Proposed regulations have many families rushing to do advanced estate planning
On Aug. 2, 2016, the IRS released proposed regulations under Section 2704 of the Internal Revenue Code. If adopted, the proposed regulations will significantly reduce the availability of valuation discounts in transferring interests in family entities, including limited partnerships and limited liability companies.
Following their publication, a public comment period began, continuing through Nov. 2, 2016. Thereafter, the IRS held a public hearing on Dec. 1, 2016. During the public hearing, Catherine Hughes, of the Treasury’s Office of Tax Policy, made several oral remarks. Specifically, Hughes noted that contrary to the plain language of the proposed regulations, the IRS does not intend to eliminate traditional discounts currently available for family-owned entities. However, if the proposed regulations are enacted as currently drafted, such discounts would be eliminated. Hughes did not provide any indication that the IRS plans to modify the proposed regulations to align with her comments. Accordingly, her remarks cannot be relied upon to mean that the final rules will not significantly reduce the availability of valuation discounts.
Unfortunately, following the hearing, it is still not clear which of the proposed regulations will be published as final rules. Over 9,000 comments were submitted to the IRS, which are expected to take some time to review. While the IRS failed to provide any insight as to the timing of the issuance of the final rules, it is still possible that final rules may be issued prior to Trump’s inauguration on Jan. 20, 2017. At a minimum, the final rules are expected to become effective 30 days after formal publication in the Federal Register.
Under current law, the IRS allows valuation discounts for intra-family transfers of interests in family-owned businesses to account for lack of control or lack of marketability. Such valuation discounts allow taxpayers to gift or transfer minority interests in family entities to family members at a discounted gift or transfer tax cost, which in turn allows clients to maximize wealth transfer between generations and reduce estate tax consequences.
For example, if mom owns a 10 percent limited partnership interest in a family limited partnership with assets valued at $30 million, the fair market value of 10 percent of the underlying assets of the partnership is $3 million. However, taking into consideration conservative discounts for lack of control and lack of marketability of 25 percent, the discounted value of mom’s limited partnership interest is only $2.25 million. If mom elects to gift her limited partnership interest to a trust for the benefit of her daughter, mom will utilize only $2.25 million of her lifetime gift tax exemption of $5.45 million. In this way, mom has effectively transferred $3 million outside of her taxable gross estate, including any future appreciation of the interest.
While it is unclear which of the proposed regulations will pass, it is possible that valuation discounts for transfers of minority interests in family-owned entities may be eliminated. Accordingly, in light of the IRS’ reluctance to provide any immediate guidance with respect to the proposed regulations, clients with taxable gross estates (in excess of $5.45 million for a single person or $10.9 million for a married couple with a properly structured estate plan) should consider business succession planning and effectuate gifting of minority interests in family-owned entities as soon as possible to take advantage of the current tax law and maximize wealth transfer.
A special thank you to Chuhak & Tecson, P.C. Associate, Kathryn Kaler, for her collaboration on this article.