sec.  25.2704-2   Transfers subject to applicable restrictions.

    (a) In general. For purposes of subtitle B (relating to estate, 
gift, and generation-skipping transfer taxes), if an interest in a 
corporation or a partnership (an entity), whether domestic or foreign, 
is transferred to or for the benefit of a member of the transferor's 
family, and the transferor and/or members of the transferor's family 
control the entity immediately before the transfer, any applicable 
restriction is disregarded in valuing the transferred interest. For 
purposes of this section, a corporation is any business entity 
described in Sec.  301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) of 
this chapter, an S corporation within the meaning of section 
1361(a)(1), and a qualified subchapter S subsidiary within the meaning 
of section 1361(b)(3)(B). For this purpose, a qualified subchapter S 
subsidiary is treated as a corporation separate from its parent 
corporation. A partnership is any other business entity within the 
meaning of Sec.  301.7701-2(a) of this chapter, regardless of how that 
entity is classified for federal tax purposes. Thus, for example, the 
term partnership includes a limited liability company that is not an S 
corporation, whether or not it is disregarded as an entity separate 
from its owner for federal tax purposes.
    (b) Applicable restriction defined--(1) In general. The term 
applicable restriction means a limitation on the ability to liquidate 
the entity, in whole or in part (as opposed to a particular holder's 
interest in the entity), if, after the transfer, that limitation either 
lapses or may be removed by the transferor, the transferor's estate, 
and/or any member of the transferor's family, either alone or 
collectively. See Sec.  25.2704-3 for restrictions on the ability to 
liquidate a particular holder's interest in the entity.
    (2) Source of limitation. An applicable restriction includes a 
restriction that is

[[Page 51421]]

imposed under the terms of the governing documents (for example, the 
corporation's by-laws, the partnership agreement, or other governing 
documents), a buy-sell agreement, a redemption agreement, or an 
assignment or deed of gift, or any other document, agreement, or 
arrangement; and a restriction imposed under local law regardless of 
whether that restriction may be superseded by or pursuant to the 
governing documents or otherwise. For this purpose, local law is the 
law of the jurisdiction, whether domestic or foreign, that governs the 
applicability of the restriction. For an exception for restrictions 
imposed or required to be imposed by federal or state law, see 
paragraph (b)(4)(ii) of this section.
    (3) Lapse or removal of limitation. 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 restriction may be 
removed after the transfer by any one or more members, either alone or 
collectively, of the group consisting of the transferor, the 
transferor's estate, and members of the transferor's family. For 
purposes of determining whether the ability to remove the restriction 
is held by any member(s) of this group, members are treated as holding 
the interests attributed to them under the rules contained in Sec.  
25.2701-6, in addition to interests held directly. The manner in which 
the restriction may be removed is irrelevant for this purpose, whether 
by voting, taking other action authorized by the governing documents or 
applicable local law, removing the restriction from the governing 
documents, revising the governing documents to override the restriction 
prescribed under local law in the absence of a contrary provision in 
the governing documents, merging the entity with an entity whose 
governing documents do not contain the restriction, terminating the 
entity, or otherwise.
    (4) Exceptions. A restriction described in this paragraph (b)(4) is 
not an applicable restriction.
    (i) Commercially reasonable restriction. 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), 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 that is publicly held.
    (ii) Imposed by federal or state law. An applicable restriction 
does not include a restriction imposed or required to be imposed by 
federal or state law. For this purpose, federal or state law means the 
laws of the United States, of any state thereof, or of the District of 
Columbia, but does not include the laws of any other jurisdiction. A 
provision of law that applies only in the absence of a contrary 
provision in the governing documents or that may be superseded with 
regard to a particular entity (whether by the shareholders, partners, 
members and/or managers of the entity or otherwise) is not a 
restriction that is imposed or required to be imposed by federal or 
state law. A law that is limited in its application to certain narrow 
classes of entities, particularly those types of entities (such as 
family-controlled entities) most likely to be subject to transfers 
described in section 2704, is not a restriction that is imposed or 
required to be imposed by federal or state law. For example, a law 
requiring a restriction that may not be removed or superseded and that 
applies only to family-controlled entities that otherwise would be 
subject to the rules of section 2704 is an applicable restriction. In 
addition, a restriction is not imposed or required to be imposed by 
federal or state law if that law also provides (either at the time the 
entity was organized or at some subsequent time) an optional provision 
that does not include the restriction or that allows it to be removed 
or overridden, or that provides a different statute for the creation 
and governance of that same type of entity that does not mandate the 
restriction, makes the restriction optional, or permits the restriction 
to be superseded, whether by the entity's governing documents or 
otherwise. For purposes of determining the type of entity, there are 
only three types of entities, specifically, the three categories of 
entities described in Sec.  25.2701-2(b)(5): Corporations; partnerships 
(including limited partnerships); and other business entities.
    (iii) Certain rights under section 2703. An option, right to use 
property, or agreement that is subject to section 2703 is not an 
applicable restriction.
    (iv) Put right of each holder. Any restriction that otherwise would 
constitute an applicable restriction under this section will not be 
considered an applicable restriction if each holder of an interest in 
the entity has a put right as described in Sec.  25.2704-3(b)(6).
    (c) Other definitions. For the definition of the term controlled 
entity, see Sec.  25.2701-2(b)(5). For the definition of the term 
member of the family, see Sec.  25.2702-2(a)(1).
    (d) Attribution. An individual, the individual's estate, and 
members of the individual's family are treated as also holding any 
interest held indirectly by such person through a corporation, 
partnership, trust, or other entity under the rules contained in Sec.  
25.2701-6.
    (e) * * * If an applicable restriction is disregarded under this 
section, the fair market value of the transferred interest is 
determined under generally applicable valuation principles as if the 
restriction (whether in the governing documents, applicable law, or 
both) does not exist. * * *
    (f) Certain transfers at death to multiple persons. Solely for 
purposes of section 2704(b), if part of a decedent's interest in an 
entity includible in the gross estate passes by reason of death to one 
or more members of the decedent's family and part of that includible 
interest passes to one or more persons who are not members of the 
decedent's family, and if the part passing to the members of the 
decedent's family is to be valued pursuant to paragraph (e) of this 
section, then that part is treated as a single, separate property 
interest. In that case, the part passing to one or more persons who are 
not members of the decedent's family is also treated as a single, 
separate property interest. See paragraph (g) Ex. 4 of Sec.  25.2704-3.
    (g) * * *

    Example 5.  * * * The preferred stock carries a right to 
liquidate X that cannot be exercised until 1999. * * *
* * * * *


Sec.  25.2704-3  [Redesignated as Sec.  25.2704-4]

0
Par. 6. Section 25.2704-3 is redesignated as Sec.  25.2704-4.
0
Par. 7. New Sec.  25.2704-3 is added to read as follows.


Sec.  25.2704-3  Transfers subject to disregarded restrictions.

    (a) In general. For purposes of subtitle B (relating to estate, 
gift and generation-skipping transfer taxes), and notwithstanding any 
provision of Sec.  25.2704-2, if an interest in a corporation or a 
partnership (an entity), whether domestic or foreign, is transferred to 
or for the benefit of a member of the transferor's family, and the 
transferor and/or members of the transferor's family control the entity 
immediately before the transfer, any restriction described in paragraph 
(b) of this section is disregarded, and the transferred interest is 
valued as provided in paragraph (f) of this section.

[[Page 51422]]

For purposes of this section, a corporation is any business entity 
described in Sec.  301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) of 
this chapter, an S corporation within the meaning of section 
1361(a)(1), and a qualified subchapter S subsidiary within the meaning 
of section 1361(b)(3)(B). For this purpose, a qualified subchapter S 
subsidiary is treated as a corporation separate from its parent 
corporation. A partnership is any other business entity within the 
meaning of Sec.  301.7701-2(a) of this chapter, regardless of how that 
entity is classified for federal tax purposes. Thus, for example, the 
term partnership includes a limited liability company that is not an S 
corporation, whether or not it is disregarded as an entity separate 
from its owner for federal tax purposes.
    (b) Disregarded restrictions defined--(1) In general. The term 
disregarded restriction means a restriction that is a limitation on the 
ability to redeem or liquidate an interest in an entity that is 
described in any one or more of paragraphs (b)(1)(i) through (iv) of 
this section, if the restriction, in whole or in part, either lapses 
after the transfer or can be removed by the transferor or any member of 
the transferor's family (subject to paragraph (b)(4) of this section), 
either alone or collectively.
    (i) The provision limits or permits the limitation of the ability 
of the holder of the interest to compel liquidation or redemption of 
the interest.
    (ii) The provision limits or permits the limitation of the amount 
that may be received by the holder of the interest on liquidation or 
redemption of the interest to an amount that is less than a minimum 
value. The term minimum value means the interest's share of the net 
value of the entity determined on the date of liquidation or 
redemption. The net value of the entity is the fair market value, as 
determined under section 2031 or 2512 and the applicable regulations, 
of the property held by the entity, reduced by the outstanding 
obligations of the entity. Solely for purposes of determining minimum 
value, the only outstanding obligations of the entity that may be taken 
into account are those that would be allowable (if paid) as deductions 
under section 2053 if those obligations instead were claims against an 
estate. For example, and subject to the foregoing limitation on 
outstanding obligations, if the entity holds an operating business, the 
rules of Sec.  20.2031-2(f)(2) or Sec.  20.2031-3 of this chapter apply 
in the case of a testamentary transfer and the rules of Sec.  25.2512-
2(f)(2) or Sec.  25.2512-3 apply in the case of an inter vivos 
transfer. The minimum value of the interest is the net value of the 
entity multiplied by the interest's share of the entity. For this 
purpose, the interest's share is determined by taking into account any 
capital, profits, and other rights inherent in the interest in the 
entity. If the property held by the entity directly or indirectly 
includes an interest in another entity, and if a transfer of an 
interest in that other entity by the same transferor (had that 
transferor owned the interest directly) would be subject to section 
2704(b), then the entity will be treated as owning a share of the 
property held by the other entity, determined and valued in accordance 
with the provisions of section 2704(b) and the regulations thereunder.
    (iii) The provision defers or permits the deferral of the payment 
of the full amount of the liquidation or redemption proceeds for more 
than six months after the date the holder gives notice to the entity of 
the holder's intent to have the holder's interest liquidated or 
redeemed.
    (iv) The provision authorizes or permits the payment of any portion 
of the full amount of the liquidation or redemption proceeds in any 
manner other than in cash or property. Solely for this purpose, except 
as provided in the following sentence, a note or other obligation 
issued directly or indirectly by the entity, by one or more holders of 
interests in the entity, or by a person related to either the entity or 
any holder of an interest in the entity, is deemed not to be property. 
In the case of an entity engaged in an active trade or business, at 
least 60 percent of whose value consists of the non-passive assets of 
that trade or business, and to the extent that the liquidation proceeds 
are not attributable to passive assets within the meaning of section 
6166(b)(9)(B), such proceeds may include such a note or other 
obligation if such note or other obligation is adequately secured, 
requires periodic payments on a non-deferred basis, is issued at market 
interest rates, and has a fair market value on the date of liquidation 
or redemption equal to the liquidation proceeds. See Sec.  25.2512-8. 
For purposes of this paragraph (b)(1)(iv), a related person is any 
person whose relationship to the entity or to any holder of an interest 
in the entity is described in section 267(b), provided that for this 
purpose the term fiduciary of a trust as used in section 267(b) does 
not include a bank as defined in section 581 that is publicly held.
    (2) Source of limitation. A disregarded restriction includes a 
restriction that is imposed under the terms of the governing documents 
(for example, the corporation's by-laws, the partnership agreement, or 
other governing documents), a buy-sell agreement, a redemption 
agreement, or an assignment or deed of gift, or any other document, 
agreement, or arrangement; and a restriction imposed under local law 
regardless of whether that restriction may be superseded by or pursuant 
to the governing documents or otherwise. For this purpose, local law is 
the law of the jurisdiction, whether domestic or foreign, which governs 
the applicability of the restriction. For an exception for restrictions 
imposed or required to be imposed by federal or state law, see 
paragraph (b)(5)(iii) of this section.
    (3) Lapse or removal of limitation. A restriction is a disregarded 
restriction only to the extent that the restriction either will lapse 
by its terms at any time after the transfer or may be removed after the 
transfer by any one or more members, either alone or collectively, of 
the group consisting of the transferor, the transferor's estate, and 
members of the transferor's family. For purposes of determining whether 
the ability to remove the restriction is held by any one or more 
members of this group, members are treated as holding interests 
attributed to them under the rules contained in Sec.  25.2701-6, in 
addition to interests held directly. See also paragraph (b)(4) of this 
section. The manner in which the restriction may be removed is 
irrelevant for this purpose, whether by voting, taking other action 
authorized by the governing documents or applicable local law, removing 
the restriction from the governing documents, revising the governing 
documents to override the restriction prescribed under local law in the 
absence of a contrary provision in the governing documents, merging the 
entity with an entity whose governing documents do not contain the 
restriction, terminating the entity, or otherwise.
    (4) Certain interests held by nonfamily members disregarded--(i) In 
general. In the case of a transfer to or for the benefit of a member of 
the transferor's family, for purposes of determining whether the 
transferor (or the transferor's estate) or any member of the 
transferor's family, either alone or collectively, may remove a 
restriction within the meaning of this paragraph (b), an interest held 
by a person other than a member of the transferor's family (a 
nonfamily-member interest) is disregarded unless all of the following 
are satisfied:
    (A) The interest has been held by the nonfamily member for at least 
three years immediately before the transfer;
    (B) On the date of the transfer, in the case of a corporation, the 
interest

[[Page 51423]]

constitutes at least 10 percent of the value of all of the equity 
interests in the corporation, and, in the case of a business entity 
within the meaning of Sec.  301.7701-2(a) of this chapter other than a 
corporation, the interest constitutes at least a 10-percent interest in 
the business entity, for example, a 10-percent interest in the capital 
and profits of a partnership;
    (C) On the date of the transfer, in the case of a corporation, the 
total of the equity interests in the corporation held by shareholders 
who are not members of the transferor's family constitutes at least 20 
percent of the value of all of the equity interests in the corporation, 
and, in the case of a business entity within the meaning of Sec.  
301.7701-2(a) of this chapter other than a corporation, the total 
interests in the entity held by owners who are not members of the 
transferor's family is at least 20 percent of all the interests in the 
entity, for example, a 20-percent interest in the capital and profits 
of a partnership; and
    (D) Each nonfamily member, as owner, has a put right as described 
in paragraph (b)(6) of this section.
    (ii) Effect of disregarding a nonfamily-member interest. If a 
nonfamily-member interest is disregarded under this section, the rules 
of this section are applied as if all interests other than disregarded 
nonfamily-member interests constitute all of the interests in the 
entity.
    (iii) Attribution. In applying the 10-percent and 20-percent tests 
when the property held by the corporation or other business entity is, 
in whole or in part, an interest in another entity, the attribution 
rules of paragraph (d) of this section apply both in determining the 
interest held by a nonfamily member, and in measuring the interests 
owned through other entities.
    (5) Exceptions. A restriction described in this paragraph (b)(5) is 
not a disregarded restriction.
    (i) Applicable restriction. A disregarded restriction does not 
include an applicable restriction on the liquidation of the entity as 
defined in and governed by Sec.  25.2704-2.
    (ii) Commercially reasonable restriction. A disregarded 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), 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 that is publicly held.
    (iii) Requirement of federal or state law. A disregarded 
restriction does not include a restriction imposed or required to be 
imposed by federal or state law. For this purpose, federal or state law 
means the laws of the United States, of any state thereof, or of the 
District of Columbia, but does not include the laws of any other 
jurisdiction. A provision of law that applies only in the absence of a 
contrary provision in the governing documents or that may be superseded 
with regard to a particular entity (whether by the shareholders, 
partners, members and/or managers of the entity or otherwise) is not a 
restriction that is imposed or required to be imposed by federal or 
state law. A law that is limited in its application to certain narrow 
classes of entities, particularly those types of entities (such as 
family-controlled entities) most likely to be subject to transfers 
described in section 2704, is not a restriction that is imposed or 
required to be imposed by federal or state law. For example, a law 
requiring a restriction that may not be removed or superseded and that 
applies only to family-controlled entities that otherwise would be 
subject to the rules of section 2704 is a disregarded restriction. In 
addition, a restriction is not imposed or required to be imposed by 
federal or state law if that law also provides (either at the time the 
entity was organized or at some subsequent time) an optional provision 
that does not include the restriction or that allows it to be removed 
or overridden, or that provides a different statute for the creation 
and governance of that same type of entity that does not mandate the 
restriction, makes the restriction optional, or permits the restriction 
to be superseded, whether by the entity's governing documents or 
otherwise. For purposes of determining the type of entity, there are 
only three types of entities, specifically, the three categories of 
entities described in Sec.  25.2701-2(b)(5): Corporations; partnerships 
(including limited partnerships); and other business entities.
    (iv) Certain rights described in section 2703. An option, right to 
use property, or agreement that is subject to section 2703 is not a 
restriction for purposes of this paragraph (b).
    (v) Right to put interest to entity. Any restriction that otherwise 
would constitute a disregarded restriction under this section will not 
be considered a disregarded restriction if each holder of an interest 
in the entity has a put right as described in paragraph (b)(6) of this 
section.
    (6) Put right. The term put right means a right, enforceable under 
applicable local law, to receive from the entity or from one or more 
other holders, on liquidation or redemption of the holder's interest, 
within six months after the date the holder gives notice of the 
holder's intent to withdraw, cash and/or other property with a value 
that is at least equal to the minimum value of the interest determined 
as of the date of the liquidation or redemption. For this purpose, 
local law is the law of the jurisdiction, whether domestic or foreign, 
that governs liquidation or redemption rights with regard to interests 
in the entity. For purposes of this paragraph (b)(6), the term other 
property does not include a note or other obligation issued directly or 
indirectly by the entity, by one or more holders of interests in the 
entity, or by one or more persons related either to the entity or to 
any holder of an interest in the entity. However, in the case of an 
entity engaged in an active trade or business, at least 60 percent of 
whose value consists of the non-passive assets of that trade or 
business, and to the extent that the liquidation proceeds are not 
attributable to passive assets within the meaning of section 
6166(b)(9)(B), the term other property does include a note or other 
obligation if such note or other obligation is adequately secured, 
requires periodic payments on a non-deferred basis, is issued at market 
interest rates, and has a fair market value on the date of liquidation 
or redemption equal to the liquidation proceeds. See Sec.  25.2512-8. 
The minimum value of the interest is the interest's share of the net 
value of the entity, as defined in paragraph (b)(1)(ii) of this 
section.
    (c) Other definitions. For the definition of the term controlled 
entity, see Sec.  25.2701-2(b)(5). For the definition of the term 
member of the family, see Sec.  25.2702-2(a)(1).
    (d) Attribution. An individual, the individual's estate, and 
members of the individual's family, as well as any other person, also 
are treated as holding any interest held indirectly by such person 
through a corporation, partnership, trust, or other entity under the 
rules contained in Sec.  25.2701-6.
    (e) Certain transfers at death to multiple persons. Solely for 
purposes of section 2704(b), if part of a decedent's interest in an 
entity includible in the gross estate passes by reason of death to one 
or more members of the decedent's family and part of that includible 
interest passes to one or more persons who are nonfamily members of the

[[Page 51424]]

decedent, and if the part passing to the members of the decedent's 
family is to be valued pursuant to paragraph (f) of this section, then 
that part is treated as a single, separate property interest. In that 
case, the part passing to one or more persons who are not members of 
the decedent's family is also treated as a single, separate property 
interest. See paragraph (g) Example 4 of this section.
    (f) Effect of disregarding a restriction. If a restriction is 
disregarded under this section, the fair market value of the 
transferred interest is determined under generally applicable valuation 
principles as if the disregarded restriction does not exist in the 
governing documents, local law, or otherwise. For this purpose, local 
law is the law of the jurisdiction, whether domestic or foreign, under 
which the entity is created or organized.
    (g) Examples. The following examples illustrate the provisions of 
this section.

    Example 1.  (i) D and D's children, A and B, are partners in 
Limited Partnership X that was created on July 1, 2016. D owns a 98 
percent limited partner interest, and A and B each own a 1 percent 
general partner interest. The partnership agreement provides that 
the partnership will dissolve and liquidate on June 30, 2066, or by 
the earlier agreement of all the partners, but otherwise prohibits 
the withdrawal of a limited partner. Under applicable local law, a 
limited partner may withdraw from a limited partnership at the time, 
or on the occurrence of events, specified in the partnership 
agreement. Under the partnership agreement, the approval of all 
partners is required to amend the agreement. None of these 
provisions is mandated by local law. D transfers a 33 percent 
limited partner interest to A and a 33 percent limited partner 
interest to B.
    (ii) By prohibiting the withdrawal of a limited partner, the 
partnership agreement imposes a restriction on the ability of a 
partner to liquidate the partner's interest in the partnership that 
is not required to be imposed by law and that may be removed by the 
transferor and members of the transferor's family, acting 
collectively, by agreeing to amend the partnership agreement. 
Therefore, under section 2704(b) and paragraph (a) of this section, 
the restriction on a limited partner's ability to liquidate that 
partner's interest is disregarded in determining the value of each 
transferred interest. Accordingly, the amount of each transfer is 
the fair market value of the 33 percent limited partner interest 
determined under generally applicable valuation principles taking 
into account all relevant factors affecting value including the 
rights determined under the governing documents and local law and 
assuming that the disregarded restriction does not exist in the 
governing documents, local law, or otherwise. See paragraphs 
(b)(1)(i) and (f) of this section.
    Example 2. The facts are the same as in Example 1, except that, 
both before and after the transfer, A's partnership interests are 
held in an irrevocable trust of which A is the sole income 
beneficiary. The trustee is a publicly-held bank. A is treated as 
holding the interests held by the trust under the rules contained in 
Sec.  25.2701-6. The result is the same as in Example 1.
    Example 3.  The facts are the same as in Example 1, except that, 
on D's subsequent death, D's remaining 32 percent limited partner 
interest passes outright to D's surviving spouse, S, who is a U.S. 
citizen. In valuing the 32 percent interest for purposes of 
determining both the amount includible in the gross estate and the 
amount allowable as a marital deduction, the analysis and result are 
as described in Example 1.
    Example 4.  (i) The facts are the same as in Example 1, except 
that D made no gifts and, on D's subsequent death pursuant to D's 
will, a 53 percent limited partner interest passes to D's surviving 
spouse who is a U.S. citizen, a 25 percent limited partner interest 
passes to C, an unrelated individual, and a 20 percent limited 
partner interest passes to E, a charity. The restriction on a 
limited partner's ability to liquidate that partner's interest is a 
disregarded restriction. In determining whether D's estate and/or 
D's family may remove the disregarded restriction after the transfer 
occurring on D's death, the interests of C and E are disregarded 
because these interests were not held by C and E for at least three 
years prior to D's death, nor do C and E have the right to withdraw 
on six months' notice and receive their respective interest's share 
of the minimum value of X. Thus, the 53 percent interest passing to 
D's surviving spouse is subject to section 2704(b). D's gross estate 
will be deemed to include two separate assets: A 53 percent limited 
partner interest subject to section 2704(b), and a 45 percent 
limited partner interest not subject to section 2704.
    (ii) The fair market value of the 53 percent interest is 
determined for both inclusion and deduction purposes under generally 
applicable valuation principles taking into account all relevant 
factors affecting value, including the rights determined under the 
governing documents and local law, and assuming that the disregarded 
restriction does not exist in the governing documents, local law, or 
otherwise. The 45 percent interest passing to nonfamily members is 
not subject to section 2704(b), and will be valued as a single 
interest for inclusion purposes under generally applicable valuation 
principles, taking into account all relevant factors affecting value 
including the rights determined under the governing documents and 
local law as well as the restriction on a limited partner's ability 
to liquidate that partner's interest. The 20 percent passing to 
charity will be valued in a similar manner for purposes of 
determining the allowable charitable deduction. Assuming that, under 
the facts and circumstances, the 45 percent interest and the 20 
percent interest are subject to the same discount factor, the 
charitable deduction will equal four-ninths of the value of the 45 
percent interest.
    Example 5.  (i) D and D's children, A and B, are partners in 
Limited Partnership Y. D owns a 98 percent limited partner interest, 
and A and B each own a 1 percent general partner interest. The 
partnership agreement provides that a limited partner may withdraw 
from the partnership at any time by giving six months' notice to the 
general partner. On withdrawal, the partner is entitled to receive 
the fair market value of his or her partnership interest payable 
over a five-year period. Under the partnership agreement, the 
approval of all partners is required to amend the agreement. None of 
these provisions are mandated by local law. D transfers a 33 percent 
limited partner interest to A and a 33 percent limited partner 
interest to B. Under paragraph (b)(1)(iii) of this section, the 
provision requiring that a withdrawing partner give at least six 
months' notice before withdrawing provides a reasonable waiting 
period and does not cause the restriction to be disregarded in 
valuing the transferred interests. However, the provision limiting 
the amount the partner may receive on withdrawal to the fair market 
value of the partnership interest, and permitting that amount to be 
paid over a five-year period, may limit the amount the partner may 
receive on withdrawal to less than the minimum value described in 
paragraph (b)(1)(ii) of this section and allows the delay of payment 
beyond the period described in paragraph (b)(1)(iii) of this 
section. The partnership agreement imposes a restriction on the 
ability of a partner to liquidate the partner's interest in the 
partnership that is not required to be imposed by law and that may 
be removed by the transferor and members of the transferor's family, 
acting collectively, by agreeing to amend the partnership agreement.
    (ii) Under section 2704(b) and paragraph (a) of this section, 
the restriction on a limited partner's ability to liquidate that 
partner's interest is disregarded in determining the value of the 
transferred interests. Accordingly, the amount of each transfer is 
the fair market value of the 33 percent limited partner interest, 
determined under generally applicable valuation principles taking 
into account all relevant factors affecting value, including the 
rights determined under the governing documents and local law, and 
assuming that the disregarded restriction does not exist in the 
governing documents, local law, or otherwise. See paragraph (f) of 
this section.
    Example 6.  The facts are the same as in Example 5, except that 
D sells a 33 percent limited partner interest to A and a 33 percent 
limited partner interest to B for fair market value (but without 
taking into account the special valuation assumptions of section 
2704(b)). Because section 2704(b) also is relevant in determining 
whether a gift has been made, D has made a gift to each child of the 
excess of the value of the transfer to each child as determined in 
Example 5 over the consideration received by D from that child.
    Example 7.  The facts are the same as in Example 5, except, in a 
transaction unrelated to D's prior transfers to A and B, D withdraws 
from the partnership and immediately receives the fair market value 
(but without taking into account the special valuation assumptions 
of section 2704(b)) of D's remaining 32 percent limited partner 
interest. Because a gift to a partnership is deemed to

[[Page 51425]]

be a gift to the other partners, D has made a gift to each child of 
one-half of the excess of the value of the 32 percent limited 
partner interest as determined in Example 5 over the consideration 
received by D from the partnership.
    Example 8.  D and D's children, A and B, organize Limited 
Liability Company X under the laws of State Y. D, A, and B each 
contribute cash to X. Under the operating agreement, X maintains a 
capital account for each member. The capital accounts are adjusted 
to reflect each member's contributions to and distributions from X 
and each member's share of profits and losses of X. On liquidation, 
capital account balances control distributions. Profits and losses 
are allocated on the basis of units issued to each member, which are 
not in proportion to capital. D holds 98 units, A and B each hold 1 
unit. D is designated in the operating agreement as the manager of X 
with the ability to cause the liquidation of X. X is not a 
corporation. Under the laws of State Y, X is neither a partnership 
nor a limited partnership. D and D's family have control of X 
because they hold at least 50 percent of the profits interests (or 
capital interests) of X. Further, D and D's family have control of X 
because D holds an interest with the ability to cause the 
liquidation of X.
    Example 9.  The facts are the same as in Example 8, except that, 
under the operating agreement, all distributions are made to members 
based on the units held, which in turn is based on contributions to 
capital. Further, X elects to be treated as a corporation for 
federal tax purposes. Under Sec.  25.2701-2(b)(5), D and D's family 
have control of X (which is not a corporation and, under local law, 
is not a partnership or limited partnership) because they hold at 
least 50 percent of the capital interests in X. Further, D and D's 
family have control of X because D holds an interest with the 
ability to cause the liquidation of X.
    Example 10.  D owns a 1 percent general partner interest and a 
74 percent limited partner interest in Limited Partnership X, which 
in turn holds a 50 percent limited partner interest in Limited 
Partnership Y and a 50 percent limited partner interest in Limited 
Partnership Z. D owns the remaining interests in partnerships Y and 
Z. A, an unrelated individual, has owned a 25 percent limited 
partner interest in partnership X for more than 3 years. The 
governing documents of all three partnerships permit liquidation of 
the entity on the agreement of the owners of 90 percent of the 
interests but, with the exception of A's interest, prohibit the 
withdrawal of a limited partner. A may withdraw on 6-months' notice 
and receive A's interest's share of the minimum value of partnership 
X as defined in paragraph (b)(1)(ii) of this section, which share 
includes a share of the minimum value of partnership Y and of 
partnership Z. Under the governing documents of all three 
partnerships, the approval of all partners is required to amend the 
documents. D transfers a 40 percent limited partner interest in 
partnership Y to D's children. For purposes of determining whether D 
and/or D's family members have the ability to remove a restriction 
after the transfer, A is treated as owning a 12.5 percent (.25 x.50) 
interest in partnership Y, thus more than a 10 percent interest, but 
less than a 20 percent interest, in partnership Y. Accordingly, 
under paragraph (b)(4)(i)(C) of this section, A's interest is 
disregarded for purposes of determining whether D and D's family 
hold the right to remove a restriction after the transfer (resulting 
in D and D's children being deemed to own 100 percent of Y for this 
purpose). However, if D instead had transferred a 40 percent limited 
partner interest in partnership X to D's children, A's ownership of 
a 25 percent interest in partnership X would not have been 
disregarded, with the result that D and D's family would not have 
had the ability to remove a restriction after the transfer.
    Example 11.  (i) D owns 85 of the outstanding shares of X, a 
corporation, and A, an unrelated individual, owns the remaining 15 
shares. Under X's governing documents, the approval of the 
shareholders holding 75 percent of the outstanding stock is required 
to liquidate X. With the exception of nonfamily members, a 
shareholder may not withdraw from X. Nonfamily members may withdraw 
on six months' notice and receive their interest's share of the 
minimum value of X as defined in paragraph (b)(1)(ii) of this 
section. D transfers 10 shares to C, a charity. Four years later, D 
dies. D bequeaths 10 shares to B, an unrelated individual, and the 
remaining 65 shares to trusts for the benefit of D's family.
    (ii) The prohibition on withdrawal is a restriction described in 
paragraph (b)(1)(i) of this section. In determining whether D's 
estate and/or D's family may remove the restriction after the 
transfer occurring on D's death, the interest of B is disregarded 
because it was not held by B for at least three years prior to D's 
death. The interests of A and C, however, are not disregarded, 
because each held an interest of at least 10 percent for at least 
three years prior to D's death, the total of those interests 
represents at least 20 percent of X, and each had the right to 
withdraw on six months' notice and receive their interest's share of 
the minimum value of X. As a result, D and D's family hold 65 of the 
deemed total of 90 shares in X, or 72 percent, which is less than 
the 75 percent needed to liquidate X. Thus, D and D's family do not 
have the ability to remove the restriction after the transfer, and 
section 2704(b) does not apply in valuing D's interest in X for 
federal estate tax purposes.

0
Par. 8. Newly designated Sec.  25.2704-4 is amended as follows:
0
1. The undesignated text is designated as paragraph (a).
0
2. In the first and second sentences of newly designated paragraph (a), 
the language ``Section'' is removed and the language ``Except as 
provided in paragraph (b) of this section, Sec.  '' is added in its 
place.
0
3. Paragraph (b) is added.
    The addition reads as follows:


Sec.  25.2704-4  Effective date.

* * * * *
    (b)(1) With respect to Sec.  25.2704-1, the first six sentences of 
paragraph (a)(1), the last sentence of paragraph (a)(2)(i), the third 
sentence of paragraph (a)(2)(iii), the first and last sentences of 
paragraph (a)(4), paragraph (a)(5), the second and last sentences of 
paragraph (c)(1), paragraph (c)(2)(i)(B), and Examples 4, 6 and 7 of 
paragraph (f), apply to lapses of rights created after October 8, 1990, 
occurring on or after the date these regulations are published as final 
regulations in the Federal Register.
    (2) With respect to Sec.  25.2704-2, paragraphs (a), (b), (c), (d), 
and (f), the first sentence of paragraph (e), and Examples 1, 3 and 5 
of paragraph (g) apply to transfers of property subject to restrictions 
created after October 8, 1990, occurring on or after the date these 
regulations are published as final regulations in the Federal Register.
    (3) Section 25.2704-3 applies to transfers of property subject to 
restrictions created after October 8, 1990, occurring 30 or more days 
after the date these regulations are published as final regulations in 
the Federal Register.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2016-18370 Filed 8-2-16; 11:15 am]
 BILLING CODE P