Valuation Implications of the Proposed Changes to Section 2704

In this whitepaper, we examine the recently proposed changes to Section 2704 of the Internal Revenue Service Code from business and valuation viewpoints.

The express goal of the Proposed Changes is to eliminate, or virtually so, valuation discounts in family partnerships (and operating companies, as well). The instruments of change are a loosened definition of control (to broaden the number of families having control), almost total family attribution of control for every transfer, and a hypothetical put right to the partners in family partnership to facilitate the elimination or reduction of valuation discounts in fair market value determinations.

A review from business and valuation perspectives finds that the Proposed Changes, if adopted as published, will affect, but not eliminate valuation discounts.

Quoting from the whitepaper:

The Proposed Changes to Section 2704 appear to be designed to eliminate the use of minority interest and marketability discounts in fair market value determinations of illiquid, minority interests in family limited partnerships (and C corporations and S corporations and limited liability companies).

They do so by assuming that there is a presumed (hypothetical) liquidation of limited partnership interests being transferred, with the presumed liquidation being at minimum value, or net asset value. All family member partners are presumed to vote in favor of eliminating restrictions on transfer, and to clear a path towards hypothetical liquidations.

The problem with the Proposed Changes is that they fail to realize that even with no restrictions on transfer, and if all applicable restrictions are ignored and we consider all of the named disregarded restrictions, appraisers are left with illiquid minority interests in family partnerships that have investment characteristics that still require analysis to determine fair market value.

This paper made certain fairly typical assumptions so that we could dig into the valuation dynamics implied by the example of Limited Partnership X and three other partnerships. We disregarded what we were instructed to disregard and still developed, under the named assumptions, a discount by whatever name is appropriate. Appraisers will have to determine what that is based on their fair market value determinations and their consideration of all relevant factors pertaining to subject interests.