Proposed Treasury Regulations Impact ‘Lapsing Rights’

Northern Nevada Business Weekly

Proposed Treasury Regulations to Section 2704 of the Internal Revenue Code threaten the utility of lapsing voting or liquidation rights (“lapsing rights”) to reduce transfer taxes on interests in family-controlled entities.

Prior to 1990, taxpayers used lapsing rights to devalue interests in family-controlled entities. For example, taxpayers in Estate of Harrison v. Commissioner, 52 T.C.M. (CCH) 1306, used lapsing liquidation rights to devalue a limited partnership interest from $59.5 million to $33 million. In that case, Father owned a 77.8 percent limited partnership interest and a 1 percent general partnership interest in a family limited partnership. Sons 1 and 2 each owned a 10.6 percent general partnership interest. Pursuant to the partnership agreement, each general partner had the right, during his lifetime, to liquidate the partnership. Upon Father’s death, the IRS valued Father’s limited partnership interest for estate tax purposes at $59.5 million, the value Father would have received for such interest if the partnership had dissolved immediately prior to Father’s death. In contrast, Father’s estate valued Father’s limited partnership interest at $33 million, the value of Father’s limited partnership interest decoupled from Father’s right as a general partner to liquidate the partnership, which right lapsed upon Father’s death. The Tax Court ruled in favor of Father’s estate on the basis that property is valued for estate tax purposes at the moment of death, not the moment immediately prior to death.

Congress responded to Estate of Harrison and similar cases in 1990 by enacting Section 2704 of the Internal Revenue Code. Section 2704 attacks the issue of lapsing rights in two ways.

First, pursuant to Section 2704(a), if a voting or liquidation right in a corporation or partnership lapses, the lapse decreases the aggregate value of the interests in the corporation or partnership, and the corporation or partnership is controlled by the transferor’s family before and after the lapse, then the decrease in aggregate value is taxable as a gift or includible in the transferor’s gross estate, as applicable.

Second, pursuant to Section 2704(b), if an interest in a corporation or partnership includes the right effectively to restrict the liquidation of the corporation or partnership, the right lapses after transfer of the interest (or the transferor or the transferor’s family may eliminate the right after transfer of the interest), the transferee is a member of the transferor’s family, and the transferor’s family controls the corporation or partnership before and after the transfer, then the restriction is disregarded for tax purposes.

Section 2704 impacted significantly the use of lapsing rights to devalue interests in family-controlled entities, but taxpayers have found many ways to avoid its application. For example, although the term “liquidation right” includes the right of an interest holder to compel the entity, including by reason of aggregate vote, to liquidate the interest holder’s equity interest in the entity, Section 2704(a) does not apply to lapses of a liquidation right resulting from transfers that do not restrict or eliminate that right.

Thus, a stockholder who can compel a corporation, by reason of his voting power, to liquidate his interest, can significantly decrease the value of his interest for estate tax purposes by making a deathbed transfer to a family member of the minimum number of shares necessary for the liquidation right to lapse. The transferred shares will remain in the family, but the aggregate value of the shares, both transferred and retained, will be reduced by the value of the lapsed right.

On Aug. 2, 2016, the Treasury Department published proposed Treasury Regulations to Section 2704 that seek to eliminate some of the more common tax-avoidance techniques. For example, the proposed Treasury Regulations impose a bright-line test to transfers such as the transfer described above, whereby all transfers resulting in the lapse of a liquidation right made in the three-year period preceding the taxpayer’s death shall be taxed for estate tax purposes as though they were made at the time of the taxpayer’s death. In addition, the proposed Treasury Regulations seek to expand the scope of Section 2704 by identifying additional restrictions that will be disregarded for tax purposes under Section 2704(b).

The proposed Treasury Regulations are controversial, especially to the extent that they expand Section 2704. The Treasury Department has requested comments on the Proposed Regulations before Nov. 2, 2016, and has scheduled a public hearing on the same for Dec. 1, 2016.

Taxpayers whose estate plans include transfers in family-controlled entities should consider contacting knowledgeable tax and estate-planning counsel before the end of the year to reevaluate their estate plans.

Sarah Baley is an associate with McDonald Carano Wilson, specializing in Trust Estate and Wealth Preservation.

About McDonald Carano

McDonald Carano has helped to shape the Nevada business and legal landscape for 70 years. With more than 60 lawyers and government affairs professionals in our offices in Las Vegas and Reno, we are Nevada's law firm for business. We proudly represent Fortune 500 companies, financial and governmental institutions, fast-growth and mid-market companies, entrepreneurs, start-up ventures, non-profit organizations and individuals. Our attorneys deliver cross-discipline, one-stop, commercial law and government affairs counsel. Our dedication to clients, innovative thinking and practical solutions based in sound business and legal judgments are at the heart of our practice. For more information, visit, call 775.788.2000 (Reno office), or 702.873.4100 (Las Vegas office) or reach us by email at

Media Contact

Ben Kieckhefer



You have chosen to send an email to McDonald Carano. The sending or receipt of this email and the information in it does not in itself create an attorney-client relationship. If you are not already a client, you should not provide us with information that you wish to have treated as privileged or confidential without first speaking to one of our lawyers. If you provide information before we confirm that you are a client and that we are willing and able to represent you, we may not be required to treat that information as privileged, confidential, or protected information, and we may be able to represent a party adverse to you.

I have read this and want to send an email.