§ 2701. — Special valuation rules in case of transfers of certain interests in corporations or partnerships.
[Laws in effect as of January 24, 2002]
[Document not affected by Public Laws enacted between
January 24, 2002 and December 19, 2002]
[CITE: 26USC2701]
TITLE 26--INTERNAL REVENUE CODE
Subtitle B--Estate and Gift Taxes
CHAPTER 14--SPECIAL VALUATION RULES
Sec. 2701. Special valuation rules in case of transfers of
certain interests in corporations or partnerships
(a) Valuation rules
(1) In general
Solely for purposes of determining whether a transfer of an
interest in a corporation or partnership to (or for the benefit of)
a member of the transferor's family is a gift (and the value of such
transfer), the value of any right--
(A) which is described in subparagraph (A) or (B) of
subsection (b)(1), and
(B) which is with respect to any applicable retained
interest that is held by the transferor or an applicable family
member immediately after the transfer,
shall be determined under paragraph (3). This paragraph shall not
apply to the transfer of any interest for which market quotations
are readily available (as of the date of transfer) on an established
securities market.
(2) Exceptions for marketable retained interests, etc.
Paragraph (1) shall not apply to any right with respect to an
applicable retained interest if--
(A) market quotations are readily available (as of the date
of the transfer) for such interest on an established securities
market,
(B) such interest is of the same class as the transferred
interest, or
(C) such interest is proportionally the same as the
transferred interest, without regard to nonlapsing differences
in voting power (or, for a partnership, nonlapsing differences
with respect to management and limitations on liability).
Subparagraph (C) shall not apply to any interest in a partnership if
the transferor or an applicable family member has the right to alter
the liability of the transferee of the transferred property. Except
as provided by the Secretary, any difference described in
subparagraph (C) which lapses by reason of any Federal or State law
shall be treated as a nonlapsing difference for purposes of such
subparagraph.
(3) Valuation of rights to which paragraph (1) applies
(A) In general
The value of any right described in paragraph (1), other
than a distribution right which consists of a right to receive a
qualified payment, shall be treated as being zero.
(B) Valuation of certain qualified payments
If--
(i) any applicable retained interest confers a
distribution right which consists of the right to a
qualified payment, and
(ii) there are 1 or more liquidation, put, call, or
conversion rights with respect to such interest,
the value of all such rights shall be determined as if each
liquidation, put, call, or conversion right were exercised in
the manner resulting in the lowest value being determined for
all such rights.
(C) Valuation of qualified payments where no liquidation, etc.
rights
In the case of an applicable retained interest which is
described in subparagraph (B)(i) but not subparagraph (B)(ii),
the value of the distribution right shall be determined without
regard to this section.
(4) Minimum valuation of junior equity
(A) In general
In the case of a transfer described in paragraph (1) of a
junior equity interest in a corporation or partnership, such
interest shall in no event be valued at an amount less than the
value which would be determined if the total value of all of the
junior equity interests in the entity were equal to 10 percent
of the sum of--
(i) the total value of all of the equity interests in
such entity, plus
(ii) the total amount of indebtedness of such entity to
the transferor (or an applicable family member).
(B) Definitions
For purposes of this paragraph--
(i) Junior equity interest
The term ``junior equity interest'' means common stock
or, in the case of a partnership, any partnership interest
under which the rights as to income and capital (or, to the
extent provided in regulations, the rights as to either
income or capital) are junior to the rights of all other
classes of equity interests.
(ii) Equity interest
The term ``equity interest'' means stock or any interest
as a partner, as the case may be.
(b) Applicable retained interests
For purposes of this section--
(1) In general
The term ``applicable retained interest'' means any interest in
an entity with respect to which there is--
(A) a distribution right, but only if, immediately before
the transfer described in subsection (a)(1), the transferor and
applicable family members hold (after application of subsection
(e)(3)) control of the entity, or
(B) a liquidation, put, call, or conversion right.
(2) Control
For purposes of paragraph (1)--
(A) Corporations
In the case of a corporation, the term ``control'' means the
holding of at least 50 percent (by vote or value) of the stock
of the corporation.
(B) Partnerships
In the case of a partnership, the term ``control'' means--
(i) the holding of at least 50 percent of the capital or
profits interests in the partnership, or
(ii) in the case of a limited partnership, the holding
of any interest as a general partner.
(C) Applicable family member
For purposes of this subsection, the term ``applicable
family member'' includes any lineal descendant of any parent of
the transferor or the transferor's spouse.
(c) Distribution and other rights; qualified payments
For purposes of this section--
(1) Distribution right
(A) In general
The term ``distribution right'' means--
(i) a right to distributions from a corporation with
respect to its stock, and
(ii) a right to distributions from a partnership with
respect to a partner's interest in the partnership.
(B) Exceptions
The term ``distribution right'' does not include--
(i) a right to distributions with respect to any
interest which is junior to the rights of the transferred
interest,
(ii) any liquidation, put, call, or conversion right, or
(iii) any right to receive any guaranteed payment
described in section 707(c) of a fixed amount.
(2) Liquidation, etc. rights
(A) In general
The term ``liquidation, put, call, or conversion right''
means any liquidation, put, call, or conversion right, or any
similar right, the exercise or nonexercise of which affects the
value of the transferred interest.
(B) Exception for fixed rights
(i) In general
The term ``liquidation, put, call, or conversion right''
does not include any right which must be exercised at a
specific time and at a specific amount.
(ii) Treatment of certain rights
If a right is assumed to be exercised in a particular
manner under subsection (a)(3)(B), such right shall be
treated as so exercised for purposes of clause (i).
(C) Exception for certain rights to convert
The term ``liquidation, put, call, or conversion right''
does not include any right which--
(i) is a right to convert into a fixed number (or a
fixed percentage) of shares of the same class of stock in a
corporation as the transferred stock in such corporation
under subsection (a)(1) (or stock which would be of the same
class but for nonlapsing differences in voting power),
(ii) is nonlapsing,
(iii) is subject to proportionate adjustments for
splits, combinations, reclassifications, and similar changes
in the capital stock, and
(iv) is subject to adjustments similar to the
adjustments under subsection (d) for accumulated but unpaid
distributions.
A rule similar to the rule of the preceding sentence shall apply
for partnerships.
(3) Qualified payment
(A) In general
Except as otherwise provided in this paragraph, the term
``qualified payment'' means any dividend payable on a periodic
basis under any cumulative preferred stock (or a comparable
payment under any partnership interest) to the extent that such
dividend (or comparable payment) is determined at a fixed rate.
(B) Treatment of variable rate payments
For purposes of subparagraph (A), a payment shall be treated
as fixed as to rate if such payment is determined at a rate
which bears a fixed relationship to a specified market interest
rate.
(C) Elections
(i) In general
Payments under any interest held by a transferor which
(without regard to this subparagraph) are qualified payments
shall be treated as qualified payments unless the transferor
elects not to treat such payments as qualified payments.
Payments described in the preceding sentence which are held
by an applicable family member shall be treated as qualified
payments only if such member elects to treat such payments
as qualified payments.
(ii) Election to have interest treated as qualified
payment
A transferor or applicable family member holding any
distribution right which (without regard to this
subparagraph) is not a qualified payment may elect to treat
such right as a qualified payment, to be paid in the amounts
and at the times specified in such election. The preceding
sentence shall apply only to the extent that the amounts and
times so specified are not inconsistent with the underlying
legal instrument giving rise to such right.
(iii) Elections irrevocable
Any election under this subparagraph with respect to an
interest shall, once made, be irrevocable.
(d) Transfer tax treatment of cumulative but unpaid distributions
(1) In general
If a taxable event occurs with respect to any distribution right
to which subsection (a)(3)(B) or (C) applied, the following shall be
increased by the amount determined under paragraph (2):
(A) The taxable estate of the transferor in the case of a
taxable event described in paragraph (3)(A)(i).
(B) The taxable gifts of the transferor for the calendar
year in which the taxable event occurs in the case of a taxable
event described in paragraph (3)(A)(ii) or (iii).
(2) Amount of increase
(A) In general
The amount of the increase determined under this paragraph
shall be the excess (if any) of--
(i) the value of the qualified payments payable during
the period beginning on the date of the transfer under
subsection (a)(1) and ending on the date of the taxable
event determined as if--
(I) all such payments were paid on the date payment
was due, and
(II) all such payments were reinvested by the
transferor as of the date of payment at a yield equal to
the discount rate used in determining the value of the
applicable retained interest described in subsection
(a)(1), over
(ii) the value of such payments paid during such period
computed under clause (i) on the basis of the time when such
payments were actually paid.
(B) Limitation on amount of increase
(i) In general
The amount of the increase under subparagraph (A) shall
not exceed the applicable percentage of the excess (if any)
of--
(I) the value (determined as of the date of the
taxable event) of all equity interests in the entity
which are junior to the applicable retained interest,
over
(II) the value of such interests (determined as of
the date of the transfer to which subsection (a)(1)
applied).
(ii) Applicable percentage
For purposes of clause (i), the applicable percentage is
the percentage determined by dividing--
(I) the number of shares in the corporation held (as
of the date of the taxable event) by the transferor
which are applicable retained interests of the same
class, by
(II) the total number of shares in such corporation
(as of such date) which are of the same class as the
class described in subclause (I).
A similar percentage shall be determined in the case of
interests in a partnership.
(iii) Definition
For purposes of this subparagraph, the term ``equity
interest'' has the meaning given such term by subsection
(a)(4)(B).
(C) Grace period
For purposes of subparagraph (A), any payment of any
distribution during the 4-year period beginning on its due date
shall be treated as having been made on such due date.
(3) Taxable events
For purposes of this subsection--
(A) In general
The term ``taxable event'' means any of the following:
(i) The death of the transferor if the applicable
retained interest conferring the distribution right is
includible in the estate of the transferor.
(ii) The transfer of such applicable retained interest.
(iii) At the election of the taxpayer, the payment of
any qualified payment after the period described in
paragraph (2)(C), but only with respect to such payment.
(B) Exception where spouse is transferee
(i) Deathtime transfers
Subparagraph (A)(i) shall not apply to any interest
includible in the gross estate of the transferor if a
deduction with respect to such interest is allowable under
section 2056 or 2106(a)(3).
(ii) Lifetime transfers
A transfer to the spouse of the transferor shall not be
treated as a taxable event under subparagraph (A)(ii) if
such transfer does not result in a taxable gift by reason
of--
(I) any deduction allowed under section 2523, or the
exclusion under section 2503(b), or
(II) consideration for the transfer provided by the
spouse.
(iii) Spouse succeeds to treatment of transferor
If an event is not treated as a taxable event by reason
of this subparagraph, the transferee spouse or surviving
spouse (as the case may be) shall be treated in the same
manner as the transferor in applying this subsection with
respect to the interest involved.
(4) Special rules for applicable family members
(A) Family member treated in same manner as transferor
For purposes of this subsection, an applicable family member
shall be treated in the same manner as the transferor with
respect to any distribution right retained by such family member
to which subsection (a)(3)(B) or (C) applied.
(B) Transfer to applicable family member
In the case of a taxable event described in paragraph
(3)(A)(ii) involving the transfer of an applicable retained
interest to an applicable family member (other than the spouse
of the transferor), the applicable family member shall be
treated in the same manner as the transferor in applying this
subsection to distributions accumulating with respect to such
interest after such taxable event.
(C) Transfer to transferors
In the case of a taxable event described in paragraph
(3)(A)(ii) involving a transfer of an applicable retained
interest from an applicable family member to a transferor, this
subsection shall continue to apply to the transferor during any
period the transferor holds such interest.
(5) Transfer to include termination
For purposes of this subsection, any termination of an interest
shall be treated as a transfer.
(e) Other definitions and rules
For purposes of this section--
(1) Member of the family
The term ``member of the family'' means, with respect to any
transferor--
(A) the transferor's spouse,
(B) a lineal descendant of the transferor or the
transferor's spouse, and
(C) the spouse of any such descendant.
(2) Applicable family member
The term ``applicable family member'' means, with respect to any
transferor--
(A) the transferor's spouse,
(B) an ancestor of the transferor or the transferor's
spouse, and
(C) the spouse of any such ancestor.
(3) Attribution of indirect holdings and transfers
An individual shall be treated as holding any interest to the
extent such interest is held indirectly by such individual through a
corporation, partnership, trust, or other entity. If any individual
is treated as holding any interest by reason of the preceding
sentence, any transfer which results in such interest being treated
as no longer held by such individual shall be treated as a transfer
of such interest.
(4) Effect of adoption
A relationship by legal adoption shall be treated as a
relationship by blood.
(5) Certain changes treated as transfers
Except as provided in regulations, a contribution to capital or
a redemption, recapitalization, or other change in the capital
structure of a corporation or partnership shall be treated as a
transfer of an interest in such entity to which this section applies
if the taxpayer or an applicable family member--
(A) receives an applicable retained interest in such entity
pursuant to such transaction, or
(B) under regulations, otherwise holds, immediately after
such transaction, an applicable retained interest in such
entity.
This paragraph shall not apply to any transaction (other than a
contribution to capital) if the interests in the entity held by the
transferor, applicable family members, and members of the
transferor's family before and after the transaction are
substantially identical.
(6) Adjustments
Under regulations prescribed by the Secretary, if there is any
subsequent transfer, or inclusion in the gross estate, of any
applicable retained interest which was valued under the rules of
subsection (a), appropriate adjustments shall be made for purposes
of chapter 11, 12, or 13 to reflect the increase in the amount of
any prior taxable gift made by the transferor or decedent by reason
of such valuation or to reflect the application of subsection (d).
(7) Treatment as separate interests
The Secretary may by regulation provide that any applicable
retained interest shall be treated as 2 or more separate interests
for purposes of this section.
(Added Pub. L. 101-508, title XI, Sec. 11602(a), Nov. 5, 1990, 104 Stat.
1388-491; amended Pub. L. 104-188, title I, Sec. 1702(f)(1)-(3)(B), (4)-
(5)(B), (6)-(10), Aug. 20, 1996, 110 Stat. 1870-1872.)
Amendments
1996--Subsec. (a)(3)(B). Pub. L. 104-188, Sec. 1702(f)(1)(B),
inserted ``certain'' before ``qualified'' in heading.
Subsec. (a)(3)(C). Pub. L. 104-188, Sec. 1702(f)(1)(A), added
subpar. (C).
Subsec. (a)(4)(B)(i). Pub. L. 104-188, Sec. 1702(f)(2), inserted
``(or, to the extent provided in regulations, the rights as to either
income or capital)'' after ``income and capital''.
Subsec. (b)(2)(C). Pub. L. 104-188, Sec. 1702(f)(3)(A), added
subpar. (C).
Subsec. (c)(1)(B)(i). Pub. L. 104-188, Sec. 1702(f)(4), amended cl.
(i) generally. Prior to amendment, cl. (i) read as follows: ``a right to
distributions with respect to any junior equity interest (as defined in
subsection (a)(4)(B)(i)),''.
Subsec. (c)(3)(C)(i). Pub. L. 104-188, Sec. 1702(f)(5)(A), amended
cl. (i) generally. Prior to amendment, cl. (i) read as follows:
``(i) Waiver of qualified payment treatment.--A transferor or
applicable family member may elect with respect to payments under any
interest specified in such election to treat such payments as payments
which are not qualified payments.''
Subsec. (c)(3)(C)(ii). Pub. L. 104-188, Sec. 1702(f)(5)(B), amended
first sentence generally. Prior to amendment, first sentence read as
follows: ``A transferor or any applicable family member may elect to
treat any distribution right as a qualified payment, to be paid in the
amounts and at the times specified in such election.''
Subsec. (d)(1). Pub. L. 104-188, Sec. 1702(f)(1)(C), substituted
``subsection (a)(3)(B) or (C)'' for ``subsection (a)(3)(B)''.
Subsec. (d)(3)(A)(iii). Pub. L. 104-188, Sec. 1702(f)(6), struck out
``the period ending on the date of'' after ``with respect to''.
Subsec. (d)(3)(B)(ii)(I). Pub. L. 104-188, Sec. 1702(f)(7), inserted
``or the exclusion under section 2503(b),'' after ``section 2523,''.
Subsec. (d)(4)(A). Pub. L. 104-188, Sec. 1702(f)(1)(C), substituted
``subsection (a)(3)(B) or (C)'' for ``subsection (a)(3)(B)''.
Subsec. (d)(4)(C). Pub. L. 104-188, Sec. 1702(f)(9), added subpar.
(C).
Subsec. (e)(3). Pub. L. 104-188, Sec. 1702(f)(3)(B), substituted
``Attribution of indirect holdings and transfers'' for ``Attribution
rules'' in par. heading, struck out subpar. (A) designation and heading
which read ``Indirect holdings and transfers'', and struck out subpar.
(B) which read as follows:
``(B) Control.--For purposes of subsections (b)(1), an individual
shall be treated as holding any interest held by the individual's
brothers, sisters, or lineal descendants.''
Subsec. (e)(5)(A). Pub. L. 104-188, Sec. 1702(f)(8)(A), substituted
``such transaction'' for ``such contribution to capital or such
redemption, recapitalization, or other change''.
Subsec. (e)(5)(B). Pub. L. 104-188, Sec. 1702(f)(8)(B), substituted
``such transaction'' for ``the transfer''.
Subsec. (e)(6). Pub. L. 104-188, Sec. 1702(f)(10), inserted ``or to
reflect the application of subsection (d)'' before period at end.
Effective Date of 1996 Amendment
Amendment by Pub. L. 104-188 effective, except as otherwise
expressly provided, as if included in the provision of the Revenue
Reconciliation Act of 1990, Pub. L. 101-508, title XI, to which such
amendment relates, see section 1702(i) of Pub. L. 104-188, set out as a
note under section 38 of this title.
Effective Date
Section 11602(e)(1) of Pub. L. 101-508 provided that:
``(A) In general.--The amendments made by subsection (a) [enacting
this chapter]--
``(i) to the extent such amendments relate to sections 2701 and
2702 of the Internal Revenue Code of 1986 (as added by such
amendments), shall apply to transfers after October 8, 1990,
``(ii) to the extent such amendments relate to section 2703 of
such Code (as so added), shall apply to--
``(I) agreements, options, rights, or restrictions entered
into or granted after October 8, 1990, and
``(II) agreements, options, rights, or restrictions which
are substantially modified after October 8, 1990, and
``(iii) to the extent such amendments relate to section 2704 of
such Code (as so added), shall apply to restrictions or rights (or
limitations on rights) created after October 8, 1990.
``(B) Exception.--For purposes of subparagraph (A)(i), with respect
to property transferred before October 9, 1990--
``(i) any failure to exercise a right of conversion,
``(ii) any failure to pay dividends, and
``(iii) any failure to exercise other rights specified in
regulations,
shall not be treated as a subsequent transfer.''
Time for Election Under Subsection (c)(3)(C)(i)
Section 1702(f)(5)(C) of Pub. L. 104-188 provided that: ``The time
for making an election under the second sentence of section
2701(c)(3)(C)(i) of the Internal Revenue Code of 1986 (as amended by
subparagraph (A)) shall not expire before the due date (including
extensions) for filing the transferor's return of the tax imposed by
section 2501 of such Code for the first calendar year ending after the
date of enactment [probably means the date of enactment of Pub. L. 104-
188, Oct. 20, 1996].''
Study of Methods Used To Distort Valuation of Property for Purposes of
Estate and Gift Tax
Section 11602(d) of Pub. L. 101-508 provided that: ``The Secretary
of the Treasury shall conduct a study of--
``(1) the prevalence and types of options and agreements used to
distort the valuation of property for purposes of subtitle B of the
Internal Revenue Code of 1986, and
``(2) other methods using discretionary rights to distort the
value of property for such purposes.
The Secretary shall, not later than December 31, 1992, report the
results of such study, together with such legislative recommendations as
the Secretary considers necessary, to the Committee on Finance of the
Senate and the Committee on Ways and Means of the House of
Representatives.''
Section Referred to in Other Sections
This section is referred to in sections 2001, 2504, 2702, 2704, 6501
of this title.
