Code §2703 severely restricts the ability of a buy-sell agreement to control estate tax values in a closely held entity. A recent private letter ruling reminds us that older agreements are not subject to Code §2703.
More particularly, agreements entered into before October 8, 1990, and that are not “substantially modified” after that date are not subject to Code §2703. Apparently, there are still a few of these older agreements out there.
The private letter ruling recognized that the older agreement was not subject to Code §2703. The ruling also sought confirmation that certain changes being made now to the agreement are not substantial modifications that will subject it to Code §2703. Treas. Regs. §25.2703-1(c) provides guidance on what is a substantial modification for this purpose.
One modification to the agreement was to extend the repayment term. The IRS viewed this as only a de minimis change to the quality, value, or timing of the rights of a party to the agreement because the agreement requires payment of a reasonable rate of interest.
The other modification was a clarification that the “prime rate” used in the agreement is a rate that is to be adjusted semiannually. This change was not a substantial modification because the regulations provide a substantial modification does not include a modification that results in an option price that more closely approximates the fair market value. Here, an adjustable interest rate should result in payments that more closely approximate fair market value.
Note that agreements that are not subject to Code §2703 still must meet the requirements of Treas.Reg. § 20.2031-2(h), Rev. Rul. 59-60, 1959-1 CB 237, and applicable case law before the purchase price provided therein will control for federal estate tax valuation purposes.
Private Letter Ruling 201313001