Valuation discounts are a significant component of estate planning. Minority (i.e., less than 50% and/or non-voting) interests in closely-held family limited partnerships (“FLPs”) or limited liability companies (“LLCs”) suffer from a lack of control and/or lack of marketability in that, often times, the interests cannot directly manage the underlying assets of the entity or be transferred without consent from other partners / members. Under current tax regulations, discounts for lack of control and/or lack of marketability are generally permitted, which greatly reduces taxes owed when the closely-held interests are transferred to family members.
Recent developments suggest that the IRS has once again prioritized its intent to limit the tax benefits afforded to FLPs and LLCs when transferring minority interests amongst family members. More specifically, the U.S. Treasury Department is proposing new regulations that would effectively raise the taxable value of assets transferred into family partnerships and LLCs. At the May 10, 2015 American Bar Association (“ABA”) Section of Taxation meeting, Cathy Hughes (Estate and Gift Tax Attorney / Advisor in the Office of Tax Policy of the U.S. Treasury Department) indicated that proposed regulations under Internal Revenue Code (“IRC”) Section 2704(b)(4) could be released in advance of the next ABA Section of Taxation meeting, which is scheduled for mid-September 2015.
Effective October 9, 1990, IRC Section 2704 was enacted to limit the use of valuation discounts in connection with the gifting of interests in family entities. One of the objectives of Section 2704 was to prevent taxpayers from imposing restrictions on the transferred interests in an effort to artificially reduce the value of the transferred property for gift tax purposes while there is no impact on the underlying economic value of the property. Section 2704(b) provides that certain “applicable restrictions” (that would normally justify discounts for lack of control and/or marketability) are to be ignored in valuing interests in family-controlled entities if those interests are transferred to, or for the benefit of, other family members. However, court decisions and state statutes have limited the applicability of Section 2704(b) in many cases by re-characterizing restrictions so that they no longer fall within the definition of an “applicable restriction.”
In 1993, under IRS Revenue Ruling 93-12, the IRS concluded that “in the case of a corporation with a single class of stock, notwithstanding the family relationship of the donor, the donee, and other shareholders, the shares of other family members will not be aggregated with the transferred shares to determine whether the transferred shares should be valued as part of a controlling interest.” As a result of this ruling, which limited the applicability of IRC Section 2704, FLPs and LLCs became popular estate planning vehicles due to the valuation discounts that were allowable for the transfer of minority interests.
Proposed amendments to IRC Section 2704 have been on the Treasury Department’s “to do” list in the past, however, no meaningful regulations have been enacted. In the President’s FY2010 thru FY2013 budgets (outlined in the Treasury’s Greenbook), there was a proposal to amend Section 2704 to create an additional category of restrictions that would be disregarded in valuing an interest in a family-controlled entity. The amendment would apply to a transfer to a family member if, after the transfer, the restriction lapsed or could be removed by the transferor and/or the transferor’s family.
Beginning with the FY2014 Greenbook, the Section 2704 statutory proposal was noticeably absent, suggesting that the proposal had either been dropped, or was being implemented without statutory revisions. Since the IRS has maintained that it already has regulatory authority under section 2704 to make changes without any statutory changes, there has been speculation that regulations will eventually be issued. The most recent Greenbook (FY2015), issued in February 2015, was also silent on the proposal.
What it Could Mean for Interests in Family-Controlled Entities
As mentioned, at a recent American Bar Association Section of Taxation meeting, an advisor in the Office of Tax Policy of the U.S. Treasury Department indicated that proposed regulations under IRS Section 2704(b)(4) could be released prior to the ABA Section of Taxation’s next meeting scheduled for mid-September 2015.
Although regulations are generally effective when finalized, there has been some indication that these regulations could be made effective as of the date the proposed regulations are released (i.e., potentially as soon as September 2015). While it is unclear exactly what the proposed regulations will entail, it is believed that there will be no “grandfathering” of pre-existing entities as it relates to future transfers; only transfers made prior to the effective date of the new regulations will be “grandfathered” in. As such, it may be prudent for taxpayers who are considering transferring closely-held interests to family members (or trusts for the benefit of family members) to take advantage of potential valuation discounts and to act sooner, rather than later.
The valuation experts at RubinBrown provide accurate, objective, and timely valuations to private and public operating companies, asset holding companies, financial institutions, private equity/hedge funds and high-net worth individuals and families. Our seasoned team of valuation professionals specializes in providing valuation services for financial reporting purposes, tax planning and compliance, transaction advisory, litigation disputes, and bankruptcy. All valuation work is performed in accordance with the most current U.S. and international accounting guidance and promulgations, which results in a high quality work product that withstands the requisite audit and regulatory scrutiny.
“Are Asset Discounts on Family Transfers a Thing of the Past?” The National Law Review. June 30, 2015.
IRS Revenue Ruling 93-12. Published January 26, 1993.
“Tax Alert 2015-3: Possible Limitations on Family Discounts.” U.S. Trust, Bank of America Private Wealth Management.
“IRS Considers New Tax on Wealthy Families.” Barron’s Penta Daily. June 30, 2015.
“Pending Proposed Regulations May Limit Valuation Discounts on Interests in Family Entities.” KPMG Report. June 23, 2015.
“General Explanations of the Administration’s Fiscal Year Revenue Proposal” (Greenbook) for FY2009 – FY2015. Department of the Treasury.
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