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Problematic Proposed Regulations May Harm Family Businesses If Left Unaddressed

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By Stephan A. Lipskis

This newsletter recently addressed proposed treasury regulations that, if enacted, will drastically impact transfers of family businesses. The hearings on the proposed regulations (the “2704 Regulations”) were held this month, and those participating were extremely critical of the proposed regulations. According to a Forbes.com report, only 1 of the 36 people who testified at the hearing on the proposed 2704 Regulations testified favorably to the proposed regulations. The poor drafting of the proposed 2704 Regulations clearly sparked a negative reaction, but what will that reaction change, and how will family-owned businesses be impacted?

Problems with the Proposed Regulations

The proposed regulations were meant to curb the heavily scrutinized practice of funding assets into an entity and claiming a valuation discount for the interest held in that entity by members of the same family. Allowing aggressive discounting of passive entities creates an opportunity for wealthy individuals to pass on relatively liquid assets (e.g. stock portfolios) at steeply discounted values to avoid estate and gift tax. Obviously, such treatment should be limited to prevent loss of tax revenue where the structure of the entity has no legitimate purpose other than tax avoidance. This goal is accomplished but not reasonably tailored to prevent harsh treatment against legitimate businesses. Treasury drafted the proposed regulations extremely broadly covering both operating and passive businesses. Furthermore, the proposed 2704 Regulations cover more diverse ownership groups than what most would consider a “family business”. However, the current proposed regulations do not except legitimate businesses that have true economic purpose other than tax avoidance. Additionally, the proposed regulations redefine the concept of “Fair Market Value” that has been a fundamental concept of tax law for decades. Because of the broad nature of the regulations, they are akin to amputating a foot because of a wart on a toe. These issues caused significant pushback from commentators and will warrant revision, or wholesale abandonment, of the proposed regulations.

The current transition of presidential administrations places this battle in an interesting political context. Like all other departments, the Treasury will cede control to a new administration next year.  Let’s explore the possible fate of the proposed regulations.

The treasury can move forward and implement a final rule with little or no modification. At that point, the rule can be challenged by litigation, overturned by Congress, or revised by later action of the treasury department. Actions against the rule can be pursued pre-emptively in Congress, and there are currently efforts underway to “vote down” the regulations legislatively. If the regulation is passed, both houses of Congress can pass a resolution of disapproval which, upon signature by the president, voids the rule. This congressional process is rarely used and would be unnecessary if a pre-emptive measure were successful. The new president would have the final say on a congressional vote to void the regulations due to the timeframe given for congressional review. A litigation challenge would be undertaken after the rule, which would subject the rule to judicial scrutiny, but could only be brought after the rule becomes final. Finally, the Treasury (under the new administration) has the ability to implement regulations of its own, which would likely walk back any rule that is implemented.

Impact on Family Businesses

Given the above opportunities for challenge, the proposed rule is likely short-lived in its current form. At a minimum, the drafting concerns voiced at the hearing need to be addressed. This presents a planning opportunity. In the near term, the hearing gave some clarification on the currently proposed regulations. In the long term, it looks like there may be a more favorable environment for transitioning ownership in family businesses. Discussing how the proposed rules and the potential changes of the next administration are critical to determining intermediate and long-range succession plans for family businesses. Contact our office to make an appointment with one of our estate planning attorneys to discuss how the current environment impacts your business.

Kit KatAsk Kit Kat – Pet Sitters

Hook Law Center:  Kit Kat, what can you tell us about dogs and how they respond to speech and tone of voice?

Kit Kat:  Well, it looks like dogs are amazingly perceptive when it comes to interpreting speech and tone of voice. Researchers at Eotvos Lorand University in Budapest, Hungary have done some pioneering work on this subject. Like people, dogs use the left hemisphere of their brain to interpret meaning, They use the right hemisphere to interpret sound and its emotional content. The study was led by Dr. Attila Andics, and the techniques used were by themselves quite pioneering. The dogs in the study had to be trained to lie perfectly still while a picture of their brain was taken by a MRI machine. This is very remarkable, because other primates like apes cannot be similarly trained. The MRI requires complete stillness, and they cannot manage that.

This is what the researchers discovered. Dogs reacted most strongly when words of praise like ‘good boy’ or ‘well done’ were used. These positive words elicited a lot of activity in their brain’s reward center. When the researchers used less defined language like conjunctions and some adverbs (‘however’ or ‘nevertheless,’ for example), the dogs’ reward center in their brains registered much less brain activity. With the words of praise, it was almost like they were given a delicious treat to eat; it was that reinforcing. So what does this mean? It means humans are not the only creatures who have the ability to understand and react to language. What’s more, other scientists like Dr. Brian Hare of Duke University believe the canine’s ability to do this developed long before humans started to use language. Did this ability aide dogs in the domestication process, as dogs moved from the wild to living with humans? More research will be needed to answer that question.

I suspect many dog owners intuitively have known how smart their dogs are. Now we have confirmation. They really are man’s best friend. (James Gorman, “With Dogs, It’s what You Say—and How You Say It,” The New York Times, Science section, August 29, 2016) (http://nyti.ms/2c40znU)

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Posted on Friday, December 9th, 2016. Filed under Newsletter.