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Reevaluating Valuation: IRS and Treasury Propose Rules Restricting Valuation Discounts

On August 2, 2016, the IRS and U.S. Department of Treasury issued highly anticipated proposed regulations concerning the valuation of interests in certain family-controlled businesses for estate, gift and generation skipping transfer tax purposes. The proposed rules would curb the use of most discounts that are applied when valuing intra-family transfers. 

Currently, a business owner may reduce her estate tax exposure by gifting ownership interests in the business to her children. The use of valuation discounts allows the business owner to transfer a greater portion of the business to her children and out of her estate, reducing her anticipated estate tax exposure. Under current law, the value of the owner's interest may be discounted if the business is not publically traded or if the owner transfers less than a majority of her ownership interest. The IRS and the Treasury previously tried to curtail the use of valuation discounts in intra-family transfers through Section 2704 of the Internal Revenue Code. However, courts have rarely disallowed valuation discounts. In response, the IRS and the Treasury proposed these new rules.

The proposed rules would provide clarification as to what entities are covered by the rules, including corporations, partnerships and LLC's. The regulations would eliminate most discounts by expanding the list of disregarded restrictions in valuing an interest. Additionally, in valuing an interest, the proposed rules would disregard the ability of a nonfamily member to block the removal of certain restrictions unless certain requirements were met. Finally, the proposed rules would treat the lapse of a voting or liquidation right as an additional transfer, and this rule would apply to transfers occurring less than 3 years before the transferor's death.

One of the major concerns with the proposed rules is that they fail to make a clear distinction between transfers of interests in family-operated businesses and transfers in family investment companies, such as Family Limited Partnerships (FLPs). This lack of distinction could make the cost of transferring a family owned business substantially higher.

It is important to remember the rules are not yet finalized. Comments are due by November 2. A public hearing has been scheduled for December 1, 2016. The final rules will go into effect 30 days after they have been published. The earliest the regulations are expected to become final is 2017. Accordingly, there is still time for business owners to do estate tax planning under the current rules.

If you have concerns regarding whether the rules would apply to you or have additional questions please contact Michael Zahrt at mzahrt@fosterswift.com or your Foster Swift tax or estate planning attorney. 

Categories: Compliance, News & Events, Tax

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