26 U.S.C. § 2704 — Treatment of certain lapsing rights and restrictions

(a) Treatment of lapsed voting or liquidation rights

(1) In general. For purposes of this subtitle, if—

(A) a voting or liquidation right in a corporation^* or partnership^* lapses; and

(B) the individual who held the right immediately before the lapse and members of that individual’s family control the entity both before and after the lapse,

the lapse must be treated as a transfer by that individual by gift, or as a transfer included in the decedent’s gross estate, whichever applies. The amount of the transfer is determined under paragraph (2).

(2) Amount of transfer. For purposes of paragraph (1), the amount of the transfer is the excess, if any, of—

(A) the value of all interests in the entity held by the individual described in paragraph (1) immediately before the lapse, determined as if the voting and liquidation rights did not lapse; over

(B) the value of those interests immediately after the lapse.

(3) Similar rights. The Secretary^* may issue regulations applying this subsection to rights similar to voting and liquidation rights. This section does not define “Secretary.”

(b) Certain restrictions on liquidation disregarded

(1) In general. For purposes of this subtitle, if—

(A) an interest in a corporation or partnership is transferred to, or for the benefit of, a member of the transferor’s family; and

(B) the transferor and members of the transferor’s family control the entity immediately before the transfer,

any applicable restriction must be disregarded when determining the value of the transferred interest.

(2) Applicable restriction. For purposes of this subsection, “applicable restriction” means any restriction—

(A) that effectively limits the corporation’s or partnership’s ability to liquidate; and

(B) for which either of the following is true:

(i) The restriction lapses, in whole or in part, after the transfer described in paragraph (1).

(ii) After the transfer, the transferor or any member of the transferor’s family, alone or together with others, has the right to remove the restriction, in whole or in part.

(3) Exceptions. “Applicable restriction” does not include—

(A) a commercially reasonable restriction that arises as part of financing by the corporation or partnership with a person who is not related to the transferor or transferee, or to a family member of either; or

(B) a restriction imposed, or required to be imposed, by Federal or State law.

(4) Other restrictions. The Secretary may issue regulations providing that other restrictions must be disregarded when determining the value of a transfer of an interest in a corporation or partnership to a member of the transferor’s family. This applies if the restriction reduces the value of the transferred interest for purposes of this subtitle but does not ultimately reduce the value of that interest to the transferee.

(c) Definitions and special rules. For purposes of this section—

(1) Control. “Control” has the meaning given to that term by section 2701(b)(2). This section does not otherwise define “control.”

(2) Member of the family. “Member of the family,” for an individual, means—

(A) the individual’s spouse;

(B) any ancestor or lineal descendant of the individual or the individual’s spouse;

(C) any brother or sister of the individual; and

(D) any spouse of a person described in subparagraph (B) or (C).

(3) Attribution. The rule in section 2701(e)(3) applies when determining the interests held by an individual.