Dramatic Proposed Changes to Impact Estate and Gift Tax Planning (article)

Dramatic Proposed Changes to Impact Estate and Gift Tax Planning (article)

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While most taxpayers are spending the summer focused on economic developments associated with the United Kingdom's recent vote to break with the European Union or election year developments closer to home, high net-worth taxpayers have other negative developments to be concerned about. The estate and gift tax rules, which became permanent after 2012, may experience dramatic changes based on new proposals by Presidential candidate Hillary Clinton and the Obama administration. High net-worth taxpayers should be aware of this potential one-two punch combination.

Current Federal law provides for an estate and gift tax exemption of $5,450,000 ($10,900,000 for a married couple). This exemption is indexed for inflation and increases each year. Hillary Clinton has proposed to reduce the estate tax exemption to $3,500,000 ($7,000,000 for a married couple), reduce the gift tax exemption to $1,000,000 ($2,000,000 for a married couple) and repeal the inflation indexing. This will significantly increase estate and gift taxes for taxpayers whose net worth is equal to or greater than the existing exemptions.

The use of valuation discounts to reduce the estate and gift tax valuation of family-owned businesses is an important estate planning tool. Discounts are commonly claimed for lack of control (minority interest discount) and lack of marketability. Applying such discounts in the context of family-controlled entities has long been a point of contention for the IRS. Unsuccessful in attempts to restrict the use of valuation discounts through legislative changes, the Treasury Department is contemplating new regulations to accomplish this goal.

Historically, the IRS maintained that a minority interest discount was not available in valuing an interest in an entity (corporation, partnership or limited liability company) that was controlled by family members. The IRS conceded this argument in 1993, when it issued Revenue Ruling 93-12. The fact pattern of that ruling involved a shareholder owning 100 percent of a corporation, who made gifts of 20 percent of the stock to each of his five children. The IRS ruled that the family's control of the entity would not be considered in valuing the gifts of minority interests.

After the ruling, family limited partnerships (FLPs) and limited liability companies (LLCs) became more popular estate planning vehicles because the available valuation discounts allowed for more wealth to be transferred free from estate, gift and generation skipping transfer (GST) taxes.

The Obama Administration proposed, without success, changing the law over several annual budget proposals in order to restrict or eliminate valuation discounts on transfers of interests in family-controlled entities. Now the IRS is exploring other means to reach the same end – specifically new tax regulations. Whether these new restrictions will withstand a court challenge remains to be seen.

Treasury Department officials continue to indicate that proposed regulations to restrict family valuation discounts could be issued this summer. Affected taxpayers can look to the Obama Administration's prior budget proposals on valuation discounts for clues about what the proposed regulations might provide. It seems likely that the proposed regulations would limit minority interest and lack of marketability discounts for interests in family-owned entities (corporations, FLPs, LLCs). The regulations would probably target only entities that do not operate an active trade or business.

The IRS has been frustrated that Congress has not acted to change the law restricting valuation discounts, and these regulations could be made effective as of the date the proposed regulations are released. This means that it is likely that any transfers of interests in family entities that took place before the regulations were issued would be "grandfathered", i.e., the IRS would respect the ability to use the discounts.

If you are in the process of planning your estate and are considering forming an FLP or an LLC, you should be aware of this development. The family valuation discounts to which we have become accustomed over the past 20 years may not continue to be available. If you have an existing family entity, you may want to revisit your estate plan to see if you would like to make additional transfers before the rules change. Many taxpayers have remaining lifetime transfer tax exemption (gift, estate and GST) to utilize in a current transfer. Please contact your CBIZ MHM tax advisor or your estate tax attorney for additional information.


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Dramatic Proposed Changes to Impact Estate and Gift Tax Planning (article)Individuals should examine their estate now before changes are made that affect gift and estate taxes....2016-07-25T09:59:00-05:00

Individuals should examine their estate now before changes are made that affect gift and estate taxes.