• IRS Proposes Regulations to Restrict Estate and Gift Tax Valuation Discounts for Family-Owned Businesses and Entities
  • December 6, 2016
  • Law Firm: Cummings Lockwood LLC - Stamford Office
  • As reported in several prior annual updates, we have long been expecting the IRS to issue regulations restricting discounts for certain asset transfers to family members and/or trusts for their benefit. The proposed Regulations have now been issued. As posted in our website alert earlier this year, on August 2, 2016, the IRS proposed major changes to the Regulations under Section 2704 of the Internal Revenue Code affecting how interests in family-held entities are to be valued when transferred among family members. If made final, the proposed Regulations would dramatically impact the discounts customarily applied by appraisers to value these interests for gift, estate and generation-skipping transfer tax purposes. Although some of the changes could go into effect as early as December of this year after a public hearing is held on December 1, 2016, it is more likely that they would become effective no earlier than January 1, 2017. If the process is delayed beyond January 20, 2017, when President-Elect Trump takes office, it is not clear if the proposed Regulations would be implemented by the new Administration at all in light of the Trump Tax Plan calling for the elimination of the estate tax and presumably the gift tax as well.

    The Internal Revenue Code generally requires property subject to gift, estate and generation-skipping transfer tax to be valued at the price a "willing buyer" would pay for the property. Such hypothetical buyer would not be willing to pay a price equal to the proportionate share of the liquidation value of a family entity if the buyer would not have the power to liquidate his or her interest. Consequently, appraisers traditionally have applied discounts, including discounts for lack of control and lack of marketability, to value interests in family owned entities to reflect the restrictions and delays that a willing buyer of the interest would have in trying to effectuate a conversion of the interest to cash.

    The proposed changes to the regulations would require that certain restrictions typically included in normal business organizational documents be disregarded for family-owned entities for purposes of gift and estate tax computations. Essentially, the proposed regulations would require that fair market value be determined without regard to these important factors if the transfer occurs between family members (or trusts for their benefit). Rather, the IRS is proposing that for intra-family transfers, liquidation value should be the value for estate and gift taxes rather than fair market value. The use of the traditional method for determining fair market value would still be acceptable for transfers between non-family members in most circumstances.

    Discounts can dramatically reduce the amount of estate tax payable at death and/or the gift tax consequence of gifts or sales to family members or transfers to grantor retained annuity trusts, techniques commonly employed by estate planners to achieve substantial transfer tax savings. The transfer of a minority interest in a family entity allows a taxpayer to take advantage of the market forces which drive down the fair market value of minority interest gifts or sales to family members, facilitating the transfer of wealth to future generations tax-efficiently.

    If you are contemplating or are in the process of transferring interests in a family-held entity (corporation, limited liability company, partnership or other business entity) to family members or trusts for family members and the use of minority interest discounts to determine fair market value would be applied by your appraiser, you should assume that such discounts may no longer be available as early as December of this year. Accordingly, you should consider whether such transfers can be effectuated prior to the date when the proposed Regulations become final. If you have questions about how the proposed new Regulations may affect your family’s estate planning, please contact your Cummings & Lockwood attorney as soon as possible.