On August 4, 2016, the IRS published proposed regulations under § 2704(b) of the Internal Revenue Code that targeted “disregarded restrictions” on interests in family-controlled partnerships, limited liability companies and corporations. While these regulations are only in proposed form for now, they are expected to be finalized sometime after a public hearing on December 1, 2016. The final regulations are likely to contain some changes from this proposed form, potentially not as restrictive as the proposed form, but at least more restrictive than current law.


Section 2704(b) and the current regulations thereunder allow the IRS to disregard certain restrictions associated with business interests that would otherwise reduce the value of the business interest for estate and gift tax purposes.

An “applicable restriction” is to be disregarded when (1) there is a transfer of an interest (whether by sale or gift) to a member of the transferor’s family, (2) the transferor and member of the transferor’s family have control of the entity after the transfer and (3) after the transfer, the restriction lapses or the transferor or any member of the transferor’s family has the right to remove the restriction.

  • Applicable Restriction. An applicable restriction is any restriction that (1) effectively limits the ability of the corporation or partnership to liquidate, (2) is more restrictive than state law limitations and (3) either, by its terms, will lapse sometime after the transfer is made or may be removed by the transferor or the family of the transferor.
  • Family Control. Control is defined as a simple majority. Family members are defined as lineal descendants, ancestors, brothers and sisters, spouses and the descendants, ancestors and brothers and sisters of spouses. Interests held by family members indirectly through trusts or other entities are also included but only to the extent of the interest in such entity owned by the family member.


Disregarded Restrictions. The proposed regulations create a new category of restrictions labeled “disregarded restrictions,” which now focus on the liquidation or redemption of an individual interest in an entity, as opposed to restrictions on the liquidation of the whole entity.

A disregarded restriction:

(1) limits the ability of the interest holder to compel liquidation or redemption of the interest;

(2) limits the liquidation or redemption proceeds to an amount less than “minimum value” (defined as fair market value of the entity reduced by allowable obligations);

(3) defers payment of the liquidation or redemption proceeds for more than six months; or

(4) permits payment of any portion of the proceeds in any manner other than cash or “other property.”

Many a new issue arises in this definition, but the last item, “other property,” presents a real problem in that the IRS would not consider a promissory note as property if the family entity is not an active trade or business with at least 60 percent of its value consisting of non-passive assets. Another very problematic issue is when the “minimum value” calculation does not yield the same redemption payment that would otherwise be calculated under state law and the governing document. This conflict with state law could arise in a number of situations, most notably in the case of assignee interest holders, who do not have full membership rights.

The disregarded restriction would arise under the same scenario for the applicable restriction, defined above, with some broadened terms. The most glaring addition is the treatment of non-family held interests. Under the current law, an applicable restriction arises only when the transferor or the transferor’s family may remove the restriction. That requires family control in some form. By including a non-family holder, such as a charity, the control element may not arise. The proposed regulations include a series of new rules that would disregard an interest held by the non-family member.


The proposed regulations will become effective upon publication of the final regulations, which may occur any time after December 1, 2016, with exception for the disregarded restrictions, which will be effective 30 days after publication. Once effective, any gift, sale or bequest of an interest in a family-controlled entity will be under increased IRS scrutiny.  If you are considering a gift or sale of a family interest, it would be advisable to finalize such transfer at this time. Likewise, you and your advisor should review your operating agreement, partnership agreement or shareholder agreement for any unintended consequences that may occur on a future sale, gift or bequest.

As always, you should feel free to reach out to the Tax and Estate lawyers at Woods Rogers PLC for guidance.