On August 2, 2016, the U.S. Treasury Department released proposed regulations under section 2704 of the Internal Revenue Code. The proposed regulations are designed to reduce the availability of valuation discounts used in valuing transfers of interests in family-controlled entities among related parties.
For decades, appraisers have applied certain valuation discounts to account for the lack of control and lack of marketability present in minority shares of closely-held securities. Empirical studies show that the market places great value on voting control and ready liquidity. Conversely, the lack of these attributes should indicate a lower (discounted) value. The effect of valuation discounts is to lower the estimate of the value of the underlying transferred security and thereby potentially lowering the overall transfer (estate, gift, generation-skipping) tax paid. Appraisers and estate planning professionals argue that such discounts commonly applied in family wealth transfers are prudent, legitimate, and market-based. The Internal Revenue Service has argued such discounts applied in the transfer of family-controlled entities are designed solely to limit transfer taxes.
The proposed regulations are currently in a 90 day public comment period. There is no question that there will be disagreement with the proposal regulations from the estate planning community during this comment period. A public hearing has been scheduled for December 1, 2016. Any final regulations may be substantially different from the proposed regulations. While it is too early to know exactly what the final regulations will include, it is never too early to begin planning. If adopted, the regulations will not be effective until the date of publication (or later) of a Treasury decision adopting the proposed regulations as final. Most planners close to the situation indicate that the earliest such regulations would become effective would be in January 2017. As such, the fourth quarter of 2016 is a critical planning period for estate, gift, and family business transfer transactions.
The proposed regulations are complex. A detailed discussion of the proposals is outside the scope of this article. The following points represent major categories of changes in the proposed regulations, none of which are beneficial to family business transfers.
- Limitations on "deathbed” transfers
- Expanding the concept of "control” of certain entities
- Modification of the concept of "applicable restrictions”
- The addition of a new category of "disregarded restrictions”
- A new definition of "family control”
As with most financial planning matters, each situation is unique. We strongly advise you to seek counsel from your trusted legal, estate, and financial advisors regarding how these proposed regulations may impact your overall estate planning situation. A proactive approach to planning is always prudent, regardless of the outcome of any pending regulations.
Trout CPA's estate, tax, and business valuation experts are ready to assist you with your unique situation and offer proactive advice and assistance as you navigate the ever-increasing complexity of government regulation and taxation.
