The United States Treasury (IRS) recently issued Proposed Regulations that could have a dramatic impact on your estate plan. In their current form, these Proposed Regulations would essentially eliminate discounts for minority control and a lack of marketability in transfer tax valuations of interests in closely held entities (e.g., family limited partnerships, closely held corporations, and other family controlled entities). Many observers see the proposed rules as the end, or near end, of discounted values for business interests transferred between family members. For individuals looking to minimize their future estate tax, this is a critical development.
The Time to Act is Now: The new IRS rules are only proposed regulations right now; however, time is of the essence. Once the Proposed Regulations are effective, the ability to claim valuation discounts might be substantially reduced or eliminated, thus curtailing planning flexibility. The public comment period on the proposed regulations closes on December 1, 2016, and so the regulations could be finalized as early as January 2017.
How Valuation Discounts Work: Here’s a simplified illustration of discounts. Mickey has a $20M estate which includes a $10M family business. Mickey gives 40% of the business to a trust for the benefit of his children so the business will appreciate out of Mickey’s estate. The gross value of the 40% business interest without discounts is $4M ($10M x 40%). Since a minority shareholder with a 40% ownership interest cannot force a sale or a redemption of the interest, the non-controlling interest in the business Mickey transferred to the trust is actually worth less than the pro-rata value of the underlying business. That is, the value of the business interest should be reduced to reflect both the difficulty of marketing the non-controlling interest in the business, as well as the lack of control of a minority interest. As a result, the value of the 40% business interest transferred to the trust might be appraised at a discounted value of $2.4M. This discount reduces the gift by $1.6M from the $4.0M gross value. Under the Proposed Regulations, however, the IRS aims to abolish or significantly reduce such discounts.
The Big Picture: While uncertainty remains regarding the Proposed Regulations and to what extent they will be implemented, they must be appreciated in the context of the current political landscape. Depending on the outcome of the November elections, we may see other—less taxpayer friendly—changes in the transfer tax regime ushered in, of which the Proposed Regulations are just a taste.
Next Steps: Do not discount the need to plan now. We encourage you to contact us if you have been considering transferring a business interest for estate tax or succession planning purposes so that your plans can be implemented before their effectiveness is blunted by the adverse effects of the Proposed Regulations.