The Demise of (valuation) Discounts?

08 November 2016 Publication
Author(s): Allen B. Craig III Chris M. Deskin Keith V. Novick Michael D. Peay

The IRS has recently issued proposed regulations under Internal Revenue Code Section 2704 (“Proposed Regulations”) which purport to alter the standards to be applied in valuing intra-family transfers of interests in family controlled entities (“FCE”) for transfer tax purposes (that is, for purposes of the estate tax, gift tax, and generation-skipping transfer tax). 

The Proposed Regulations are complicated, and raise numerous uncertainties regarding their application and ultimate impact on valuing FCEs.  Based on our review and analysis of the Proposed Regulations, the most important aspects for you to consider at this time are as follows:

  1. Significant Reduction in Valuation Discounts.
    1. If the Proposed Regulations become final, they (i) will likely significantly reduce (or possibly eliminate) discounts for lack of control that have traditionally been applied in valuing interests in FCEs, and (ii) may reduce discounts for lack of marketability that have traditionally been applied in valuing interests in FCEs.
    2. In other words, the ultimate effect of the Proposed Regulations (if they become final) will be to significantly increase the value of FCEs for transfer tax purposes and, therefore, to increase the amount of estate tax, gift tax, and/or generation-skipping transfer tax payable on intra-family transfers of FCEs.
  2. Applies to All Type of Entities Controlled by Family.  The new valuation rules under the Proposed Regulations will apply to all types of entities (e.g., corporations, family limited partnerships, limited liability companies, etc.) that are controlled directly or indirectly (for example, through trusts) by the transferor and members of the transferor’s family.  For such purposes control generally means (i) holding at least 50% of the voting power or equity interests in an entity or (ii) holding any general partner interest in a limited partnership.
  3. No Distinction for Active Businesses.  The Proposed Regulations do not distinguish between FCEs that primarily hold passive investments (e.g., cash and marketable securities) and FCEs engaged in active, operating businesses.  In other words, the new valuation rules under the Proposed Regulations will apply to both types of FCEs.
  4. New Rules Do Not Become Effective Until Proposed Regulations Become Final.
    1. The new valuation rules under the Proposed Regulations are not effective now and will only apply to transfers made after the date on which the final regulations are published.
    2. The earliest the final regulations could be published would be late December 2016.  However, because of the complicated and controversial nature of the Proposed Regulations, it is likely (but not certain) that the final regulations would not be published until sometime in 2017.

There is now a window of opportunity to implement estate planning transactions involving FCEs but if you do not act before the Proposed Regulations become effective, the opportunity may be lost.  If you would like to discuss in more detail how the Proposed Regulations might affect you and your family and what your current and future planning options may be, please contact one of our estate planning attorneys listed below.

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