26 C.F.R. §§ 25.2701-1–25.2701-4

4 sections in range

§25.2701-1. Special valuation rules in the case of transfers of certain interests in corporations and partnerships.

26 C.F.R. § 25.2701-1

(a)

In general—

(1)

Scope of section 2701. Section 2701 provides special valuation rules to determine the amount of the gift when an individual transfers an equity interest in a corporation or partnership to a member of the individual's family. For section 2701 to apply, the transferor or an applicable family member (as defined in paragraph (d)(2) of this section) must, immediately after the transfer, hold an applicable retained interest (a type of equity interest defined in § 25.2701-2(b)(1)). If certain subsequent payments with respect to the applicable retained interest do not conform to the assumptions used in valuing the interest at the time of the initial transfer, § 25.2701-4 provides a special rule to increase the individual's later taxable gifts or taxable estate. Section 25.2701-5 provides an adjustment to mitigate the effects of double taxation when an applicable retained interest is subsequently transferred.

(2)

Effect of section 2701. If section 2701 applies to a transfer, the amount of the transferor's gift, if any, is determined using a subtraction method of valuation (described in § 25.2701-3). Under this method, the amount of the gift is determined by subtracting the value of any family-held applicable retained interests and other non-transferred equity interests from the aggregate value of family-held interests in the corporation or partnership (the “entity”). Generally, in determining the value of any applicable retained interest held by the transferor or an applicable family member—

(i)

Any put, call, or conversion right, any right to compel liquidation, or any similar right is valued at zero if the right is an “extraordinary payment right” (as defined in § 25.2701-2(b)(2));

(ii)

Any distribution right in a controlled entity (e.g., a right to receive dividends) is valued at zero unless the right is a “qualified payment right” (as defined in § 25.2701-2(b)(6)); and

(iii)

Any other right (including a qualified payment right) is valued as if any right valued at zero did not exist but otherwise without regard to section 2701.

(3)

Example. The following example illustrates rules of this paragraph (a).

(b)

Transfers and other triggering events—

(1)

Completed transfers. Section 2701 applies to determine the existence and amount of any gift, whether or not the transfer would otherwise be a taxable gift under chapter 12 of the Internal Revenue Code. For example, section 2701 applies to a transfer that would not otherwise be a gift under chapter 12 because it was a transfer for full and adequate consideration.

(2)

Transactions treated as transfers—

(i)

In general. Except as provided in paragraph (b)(3) of this section, for purposes of section 2701, transfer includes the following transactions:

(A)

A contribution to the capital of a new or existing entity;

(B)

A redemption, recapitalization, or other change in the capital structure of an entity (a “capital structure transaction”), if—

(1) The transferor or an applicable family member receives an applicable retained interest in the capital structure transaction;

(2) The transferor or an applicable family member holding an applicable retained interest before the capital structure transaction surrenders an equity interest that is junior to the applicable retained interest (a “subordinate interest”) and receives property other than an applicable retained interest; or

(3) The transferor or an applicable family member holding an applicable retained interest before the capital structure transaction surrenders an equity interest in the entity (other than a subordinate interest) and the fair market value of the applicable retained interest is increased; or

(C)

The termination of an indirect holding in an entity (as defined in § 25.2701-6) (or a contribution to capital by an entity to the extent an individual indirectly holds an interest in the entity), if—

(1) The property is held in a trust as to which the indirect holder is treated as the owner under subchapter J of chapter 1 of the Internal Revenue Code; or

(2) If the termination (or contribution) is not treated as a transfer under paragraph (b)(2)(i)(C)(1) of this section, to the extent the value of the indirectly-held interest would have been included in the value of the indirect holder's gross estate for Federal estate tax purposes if the indirect holder died immediately prior to the termination.

(ii)

Multiple attribution. For purposes of paragraph (b)(2)(i)(C) of this section, if the transfer of an indirect holding in property is treated as a transfer with respect to more than one indirect holder, the transfer is attributed in the following order:

(A)

First, to the indirect holder(s) who transferred the interest to the entity (without regard to section 2513);

(B)

Second, to the indirect holder(s) possessing a presently exercisable power to designate the person who shall possess or enjoy the property;

(C)

Third, to the indirect holder(s) presently entitled to receive the income from the interest;

(D)

Fourth, to the indirect holder(s) specifically entitled to receive the interest at a future date; and

(E)

Last, to any other indirect holder(s) proportionally.

(3)

Excluded transactions. For purposes of section 2701, a transfer does not include the following transactions:

(i)

A capital structure transaction, if the transferor, each applicable family member, and each member of the transferor's family holds substantially the same interest after the transaction as that individual held before the transaction. For this purpose, common stock with non-lapsing voting rights and nonvoting common stock are interests that are substantially the same;

(ii)

A shift of rights occurring upon the execution of a qualified disclaimer described in section 2518; and

(iii)

A shift of rights occurring upon the release, exercise, or lapse of a power of appointment other than a general power of appointment described in section 2514, except to the extent the release, exercise, or lapse would otherwise be a transfer under chapter 12.

(c)

Circumstances in which section 2701 does not apply. To the extent provided, section 2701 does not apply in the following cases:

(1)

Marketable transferred interests. Section 2701 does not apply if there are readily available market quotations on an established securities market for the value of the transferred interests.

(2)

Marketable retained interests. Section 25.2701-2 does not apply to any applicable retained interest if there are readily available market quotations on an established securities market for the value of the applicable retained interests.

(3)

Interests of the same class. Section 2701 does not apply if the retained interest is of the same class of equity as the transferred interest or if the retained interest is of a class that is proportional to the class of the transferred interest. A class is the same class as (or is proportional to the class of) the transferred interest if the rights are identical (or proportional) to the rights of the transferred interest, except for non-lapsing differences in voting rights (or, for a partnership, non-lapsing differences with respect to management and limitations on liability). For purposes of this section, non-lapsing provisions necessary to comply with partnership allocation requirements of the Internal Revenue Code (e.g., section 704(b)) are non-lapsing differences with respect to limitations on liability. A right that lapses by reason of Federal or State law is treated as a non-lapsing right unless the Secretary determines, by regulation or by published revenue ruling, that it is necessary to treat such a right as a lapsing right to accomplish the purposes of section 2701. An interest in a partnership is not an interest in the same class as the transferred interest if the transferor or applicable family members have the right to alter the liability of the transferee.

(4)

Proportionate transfers. Section 2701 does not apply to a transfer by an individual to a member of the individual's family of equity interests to the extent the transfer by that individual results in a proportionate reduction of each class of equity interest held by the individual and all applicable family members in the aggregate immediately before the transfer. Thus, for example, section 2701 does not apply if P owns 50 percent of each class of equity interest in a corporation and transfers a portion of each class to P's child in a manner that reduces each interest held by P and any applicable family members, in the aggregate, by 10 percent even if the transfer does not proportionately reduce P's interest in each class. See § 25.2701-6 regarding indirect holding of interests.

(d)

Family definitions—

(1)

Member of the family. A member of the family is, with respect to any transferor—

(i)

The transferor's spouse;

(ii)

Any lineal descendant of the transferor or the transferor's spouse; and

(iii)

The spouse of any such lineal descendant.

(2)

Applicable family member. An applicable family member is, with respect to any transferor—

(i)

The transferor's spouse;

(ii)

Any ancestor of the transferor or the transferor's spouse; and

(iii)

The spouse of any such ancestor.

(3)

Relationship by adoption. For purposes of section 2701, any relationship by legal adoption is the same as a relationship by blood.

(e)

Examples. The following examples illustrate provisions of this section:

Notes, amendments, and revision history

Amendments

[T.D. 8395, 57 FR 4255, Feb. 4, 1992; 57 FR 11264, Apr. 2, 1992, as amended by T.D. 8536, 59 FR 23154, May 5, 1994]

Authority

Authority: 26 U.S.C. 7805. Section 25.2505-2 also issued under 26 U.S.C. 2010(c)(6). Section 25.2512-5 also issued under 26 U.S.C. 7520(c)(2). Section 25.2512-5A also issued under 26 U.S.C. 7520(c)(2). Section 25.2518-2 is also issued under 26 U.S.C. 2518(b). Section 25.6060-1 also issued under 26 U.S.C. 6060(a). Section 25.6081-1 also issued under the authority of 26 U.S.C. 6081(a). Section 25.6109-2 also issued under 26 U.S.C. 6109(a). Section 25.6302-1 also issued under 26 U.S.C. 6302(a) and (h). Section 25.6695-1 also issued under 26 U.S.C. 6695(b). Section 25.7520-1 also issued under 26 U.S.C. 7520(c)(2). Section 25.7520-2 also issued under 26 U.S.C. 7520(c)(2). Section 25.7520-3 also issued under 26 U.S.C. 7520(c)(2). Section 25.7520-4 also issued under 26 U.S.C. 7520(c)(2).

Source

Source: T.D. 6334, 23 FR 8904, Nov. 15, 1958; 25 FR 14021, Dec. 31, 1960, unless otherwise noted.

Amendments

[T.D. 8395, 57 FR 4255, Feb. 4, 1992; 57 FR 11264, Apr. 2, 1992, as amended by T.D. 8536, 59 FR 23154, May 5, 1994]

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

26 C.F.R. § 25.2701-2

(a)

In general. In determining the amount of a gift under § 25.2701-3, the value of any applicable retained interest (as defined in paragraph (b)(1) of this section) held by the transferor or by an applicable family member is determined using the rules of chapter 12, with the modifications prescribed by this section. See § 25.2701-6 regarding the indirect holding of interests.

(1)

Valuing an extraordinary payment right. Any extraordinary payment right (as defined in paragraph (b)(2) of this section) is valued at zero.

(2)

Valuing a distribution right. Any distribution right (as defined in paragraph (b)(3) of this section) in a controlled entity is valued at zero, unless it is a qualified payment right (as defined in paragraph (b)(6) of this section). Controlled entity is defined in paragraph (b)(5) of this section.

(3)

Special rule for valuing a qualified payment right held in conjunction with an extraordinary payment right. If an applicable retained interest confers a qualified payment right and one or more extraordinary payment rights, the value of all these rights is determined by assuming that each extraordinary payment right is exercised in a manner that results in the lowest total value being determined for all the rights, using a consistent set of assumptions and giving due regard to the entity's net worth, prospective earning power, and other relevant factors (the “lower of” valuation rule). See §§ 20.2031-2(f) and 20.2031-3 for rules relating to the valuation of business interests generally.

(4)

Valuing other rights. Any other right (including a qualified payment right not subject to the prior paragraph) is valued as if any right valued at zero does not exist and as if any right valued under the lower of rule is exercised in a manner consistent with the assumptions of that rule but otherwise without regard to section 2701. Thus, if an applicable retained interest carries no rights that are valued at zero or under the lower of rule, the value of the interest for purposes of section 2701 is its fair market value.

(5)

Example. The following example illustrates rules of this paragraph (a).

(b)

Definitions—

(1)

Applicable retained interest. An applicable retained interest is any equity interest in a corporation or partnership with respect to which there is either—

(i)

An extraordinary payment right (as defined in paragraph (b)(2) of this section), or

(ii)

In the case of a controlled entity (as defined in paragraph (b)(5) of this section), a distribution right (as defined in paragraph (b)(3) of this section).

(2)

Extraordinary payment right. Except as provided in paragraph (b)(4) of this section, an extraordinary payment right is any put, call, or conversion right, any right to compel liquidation, or any similar right, the exercise or nonexercise of which affects the value of the transferred interest. A call right includes any warrant, option, or other right to acquire one or more equity interests.

(3)

Distribution right. A distribution right is the right to receive distributions with respect to an equity interest. A distribution right does not include—

(i)

Any right to receive distributions with respect to an interest that is of the same class as, or a class that is subordinate to, the transferred interest;

(ii)

Any extraordinary payment right; or

(iii)

Any right described in paragraph (b)(4) of this section.

(4)

Rights that are not extraordinary payment rights or distribution rights. Mandatory payment rights, liquidation participation rights, rights to guaranteed payments of a fixed amount under section 707(c), and non-lapsing conversion rights are neither extraordinary payment rights nor distribution rights.

(i)

Mandatory payment right. A mandatory payment right is a right to receive a payment required to be made at a specific time for a specific amount. For example, a mandatory redemption right in preferred stock requiring that the stock be redeemed at its fixed par value on a date certain is a mandatory payment right and therefore not an extraordinary payment right or a distribution right. A right to receive a specific amount on the death of the holder is a mandatory payment right.

(ii)

Liquidation participation rights. A liquidation participation right is a right to participate in a liquidating distribution. If the transferor, members of the transferor's family, or applicable family members have the ability to compel liquidation, the liquidation participation right is valued as if the ability to compel liquidation—

(A)

Did not exist, or

(B)

If the lower of rule applies, is exercised in a manner that is consistent with that rule.

(iii)

Right to a guaranteed payment of a fixed amount under section 707(c). The right to a guaranteed payment of a fixed amount under section 707(c) is the right to a guaranteed payment (within the meaning of section 707(c)) the amount of which is determined at a fixed rate (including a rate that bears a fixed relationship to a specified market interest rate). A payment that is contingent as to time or amount is not a guaranteed payment of a fixed amount.

(iv)

Non-lapsing conversion right—

(A)

Corporations. A non-lapsing conversion right, in the case of a corporation, is a non-lapsing right to convert an equity interest in a corporation into a fixed number or a fixed percentage of shares of the same class as the transferred interest (or into an interest that would be of the same class but for non-lapsing differences in voting rights), that is subject to proportionate adjustments for changes in the equity ownership of the corporation and to adjustments similar to those provided in section 2701(d) for unpaid payments.

(B)

Partnerships. A non-lapsing conversion right, in the case of a partnership, is a non-lapsing right to convert an equity interest in a partnership into a specified interest (other than an interest represented by a fixed dollar amount) of the same class as the transferred interest (or into an interest that would be of the same class but for non-lapsing differences in management rights or limitations on liability) that is subject to proportionate adjustments for changes in the equity ownership of the partnership and to adjustments similar to those provided in section 2701(d) for unpaid payments.

(C)

Proportionate adjustments in equity ownership. For purposes of this paragraph (b)(4), an equity interest is subject to proportionate adjustments for changes in equity ownership if, in the case of a corporation, proportionate adjustments are required to be made for splits, combinations, reclassifications, and similar changes in capital stock, or, in the case of a partnership, the equity interest is protected from dilution resulting from changes in the partnership structure.

(D)

Adjustments for unpaid payments. For purposes of this paragraph (b)(4), an equity interest is subject to adjustments similar to those provided in section 2701(d) if it provides for—

(1) Cumulative payments;

(2) Compounding of any unpaid payments at the rate specified in § 25.2701-4(c)(2); and

(3) Adjustment of the number or percentage of shares or the size of the interest into which it is convertible to take account of accumulated but unpaid payments.

(5)

Controlled entity—

(i)

In general. For purposes of section 2701, a controlled entity is a corporation or partnership controlled, immediately before a transfer, by the transferor, applicable family members, and any lineal descendants of the parents of the transferor or the transferor's spouse. See § 25.2701-6 regarding indirect holding of interests.

(ii)

Corporations—

(A)

In general. In the case of a corporation, control means the holding of at least 50 percent of the total voting power or total fair market value of the equity interests in the corporation.

(B)

Voting rights. Equity interests that carry no right to vote other than on liquidation, merger, or a similar event are not considered to have voting rights for purposes of this paragraph (b)(5)(ii). Generally, a voting right is considered held by an individual to the extent that the individual, either alone or in conjunction with any other person, is entitled to exercise (or direct the exercise of) the right. However, if an equity interest carrying voting rights is held in a fiduciary capacity, the voting rights are not considered held by the fiduciary, but instead are considered held by each beneficial owner of the interest and by each individual who is a permissible recipient of the income from the interest. A voting right does not include a right to vote that is subject to a contingency that has not occurred, other than a contingency that is within the control of the individual holding the right.

(iii)

Partnerships. In the case of any partnership, control means the holding of at least 50 percent of either the capital interest or the profits interest in the partnership. Any right to a guaranteed payment under section 707(c) of a fixed amount is disregarded in making this determination. In addition, in the case of a limited partnership, control means the holding of any equity interest as a general partner. See § 25.2701-2(b)(4)(iii) for the definition of a right to a guaranteed payment of a fixed amount under section 707(c).

(6)

Qualified payment right—

(i)

In general. A qualified payment right is a right to receive qualified payments. A qualified payment is a distribution that is—

(A)

A dividend payable on a periodic basis (at least annually) under any cumulative preferred stock, to the extent such dividend is determined at a fixed rate;

(B)

Any other cumulative distribution payable on a periodic basis (at least annually) with respect to an equity interest, to the extent determined at a fixed rate or as a fixed amount; or

(C)

Any distribution right for which an election has been made pursuant to paragraph (c)(2) of this section.

(ii)

Fixed rate. For purposes of this section, a payment rate that bears a fixed relationship to a specified market interest rate is a payment determined at a fixed rate.

(c)

Qualified payment elections—

(1)

Election to treat a qualified payment right as other than a qualified payment right. Any transferor holding a qualified payment right may elect to treat all rights held by the transferor of the same class as rights that are not qualified payment rights. An election may be a partial election, in which case the election must be exercised with respect to a consistent portion of each payment right in the class as to which the election has been made.

(2)

Election to treat other distribution rights as qualified payment rights. Any individual may elect to treat a distribution right held by that individual in a controlled entity as a qualified payment right. An election may be a partial election, in which case the election must be exercised with respect to a consistent portion of each payment right in the class as to which the election has been made. An election under this paragraph (c)(2) will not cause the value of the applicable retained interest conferring the distribution right to exceed the fair market value of the applicable retained interest (determined without regard to section 2701). The election is effective only to the extent—

(i)

Specified in the election, and

(ii)

That the payments elected are permissible under the legal instrument giving rise to the right and are consistent with the legal right of the entity to make the payment.

(3)

Elections irrevocable. Any election under paragraph (c)(1) or (c)(2) of this section is revocable only with the consent of the Commissioner.

(4)

Treatment of certain payments to applicable family members. Any payment right described in paragraph (b)(6) of this section held by an applicable family member is treated as a payment right that is not a qualified payment right unless the applicable family member elects (pursuant to paragraph (c)(2) of this section) to treat the payment right as a qualified payment right. An election may be a partial election, in which case the election must be exercised with respect to a consistent portion of each payment right in the class as to which the election has been made.

(5)

Time and manner of elections. Any election under paragraph (c)(1) or (c)(2) of this section is made by attaching a statement to the Form 709, Federal Gift Tax Return, filed by the transferor on which the transfer is reported. An election filed after the time of the filing of the Form 709 reporting the transfer is not a valid election. An election filed as of April 6, 1992, for transfers made prior to its publication is effective. The statement must—

(i)

Set forth the name, address, and taxpayer identification number of the electing individual and of the transferor, if different;

(ii)

If the electing individual is not the transferor filing the return, state the relationship between the individual and the transferor;

(iii)

Specifically identify the transfer disclosed on the return to which the election applies;

(iv)

Describe in detail the distribution right to which the election applies;

(v)

State the provision of the regulation under which the election is being made; and

(vi)

If the election is being made under paragraph (c)(2) of this section—

(A)

State the amounts that the election assumes will be paid, and the times that the election assumes the payments will be made;

(B)

Contain a statement, signed by the electing individual, in which the electing individual agrees that— (1) If payments are not made as provided in the election, the individual's subsequent taxable gifts or taxable estate will, upon the occurrence of a taxable event (as defined in § 25.2701-4(b)), be increased by an amount determined under § 25.2701-4(c), and

(2) The individual will be personally liable for any increase in tax attributable thereto.

(d)

Examples. The following examples illustrate provisions of this section:

Notes, amendments, and revision history

Amendments

[T.D. 8395, 57 FR 4257, Feb. 4, 1992]

Authority

Source

Source: T.D. 6334, 23 FR 8904, Nov. 15, 1958; 25 FR 14021, Dec. 31, 1960, unless otherwise noted.

Amendments

[T.D. 8395, 57 FR 4257, Feb. 4, 1992]

§25.2701-3. Determination of amount of gift.

26 C.F.R. § 25.2701-3

(a)

Overview—

(1)

In general. The amount of the gift resulting from any transfer to which section 2701 applies is determined by a subtraction method of valuation. Under this method, the amount of the transfer is determined by subtracting the values of all family-held senior equity interests from the fair market value of all family-held interests in the entity determined immediately before the transfer. The values of the senior equity interests held by the transferor and applicable family members generally are determined under section 2701. Other family-held senior equity interests are valued at their fair market value. The balance is then appropriately allocated among the transferred interests and other family-held subordinate equity interests. Finally, certain discounts and other appropriate reductions are provided, but only to the extent permitted by this section.

(2)

Definitions. The following definitions apply for purposes of this section.

(i)

Family-held. Family-held means held (directly or indirectly) by an individual described in § 25.2701-2(b)(5)(i).

(ii)

Senior equity interest. Senior equity interest means an equity interest in the entity that carries a right to distributions of income or capital that is preferred as to the rights of the transferred interest.

(iii)

Subordinate equity interest. Subordinate equity interest means an equity interest in the entity as to which an applicable retained interest is a senior equity interest.

(b)

Valuation methodology. The following methodology is used to determine the amount of the gift when section 2701 applies.

(1)

Step 1—Valuation of family-held interest—

(i)

In general. Except as provided in paragraph (b)(1)(ii) of this section determine the fair market value of all family-held equity interests in the entity immediately after the transfer. The fair market value is determined by assuming that the interests are held by one individual, using a consistent set of assumptions.

(ii)

Special rule for contributions to capital. In the case of a contribution to capital, determine the fair market value of the contribution.

(2)

Step 2— Subtract the value of senior equity interests—(i) In general. If the amount determined in Step 1 of paragraph (b)(1) of this section is not determined under the special rule for contributions to capital, from that value subtract the following amounts:

(A)

An amount equal to the sum of the fair market value of all family-held senior equity interests, (other than applicable retained interests held by the transferor or applicable family members) and the fair market value of any family-held equity interests of the same class or a subordinate class to the transferred interests held by persons other than the transferor, members of the transferor's family, and applicable family members of the transferor. The fair market value of an interest is its pro rata share of the fair market value of all family-held senior equity interests of the same class (determined, immediately after the transfer, as is all family-held senior equity interests were held by one individual); and

(B)

The value of all applicable retained interests held by the transferor or applicable family members (other than an interest received as consideration for the transfer) determined under § 25.2701-2, taking into account the adjustment described in paragraph (b)(5) of this section.

(ii)

Special rule for contributions to capital. If the value determined in Step 1 of paragraph (b)(1) of this section is determined under the special rule for contributions to capital, subtract the value of any applicable retained interest received in exchange for the contribution to capital determined under § 25.2701-2.

(2)

Step 2—Subtract the value of senior equity interests. From the value determined in Step 1, subtract the following amounts:

(i)

An amount equal to the fair market value of all family-held senior equity interests, other than applicable retained interests held by the transferor or applicable family members. The fair market value of an interest is its pro rata share of the fair market value of all family-held senior equity interests of the same class (determined as if all family-held senior equity interests were held by one individual); and

(ii)

The value of all applicable retained interests held by the transferor or applicable family members determined under § 25.2701-2, taking into account the adjustment described in paragraph (b)(5) of this section.

(3)

Step 3—Allocate the remaining value among the transferred interests and other family-held subordinate equity interests. The value remaining after Step 2 is allocated among the transferred interests and other subordinate equity interests held by the transferor, applicable family members, and members of the transferor's family. If more than one class of family-held subordinate equity interest exists, the value remaining after Step 2 is allocated, beginning with the most senior class of subordinate equity interest, in the manner that would most fairly approximate their value if all rights valued under section 2701 at zero did not exist (or would be exercised in a manner consistent with the assumptions of the rule of § 25.2702-2(a)(4), if applicable). If there is no clearly appropriate method of allocating the remaining value pursuant to the preceding sentence, the remaining value (or the portion remaining after any partial allocation pursuant to the preceding sentence) is allocated to the interests in proportion to their fair market values determined without regard to section 2701.

(4)

Step 4—Determine the amount of the gift—

(i)

In general. The amount allocated to the transferred interests in Step 3 is reduced by the amounts determined under this paragraph (b)(4).

(ii)

Reduction for minority or similar discounts. Except as provided in § 25.2701-3(c), if the value of the transferred interest (determined without regard to section 2701) would be determined after application of a minority or similar discount with respect to the transferred interest, the amount of the gift determined under section 2701 is reduced by the excess, if any, of—

(A)

A pro rata portion of the fair market value of the family-held interests of the same class (determined as if all voting rights conferred by family-held equity interests were held by one person who had no interest in the entity other than the family-held interests of the same class, but otherwise without regard to section 2701), over

(B)

The value of the transferred interest (without regard to section 2701).

(iii)

Adjustment for transfers with a retained interest. If the value of the transferor's gift (determined without regard to section 2701) would be reduced under section 2702 to reflect the value of a retained interest, the value determined under section 2701 is reduced by the same amount.

(iv)

Reduction for consideration. The amount of the transfer (determined under section 2701) is reduced by the amount of consideration in money or money's worth received by the transferor, but not in excess of the amount of the gift (determined without regard to section 2701). The value of consideration received by the transferor in the form of an applicable retained interest in the entity is determined under section 2701 except that, in the case of a contribution to capital, the Step 4 value of such an interest is zero.

(5)

Adjustment in Step 2—

(i)

In general. For purposes of paragraph (b)(2) of this section, if the percentage of any class of applicable retained interest held by the transferor and by applicable family members (including any interest received as consideration for the transfer) exceeds the family interest percentage, the excess is treated as a family-held interest that is not held by the transferor or an applicable family member.

(ii)

Family interest percentage. The family interest percentage is the highest ownership percentage (determined on the basis of relative fair market values) of family-held interests in—

(A)

Any class of subordinate equity interest; or

(B)

All subordinate equity interests, valued in the aggregate.

(c)

Minimum value rule—

(1)

In general. If section 2701 applies to the transfer of an interest in an entity, the value of a junior equity interest is not less than its pro-rata portion of 10 percent of the sum of—

(i)

The total value of all equity interests in the entity, and

(ii)

The total amount of any indebtedness of the entity owed to the transferor and applicable family members.

(2)

Junior equity interest. For purposes of paragraph (c)(1) of this section, junior equity interest means common stock or, in the case of a partnership, any partnership interest under which the rights to income and capital are junior to the rights of all other classes of partnership interests. Common stock means the class or classes of stock that, under the facts and circumstances, are entitled to share in the reasonably anticipated residual growth in the entity.

(3)

Indebtedness—

(i)

In general. For purposes of paragraph (c)(1) of this section, indebtedness owed to the transferor (or an applicable family member) does not include—

(A)

Short-term indebtedness incurred with respect to the current conduct of the entity's trade or business (such as amounts payable for current services);

(B)

Indebtedness owed to a third party solely because it is guaranteed by the transferor or an applicable family member; or

(C)

Amounts permanently set aside in a qualified deferred compensation arrangement, to the extent the amounts are unavailable for use by the entity.

(ii)

Leases. A lease of property is not indebtedness, without regard to the length of the lease term, if the lease payments represent full and adequate consideration for use of the property. Lease payments are considered full and adequate consideration if a good faith effort is made to determine the fair rental value under the lease and the terms of the lease conform to the value so determined. Arrearages with respect to a lease are indebtedness.

(d)

Examples. The application of the subtraction method described in this section is illustrated by the following Examples:

Notes, amendments, and revision history

Amendments

[T.D. 8395, 57 FR 4259, Feb. 4, 1992; T.D. 8395, 57 FR 11264, Apr. 2, 1992]

Authority

Source

Source: T.D. 6334, 23 FR 8904, Nov. 15, 1958; 25 FR 14021, Dec. 31, 1960, unless otherwise noted.

Amendments

[T.D. 8395, 57 FR 4259, Feb. 4, 1992; T.D. 8395, 57 FR 11264, Apr. 2, 1992]

§25.2701-4. Accumulated qualified payments.

26 C.F.R. § 25.2701-4

(a)

In general. If a taxable event occurs with respect to any applicable retained interest conferring a distribution right that was previously valued as a qualified payment right (a “qualified payment interest”), the taxable estate or taxable gifts of the individual holding the interest are increased by the amount determined under paragraph (c) of this section.

(b)

Taxable event—

(1)

In general. Except as otherwise provided in this section, taxable event means the transfer of a qualified payment interest, either during life or at death, by the individual in whose hands the interest was originally valued under section 2701 (the “interest holder”) or by any individual treated pursuant to paragraph (b)(3) of this section in the same manner as the interest holder. Except as provided in paragraph (a)(2) of this section, any termination of an individual's rights with respect to a qualified payment interest is a taxable event. Thus, for example, if an individual is treated as indirectly holding a qualified payment interest held by a trust, a taxable event occurs on the earlier of—

(i)

The termination of the individual's interest in the trust (whether by death or otherwise), or

(ii)

The termination of the trust's interest in the qualified payment interest (whether by disposition or otherwise).

(2)

Exception. If, at the time of a termination of an individual's rights with respect to a qualified payment interest, the value of the property would be includible in the individual's gross estate for Federal estate tax purposes if the individual died immediately after the termination, a taxable transfer does not occur until the earlier of—

(i)

The time the property would no longer be includible in the individual's gross estate (other than by reason of section 2035), or

(ii)

The death of the individual.

(3)

Individual treated as interest holder—

(i)

In general. If a taxable event involves the transfer of a qualified payment interest by the interest holder (or an individual treated as the interest holder) to an applicable family member of the individual who made the transfer to which section 2701 applied (other than the spouse of the individual transferring the qualified payment interest), the transferee applicable family member is treated in the same manner as the interest holder with respect to late or unpaid qualified payments first due after the taxable event. Thus, for example, if an interest holder transfers during life a qualified payment interest to an applicable family member, that transfer is a taxable event with respect to the interest holder whose taxable gifts are increased for the year of the transfer as provided in paragraph (c) of this section. The transferee is treated thereafter in the same manner as the interest holder with respect to late or unpaid qualified payments first due after the taxable event.

(ii)

Transfers to spouse—

(A)

In general. If an interest holder (or an individual treated as the interest holder) transfers a qualified payment interest, the transfer is not a taxable event to the extent a marital deduction is allowed with respect to the transfer under sections 2056, 2106(a)(3), or 2523 or, in the case of a transfer during the individual's lifetime, to the extent the spouse furnishes consideration for the transfer. If this exception applies, the transferee spouse is treated as if he or she were the holder of the interest from the date the transferor spouse acquired the interest. If the deduction for a transfer to a spouse is allowable under section 2056(b)(8) or 2523(g) (relating to charitable remainder trusts), the transferee spouse is treated as the holder of the entire interest passing to the trust.

(B)

Marital bequests. If the selection of property with which a marital bequest is funded is discretionary, a transfer of a qualified payment interest will not be considered a transfer to the surviving spouse unless—

(1) The marital bequest is funded with the qualified payment interest before the due date for filing the decedent's Federal estate tax return (including extensions actually granted) (the “due date”), or

(2) The executor—

(i) Files a statement with the return indicating the extent to which the marital bequest will be funded with the qualified payment interest, and

(ii) Before the date that is one year prior to the expiration of the period of limitations on assessment of the Federal estate tax, notifies the District Director having jurisdiction over the return of the extent to which the bequest was funded with the qualified payment interest (or the extent to which the qualified payment interest has been permanently set aside for that purpose).

(C)

Purchase by the surviving spouse. For purposes of this section, the purchase (before the date prescribed for filing the decedent's estate tax return, including extensions actually granted) by the surviving spouse (or a trust described in section 2056(b)(7)) of a qualified payment interest held (directly or indirectly) by the decedent immediately before death is considered a transfer with respect to which a deduction is allowable under section 2056 or section 2106(a)(3), but only to the extent that the deduction is allowed to the estate. For example, assume that A bequeaths $50,000 to A's surviving spouse, B, in a manner that qualifies for deduction under section 2056, and that subsequent to A's death B purchases a qualified payment interest from A's estate for $200,000, its fair market value. The economic effect of the transaction is the equivalent of a bequest by A to B of the qualified payment interest, one-fourth of which qualifies for the marital deduction. Therefore, for purposes of this section, one-fourth of the qualified payment interest purchased by B ($50,000 ÷ $200,000) is considered a transfer of an interest with respect to which a deduction is allowed under 2056. If the purchase by the surviving spouse is not made before the due date of the decedent's return, the purchase of the qualified payment interest will not be considered a bequest for which a marital deduction is allowed unless the executor—

(1) Files a statement with the return indicating the qualified payment interests to be purchased by the surviving spouse (or a trust described in section 2056(b)(7)), and

(2) Before the date that is one year prior to the expiration of the period of limitations on assessment of the Federal estate tax, notifies the District Director having jurisdiction over the return that the purchase of the qualified payment interest has been made (or that the funds necessary to purchase the qualified payment interest have been permanently set aside for that purpose).

(c)

Amount of increase—

(1)

In general. Except as limited by paragraph (c)(6) of this section, the amount of the increase to an individual's taxable estate or taxable gifts is the excess, if any, of—

(i)

The sum of—

(A)

The amount of qualified payments payable during the period beginning on the date of the transfer to which section 2701 applied (or, in the case of an individual treated as the interest holder, on the date the interest of the prior interest holder terminated) and ending on the date of the taxable event; and

(B)

The earnings on those payments, determined hypothetically as if each payment were paid on its due date and reinvested as of that date at a yield equal to the appropriate discount rate (as defined below); over

(ii)

The sum of—

(A)

The amount of the qualified payments actually paid during the same period;

(B)

The earnings on those payments, determined hypothetically as if each payment were reinvested as of the date actually paid at a yield equal to the appropriate discount rate; and

(C)

To the extent required to prevent double inclusion, by an amount equal to the sum of— (1) The portion of the fair market value of the qualified payment interest solely attributable to any right to receive unpaid qualified payments determined as of the date of the taxable event;

(2) The fair market value of any equity interest in the entity received by the individual in lieu of qualified payments and held by the individual at the taxable event, and

(3) The amount by which the individual's aggregate taxable gifts were increased by reason of the failure of the individual to enforce the right to receive qualified payments.

(2)

Due date of qualified payments. With respect to any qualified payment, the “due date” is that date specified in the governing instrument as the date on which payment is to be made. If no date is specified in the governing instrument, the due date is the last day of each calendar year.

(3)

Appropriate discount rate. The appropriate discount rate is the discount rate that was applied in determining the value of the qualified payment right at the time of the transfer to which section 2701 applied.

(4)

Application of payments. For purposes of this section, any payment of an unpaid qualified payment is applied in satisfaction of unpaid qualified payments beginning with the earliest unpaid qualified payment. Any payment in excess of the total of all unpaid qualified payments is treated as a prepayment of future qualified payments.

(5)

Payment. For purposes of this paragraph (c), the transfer of a debt obligation bearing compound interest from the due date of the payment at a rate not less than the appropriate discount rate is a qualified payment if the term of the obligation (including extensions) does not exceed four years from the date issued. A payment in the form of an equity interest in the entity is not a qualified payment. Any payment of a qualified payment made (or treated as made) either before or during the four-year period beginning on the due date of the payment but before the date of the taxable event is treated as having been made on the due date.

(6)

Limitation—

(i)

In general. The amount of the increase to an individual's taxable estate or taxable gifts is limited to the applicable percentage of the excess, if any, of—

(A)

The sum of— (1) The fair market value of all outstanding equity interests in the entity that are subordinate to the applicable retained interest, determined as of the date of the taxable event without regard to any accrued liability attributable to unpaid qualified payments; and

(2) Any amounts expended by the entity to redeem or otherwise acquire any such subordinate interest during the period beginning on the date of the transfer to which section 2701 applied (or, in the case of an individual treated as an interest holder, on the date the interest of the prior interest holder terminated) and ending on the date of the taxable event (reduced by any amounts received on the resale or issuance of any such subordinate interest during the same period); over

(B)

The fair market value of all outstanding equity interests in the entity that are subordinate to the applicable retained interest, determined as of the date of the transfer to which section 2701 applied (or, in the case of an individual treated as an interest holder, on the date the interest of the prior interest holder terminated).

(ii)

Computation of limitation. For purposes of computing the limitation applicable under this paragraph (c)(6), the aggregate fair market value of the subordinate interests in the entity are determined without regard to § 25.2701-3(c).

(iii)

Applicable percentage. The applicable percentage is determined by dividing the number of shares or units of the applicable retained interest held by the interest holder (or an individual treated as the interest holder) on the date of the taxable event by the total number of such shares or units outstanding on the same date. If an individual holds applicable retained interests in two or more classes of interests, the applicable percentage is equal to the largest applicable percentage determined with respect to any class. For example, if T retains 40 percent of the class A preferred and 60 percent of the class B preferred in a corporation, the applicable percentage with respect to T's holdings is 60 percent.

(d)

Taxpayer election—

(1)

In general. An interest holder (or individual treated as an interest holder) may elect to treat as a taxable event the payment of an unpaid qualified payment occurring more than four years after its due date. Under this election, the increase under paragraph (c) of this section is determined only with respect to that payment and all previous payments for which an election was available but not made. Payments for which an election applies are treated as having been paid on their due dates for purposes of subsequent taxable events. The election is revocable only with the consent of the Commissioner.

(2)

Limitation not applicable. If a taxable event occurs by reason of an election described in paragraph (d)(1) of this section, the limitation described in paragraph (c)(6) of this section does not apply.

(3)

Time and manner of election—

(i)

Timely-filed returns. The election may be made by attaching a statement to a Form 709, Federal Gift Tax Return, filed by the recipient of the qualified payment on a timely basis for the year in which the qualified payment is received. In that case, the taxable event is deemed to occur on the date the qualified payment is received.

(ii)

Election on late returns. The election may be made by attaching a statement to a Form 709, Federal Gift Tax Return, filed by the recipient of the qualified payment other than on a timely basis for the year in which the qualified payment is received. In that case, the taxable event is deemed to occur on the first day of the month immediately preceding the month in which the return is filed. If an election, other than an election on a timely return, is made after the death of the interest holder, the taxable event with respect to the decedent is deemed to occur on the later of—

(A)

The date of the recipient's death, or

(B)

The first day of the month immediately preceding the month in which the return is filed.

(iii)

Requirements of statement. The statement must—

(A)

Provide the name, address, and taxpayer identification number of the electing individual and the interest holder, if different;

(B)

Indicate that a taxable event election is being made under paragraph (d) of this section;

(C)

Disclose the nature of the qualified payment right to which the election applies, including the due dates of the payments, the dates the payments were made, and the amounts of the payments;

(D)

State the name of the transferor, the date of the transfer to which section 2701 applied, and the discount rate used in valuing the qualified payment right; and

(E)

State the resulting amount of increase in taxable gifts.

(4)

Example. The following example illustrates the rules of this paragraph (d).

Notes, amendments, and revision history

Amendments

[T.D. 8395, 57 FR 4261, Feb. 4, 1992]

Authority

Source

Source: T.D. 6334, 23 FR 8904, Nov. 15, 1958; 25 FR 14021, Dec. 31, 1960, unless otherwise noted.

Amendments

[T.D. 8395, 57 FR 4261, Feb. 4, 1992]

26 C.F.R. §§ 25.2701-1–25.2701-4

§25.2701-1. Special valuation rules in the case of transfers of certain interests in corporations and partnerships.

Amendments

Authority

Source

Amendments

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

Amendments

Authority

Source

Amendments

§25.2701-3. Determination of amount of gift.

Amendments

Authority

Source

Amendments

§25.2701-4. Accumulated qualified payments.

Amendments

Authority

Source

Amendments

Cite this provision

Incoming references