Important gift tax return requirements under secs. 2701 and 2702.

• Author: Thorne, Steven A.

With the enactment of Secs. 2701 and 2702 by the Revenue Reconciliation Act of 1990, many transactions involving family-held corporate or partnership equity interests and certain trust transactions must now be fully disclosed on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. This reporting requirement may apply even though the transaction was implemented solely for business reasons or did not result in a taxable gift. The Sec. 2701 reporting requirements may be invoked for corporate or partnership equity transactions (e.g., capital contributions, redemptions, recapitalizations, gifts and sales) if (1) more than one family member owns an equity interest and (2) there is more than one class of equity interest (other than interests that differ solely due to voting rights or legal liability limitations). Special reporting requirements also apply to grantor retained annuity trusts and unitrusts (GRATs and GRUTs). When Sec. 2701 or 2702 applies, special disclosures are necessary to begin the running of the gift tax statute of limitations (SOL). Certain Sec. 2701 elections necessary to avoid unexpected gift tax can be made only on timely filed (with extensions) gift tax returns.

General scope of Sec. 2701

Sec. 2701 provides special rules for determining the value of an interest in a corporation or partnership for gift tax purposes. The primary impact of Sec. 2701 is to increase the gift tax value of a junior equity interest directly or indirectly transferred to a family member, by arbitrarily valuing at zero certain senior equity interests and discretionary distribution rights held by the transferor or applicable family members.

The zero valuation rule generally applies if (1) a junior (e.g., common stock) equity interest in a corporation or partnership is directly or indirectly transferred to a family member and (2) the transferor or an applicable family member retains a more senior equity interest (e.g., preferred stock or preferential partnership interest). Nonqualified senior equity interests (e.g., noncumulative preferred stock, most preferential partnership income and capital rights, and discretionary rights, such as a liquidation, put, call or conversion right) are generally valued at zero in determining the gift tax value of a transferred junior equity interest.

Common examples of Sec. 2701 transactions include:

* A gift or sale of a common equity interest to a family member when the transferor or applicable...