August 24, 2016

Estate Planning Alert – Valuation Discounts at Risk

On August 2, 2016, the Treasury issued proposed regulations under Section 2704(b)(4) of the Internal Revenue Code. If enacted, these proposed regulations would significantly limit or eliminate the use of valuation discounts as they apply to transfers of interest in certain family limited partnerships, closely held corporations, and similar entities. So what does this mean and who does it affect?

Current Estate Tax Conditions

Many taxpayers, as part of their estate plan, gift interests in family controlled entities to their children. These entities may be closely held operating businesses, or entities that own real estate or stocks and bonds. They are often used by families to limit liability, provide creditor protection and manage and control family assets. Transferring interests in these types of entities to children lowers estate taxes by removing both the current value of the assets from the parent’s taxable estate and any future appreciation earned on those assets.

Gifts of interests in family controlled entities are, of course, subject to gift tax. Valuing interest in a family controlled entity for gift tax purposes is challenging. Since the gifted interest is usually a minority interest and the child receiving the interest is unable to control the entity or cash-out his/her new investment by redeeming or selling it, these interests are traditionally discounted for gift tax purposes. A discount lowers the value of the gift to be less than its proportionate share of the FMV of the assets inside the entity.

In 1990, tax legislation designed to limit these types of valuation discounts was enacted. The Treasury Department has determined this legislation has been ineffective and has proposed a new set of regulations.

New Proposed Regulations

If the proposed regulations are finalized in their current form, discounts will be disregarded. Gifted interests will be valued as a pro-rata share of the fair market value of the assets within their entities. Gift value will be higher than under the current regime and will result in more lifetime exemption being used and, in cases where gift tax applies, more gift tax will be due.

Moving Forward

The Treasury has called for a 90-day comment period and a public hearing scheduled for December 1, 2016. Final regulations will be issued no earlier than December 2016 and possibly not until 2017. This gives taxpayers a limited period of time to plan under the current rules, which provide the maximum valuation discount benefits.

If you are in the process of an estate planning transaction that utilizes valuation discounts with family controlled entities, or if you are contemplating such a transaction, we suggest that you consider completing it promptly. There is still time to initiate new planning with family discounts before the proposed regulations take effect. We would be happy to discuss these proposed regulations and your planning options with you.