The use of valuation discounts has been a significant tool in estate and gift tax planning. They reduce the value of a transferred asset in a way that minimizes the potential impact of federal gift and estate tax on gifts or bequests to family members.
If properly structured, valuation discounts for lack of control and lack of marketability ranging from 10% to 35% have been proven to be an effective method for transferring wealth to subsequent generations. Estate planning professionals have often used this strategy by establishing family limited partnerships or LLCs and transferring fractional interests to family members or trusts for their benefit.
From time to time, the IRS has attempted to limit such valuation discounts by the enactment of “freeze” rules. However, up to now, properly structured minority and lack-of-marketability valuation discounts have generally been respected.
On August 4, 2016, the IRS published broadly-anticipated proposed regulations concerning the valuation of certain interests transferred to family members for estate, gift, and generation-skipping tax purposes. These proposed regulations expand the scope of the previously enacted rules related to such family valuation discounts and impact certain transfers of interests; the IRS believes the new rules are necessary to prevent the undervaluation of such interests.
There may still be time to take advantage of the pre-proposed regulation valuation discounts for transfers – if they are made prior to the regulations’ adoption.
Most of the changes in the proposed regulations will be effective as to transfers on and after the date of the adoption of the rules as final regulations. However, the proposed regulations must first go through a 90-day public comment period, during which there will likely be significant negative comments from estate planning professionals.
The new regulations, which apply not only to corporations and partnerships but also to limited liability companies and other domestic or foreign entities, address:
- The ability of non-family members holding an insubstantial interest in an entity to constrain the family’s control of an entity – and add a “bright line” (objective) test to determine if a non-family member’s impact should be disregarded.
- What constitutes “control” of an LLC or other entity or arrangement that is not a corporation or partnership.
- “Death bed” transfers that result in the lapse of a liquidation right.
However, the proposed regulation with the most impact upon estate planning provides a new class of restrictions that would be disregarded when valuing gifts or bequests to family members – thus, eliminating certain methods of discounting the value of the transferred interests. Disregarded restrictions include those which:
- 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 (with minimum value defined as the interest’s share of the net value of the entity on the date of liquidation or redemption).
- Defer the payment of the liquidation proceeds for more than six months.
- Permit the payment of the liquidation proceeds in any manner other than cash or certain notes.
For additional information or clarification of these changes or to determine if your estate plan will be affected by these changes, please contact one of our Estate Planning and Administration attorneys.