The clock is now ticking on a popular and very effective estate planning tool that allows business owners to transfer ownership interests to family members at an often substantially discounted value for estate and gift tax purposes. The good news is there is still time to take advantage of this rapidly closing loophole.
At issue is the use of valuation discounts for minority interests in closely held entities. For years the IRS challenged the use of valuation discounts in family business entities based on its interpretation of Internal Revenue Code Section 2704. The Courts have consistently ruled against the IRS on the basic idea behind the valuation discount which is that, even in family business situations, a minority interest in a closely held business is not worth its full book value because of restrictions inherent in such an interest – namely lack of control and marketability. This concept allows business owners (and others such as high net worth investors) to gift interests in entities (usually LLC’s and Limited Partnerships) to family members at a reduced gift tax value thus minimizing the estate and gift tax cost of the transfer.
Valuation discounts of 20% to 30% or more are commonly utilized and with a combined federal and NYS estate tax rate of around 50%, the potential savings are enormous. In its latest effort to shut down this tax break the IRS has now issued proposed regulations to IRC 2704 that would effectively prohibit the use of valuation discounts in situations where interests in the business are gifted to members of the Grantor’s family. It is expected that the new Regulations will eventually be challenged in Court but unless a taxpayer is willing to litigate the issue, with all the risks and costs that this entails, they will be bound by the Regulations unless and until the Courts rule otherwise.
The proposed regulations will be the subject of a public hearing to be held on December 1, 2016 and it is expected that they will go into effect shortly thereafter. Transfers made prior to such effective date will generally not be subject to these Regulations and so we encourage all business owners and other high net worth individuals to consult with their tax advisors to consider utilizing the current favorable valuation laws before the window of opportunity closes. Of course there are other very effective tax planning techniques that should be considered as well that are not affected by the new regulations. In taxes, as in life, careful planning can yield significant benefits.
Since this potential tax saving technique is extremely time sensitive, we urge our clients, friends and other interested parties who are considering this technique to move forward expeditiously. For further information, please contact George Bruckman or Christopher Canfield.