Estate and Succession Planning
Dean Mead’s Estate and Succession Planning Department is one of the largest and most respected groups of estate planning attorneys in Florida. We are frequently…
IRS Attack on Valuation Discounts Creates Urgency for Transfer Tax Planning Prior to Year-End
On August 2, 2016, the IRS issued proposed regulations under Code section 2704 that, if finalized in their current form, will effectively eliminate any meaningful valuation discounts for transfers of interests in family-controlled entities between family members. The issuance of these proposed regulations is one of the most important developments for high net worth families in recent years.
In the estate planning world, valuation discounts are commonly utilized to significantly leverage the transfer of wealth to younger generations at a greatly reduced transfer tax cost. For example, suppose you own an interest in a limited liability company or other entity and either gift or sell an interest in the entity to a family member or trust for the benefit of a family member. Due to restrictions imposed on the ownership interest under state law or the governing documents, such as the inability to control the management of the entity or liquidate the interest, it is often appropriate to apply valuation discounts so that the fair market value of the interest transferred is something less than its pro rata share of the net asset value of the entity. These discounts can be quite substantial and often range from 30 to 50 percent. Valuation discounts, such as for lack of control (commonly referred to as the “minority interest” discount) and lack of marketability, reduce the value of the transferred property for estate, gift and generation-skipping transfer tax purposes, and, therefore, reduce the burden of those taxes.
Valuation discounts have drawn the ire of the IRS and been the subject of transfer tax litigation for many years because of their effectiveness at significantly reducing transfer tax values. However, valuation discounts are generally defensible and have been upheld by the courts. The success of the IRS in attacking discounts in court generally has been limited to reducing the extent of the discounts claimed by the taxpayer, not eliminating them altogether. Further, prior attempts to enact legislation eliminating valuation discounts have failed to gain momentum in Congress. As a result, the IRS is now attempting to eliminate valuation discounts through its regulatory rule-making authority.
The IRS has been working on regulations under Code section 2704 for quite some time and many practitioners thought that these regulations would be limited to passive, non-operating investment entities. However, the scope of the recently-released proposed regulations is extremely broad and covers all types of entities, including active, family-run businesses. The broad net cast by the proposed regulations means that the opportunity for taxpayers to take advantage of valuation discounts will vanish if the proposed regulations are finalized in a similar form.
It is important to note that the proposed regulations are not yet effective. The IRS scheduled a public hearing on the proposed regulations for December 1, 2016 and will accept written comments until November 2, 2016. We anticipate that numerous organizations across the country will submit comments to the IRS raising issues with the current form of the regulations and requesting changes. Many commentators believe the IRS has overreached on its regulatory authority. However, it is impossible to predict whether the IRS will back down from its position expressed in the proposed regulations, and it certainly would not be prudent to assume it will. It is unknown when the final regulations will be issued. It is possible that they will not be finalized for some time considering the pushback the IRS is expected to receive; however it is also possible that they will be “fast-tracked” and will be finalized by the IRS as early as the end of 2016. Because this is an election year, the IRS may intend to finalize the proposed regulations before the next administration takes office.
Until the final regulations are issued, there is a window of opportunity for taxpayers to implement estate planning techniques incorporating valuation discounts. We do not know whether or how long this window will remain open beyond the end of 2016, but we anticipate there will be a rush of taxpayers seeking to transfer interests in family-controlled entities during the remainder of 2016. Appraisers, who are an essential part of discount planning, will undoubtedly be very busy for the remainder of this year. Therefore, if you have been considering transferring ownership interests in a family business, or have an interest in doing so, for estate planning purposes, now is the time to act so that there will be enough time to fully implement your plan before the end of the year. Even if you have never given transfer tax planning much thought, you should consider how these rules may affect you. We recommend you contact your estate planning or tax advisor to discuss how these regulations impact your overall estate plan and what planning opportunities may be appropriate for you before the final regulations are issued by the IRS.
About the Authors:
Matthew J. Ahearn is Board Certified in both Wills, Trusts & Estates and Tax Law by The Florida Bar Board of Legal Specialization. He has extensive experience in the areas of estate and business succession planning, asset protection planning, charitable planning and planning to minimize or avoid wealth transfer taxes. Mr. Ahearn handles all aspects of probate and trust administrations, including estate and gift tax audits before the Internal Revenue Service. He represents both beneficiaries and fiduciaries in contested matters. He may be reached at mahearn@www.deanmead.com.
Brian M. Malec is a shareholder in Dean Mead’s Orlando Office. He is Board Certified in wills, trusts and estates. He handles all aspects of estate and succession planning, including the implementation of wills, trusts, business entities and sophisticated estate planning techniques to protect and transfer wealth among individuals and families while minimizing income, gift, estate and generation-skipping transfer taxes. Mr. Malec also handles all aspects of probate and trust administration, including advising fiduciaries throughout the administrative process and representing beneficiaries seeking to assert their rights in an estate or trust. He currently serves as director of the Federal Tax Division of the Tax Section. He also served on the drafting committee for the Florida Family Trust Company Act. He may be reached at bmalec@www.deanmead.com.
