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August 9, 2016

IRS Proposes Curbing Estate and Gift Tax Valuation Discounts (article)

The IRS recently issued proposed regulations eliminating important valuation discounts commonly used in gift and estate tax planning. If finalized as currently proposed, these changes could increase an individual’s gift and estate tax liabilities by more than 60 percent. The Obama administration has attempted to limit valuation discounts on family-owned businesses for several years but has been unable to impose these restrictions through legislation. Now the Treasury Department has decided to achieve this goal through the regulatory route. Taxpayers have a small window of opportunity to take action before these regulations are finalized and become effective, which we anticipate to be sometime in 2017.

As we discussed in a recent article, case law over the years has firmly established  that if you own less than a controlling interest in a business or an investment entity, you may be entitled for gift and estate tax purposes to valuation discounts for lack of control (i.e., a minority interest) and/or for lack of marketability (i.e., the inability to sell an interest for its true value due to the lack of a true market of potential buyers). These discounts, when combined, can range from 30 to 50 percent, or even higher, depending on your facts and circumstances.

For example, suppose you own a family business (or investment entity) with an underlying value of $5 million. Under current law, you could structure the transfer of this business to your family members in such a way to reduce this $5 million value to $3 million for gift and estate tax purposes (assuming a 40 percent discount). The elimination of this $2 million could save your family $800,000 in federal gift and estate tax at the current maximum rate of 40 percent and even more if you are also subject to state inheritance and/or estate taxes. 

Applying such discounts in the context of family-controlled entities has long been a point of contention for the IRS. Because the Administration has been unsuccessful in attempts to restrict the use of valuation discounts through legislative changes, the Treasury Department has issued proposed regulations to try to accomplish this goal.

The proposed regulations do not simply disallow valuation discounts on intra-family transfers. Instead, they:

  1.  Attempt to curb the use of these discounts by disregarding certain restrictions on redemption and liquidation rights, and
  2. Treat the lapse of voting or liquidation rights by the transferor as an additional taxable transfer if it occurs within three years of the transferor’s death and the entity is controlled by the transferor’s family immediately before and after the lapse.

What Is the Effect of the Proposed Regulations?

The ultimate impact is that the regulations may effectively eliminate valuation discounts used by many people today.

The loss of these valuation discounts will dramatically affect:

  • The portion of your estate that you can transfer without incurring estate and gift taxes by using the lifetime exemption of $5.45 million ($10.9 million for a married couple);
  • The portion of your estate that you can transfer annually without incurring gift taxes by using the annual exclusion of $14,000 ($28,000 for couples who elect to split gifts);
  • To the extent that you are now restricted in your ability to transfer certain assets without gift tax, any post-transfer appreciation on those assets that will still be included in your estate, and
  • Several other estate planning techniques and opportunities, such as charitable lead trusts and grantor retained annuity trusts (GRATs).

When Do These Rules Go Into Effect?

These rules will not become effective until 30 days after the final regulations are issued. The IRS is currently accepting comments on the proposed regulations, with a hearing scheduled for December 1. Therefore, the earliest we would expect these rules to go into effect is sometime in 2017. There may also be legal challenges to the regulations asserting that the Treasury Department did not have the authority to issue them.   

What Should You Do?

If you have been contemplating transfers of interests in your business to your family members, you should contact your CBIZ tax advisor or estate planning attorney as soon as possible to discuss your options and the implications of these rules. Remember that any change in your estate planning will take time to implement after you make decisions with your advisors. This is also an appropriate time to revisit your entire estate plan, especially if you were counting on valuation discounts which may no longer be available. Keep in mind that other estate tax changes could be on the way, depending on the outcome of this year’s Presidential election. Secretary Clinton has proposed reducing the lifetime estate and gift tax exemption from $5.45 million to $1 million and increasing the maximum rate to 45 percent, while Mr. Trump has proposed repealing the tax regime completely.


Copyright © 2016, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).

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