Estate Planning Alert

By Harold G. Martin, Jr., CPA/ABV/CFF, ASA, CFE
Partner, Valuation and Forensic Services

IRS issues proposed regulations to eliminate valuation discounts for family businesses

Summary

On August 4, 2016, the Department of the Treasury published a draft of proposed regulations relating to the valuation of interests in corporations and partnerships for estate and gift tax purposes.  If approved, the regulations would effectively eliminate valuation discounts on family owned businesses for estate and gift taxes.

The Department of the Treasury has scheduled a public hearing on December 1, 2016.  If approved, the regulations would not become effective until 30 days following the issuance of the final regulations.  Given this schedule, there is still an opportunity for owners of family businesses who wish to make gifts or other transfers and take advantage of applicable valuation discounts.

Background

Currently, in estimating the fair market value of an ownership interest in a closely held business for estate and gift tax purposes, the interest may be discounted for lack of control (e.g., minority interest) and lack of marketability (e.g., illiquidity).  These discounts reduce the value of the ownership interest for determining the applicable estate or gift tax and permit the owner to transfer the interest in the business at a lower overall tax.

The IRS has historically challenged the validity of such discounts for family owned businesses. However, the tax courts have often sided with the petitioners against the IRS.  If approved, the proposed regulations would require that the valuation of intra-family transfers for estate and gift taxes ignore “disregarded restrictions” as defined in the regulation such as restrictions on voting rights and liquidation.

Such rights are often included in the provisions of either the articles of incorporation and bylaws (for corporations) or operating agreements (for partnerships and limited liability companies).  Oftentimes, these provisions provide for the lapse of voting rights upon a triggering event resulting in a transfer of an ownership interest with differing attributes to the recipient.  In addition, there may also be restrictions on an owner’s ability to liquidate an ownership interest.  Such restrictions effectively reduce the fair market value of the interest and, consequently, discounts for lack of control and marketability may be appropriate.  However, if approved, the regulations would eliminate such discounts for transfers of interests in family owned businesses.

If an owner of a family business is planning to make a transfer in anticipation that the proposed regulations are ultimately approved, they should be aware that the regulations provide that if the owner gifts an interest for which the value has been discounted and then dies within three years, the discount will be treated as a lapsed restriction at the date of death and the discount relating to the gift will be included in the taxable estate.

Questions on this topic? Contact your Keiter representative or Email | 804.747.000. We can help.

…………………..

Selected Bibliography

“Proposed Regulations Would Limit Valuation Discounts for Family-Controlled Entities.”  U.S. Trust Bank of America Private Wealth Management Tax Alert 2016-2.  August 2016.

Rubin, Richard.  “U.S. Aims to Clamp Down on Tactic to Avoid Estate Tax.”  The Wall Street Journal.  August 2, 2016.  http://www.wsj.com/articles/government-aims-to-limit-technique-for-lowering-estate-gift-taxes-1470155292.

“The end of valuation discounts in a family business context?” PricewaterhouseCoopers Insights, August 23, 2016.