Profits Interests Gifts Under Section 2701: 'I Am Not a Monster'
28 Pages Posted: 9 May 2009 Last revised: 18 May 2009
Date Written: May 11, 2009
Section 2701 provides special gift tax valuation rules for transfers of a partnership or corporate interest when the entity has multiple classes of equity. Congress enacted section 2701 to deal with potential valuation abuses it identified in the preferred stock recapitalization. Section 2701 was enacted to replace section 2036(c) that Congress believed unnecessarily restricted the flexibility of family business owners to arrange their affairs. Ironically the complexity of section 2701 has led estate planners to urge their clients to impose similar restrictions on family entities to avoid imagined disastrous gift tax costs. This concern has particularly impacted planning for a gift of a profits interest in a hedge or venture capital fund where its complex character clearly runs afoul of section 2701.
As families began to use simpler proportional profits interests in partnerships to shift investment risks among family members, estate planners have begun to reevaluate whether section 2701 even applies to partnerships with only this profits interest. This report represents the author's year long struggle to apply section 2701 in this context, despite having been involved with its drafting almost 20 years ago. The author concludes that these proportional profits interests are outside section 2701, subject perhaps to a few tweaks. Moreover, a careful analysis of section 2701 reveals that it will produce a value which differs little from the fair market value analysis of a profits interest under the gift tax provisions of chapter 12. In fact using the subtraction method under section 2701 may be preferable to other valuation analyses.
Whether you are a corporate lawyer with little knowledge of section 2701 or an experienced estate planner, this report will surprise you. But remember, section 2701 - unlike section 2036(c) that it replaced - is not a Monster so be not afraid.
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