Wealth Transfers: No More Valuation Discounts?

Melissa Barbosa, CPA, MBA, ABV, Valuation & Litigation Support Services

Recently, the IRS issued proposed regulations to section 2704 in an effort to limit valuation discounts on transfers of interests in family-controlled entities for gift, estate and generation-skipping transfer tax purposes.   The long awaited and much speculated regulations are intended to address perceived shortcomings that have developed in the effectiveness of section 2704 to prevent taxpayers from using structural tactics to discount the value of interests for gift, estate and generation-skipping transfer tax purposes.

The regulations would generally not be effective until they become final. That won’t happen (if at all) until after early December, when the estate planning and valuation communities, among others, present their comments at a public hearing, scheduled for December 1, 2016.

As issued, the proposed regulations expand the scope and reach of section 2704 to preclude use of various structural techniques to artificially suppress the value of interests in entities transferred by taxpayers or owned by them at death.

In summary, some of the key provisions of the proposed regulations include:

  • Clarification that section 2704 applies to corporations, partnerships, limited liability corporations and other business entities and arrangements. This precludes a hyper-technical narrow reading of the kinds of entities to which section 2704 applies.
  • Defines control of an entity as 50 percent of the equity, capital or profits interest. For purposes of determining control, Reg. section 25.2701-6’s attribution rules will treat an individual, the individual’s estate and members of the individual’s family as owners of interests held through an entity.
  • Disregards liquidation restrictions of a family-controlled entity if the restrictions will lapse at any time after the transfer or if the transferor or the transferor and family members without regard to certain interests held by non-family members, may remove or override the restrictions.
  • Disregards liquidation restrictions for family-controlled entities that limit the ability of the holder of the interest to liquidate the interest, limit the liquidation proceeds to an amount that is less than a minimum value, defers the payment of the liquidation proceeds for more than six months, or permits the payment of the liquidation proceeds in any manner other than in cash or other property, or other than certain notes.
  • Disregards a non-family member interest if the interest in not economically substantial.  To be deemed economically substantial the interest must be held by the non-family member for at least three years immediately before the transfer and constitute at least 10 percent  of the value of all of the equity, capital or profits interest.  Further the total non-family equity, capital or profits interest must constitute at least 20 percent of the value of all of the equity, capital or profits interest and each non-family member must have a put right.

The IRS is likely to receive a great deal of commentary from the public, so the form and timing of final regulations is difficult to predict. In the meantime, owners of family businesses and other individuals who are considering wealth transfer have ever more reason to revisit their plans and, where appropriate, implement them before the regulations become final. Now is a great time for a valuation of your business to take advantage of these discounts before they potentially go away!

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