Treasury Department and IRS Proposed Regulations May Cause Family-Controlled Entities to Lose Estate-Planning Discount

The Treasury Department and IRS released proposed regulations, which, if finalized, will reduce the valuation discounts when transferring interests in family-controlled entities among family members.

Valuation discounts are frequently used to lessen the value of interests in closely-held entities for estate, gift and generation-skipping transfer tax purposes. These discounts allow a greater amount of property to be transferred to younger generations, by using less of taxpayer’s estate/gift lifetime exclusion. The proposed regulations affect the value of the interests transferred, but not the entities themselves, by reducing or eliminating the ability to apply valuation discounts in certain circumstances. The proposed regulations were issued on August 4, 2016.

In order to be affected by the proposed regulations, the following three criteria must apply:

  1. Family member owners of entities which are corporations, partnerships, LLCs or other arrangements deemed to be a business entity;
  2. Entities which are controlled by family members before and after a transfer:
    • LLCs or other entities:
      • at least 50 percent of the capital interests in the entity or arrangement; or
      • at least 50 percent of the profit interests in the entity or arrangement; or
      • an equity interest with the ability to cause the liquidation of the entity or arrangement in whole or in part.
    • Corporations:
      • at least 50 percent of the total voting power of the equity interest of the entity; or
      • at least 50 percent of the total fair market value of the equity interests of the entity.
    • Partnerships:
      • at least 50 percent of the capital interest in the partnership; or
      • at least 50 percent of the profits interest in the partnership; or
      • a general partner in a limited partnership regardless of their ownership percentage.
  3. Controlled by the transferor and/or family members. Family includes, for this purpose, the spouse of the transferor, any ancestor or lineal descendant of the transferor or their spouses, and any brother or sister of the transferor and their descendants and spouses. If the owner is an entity, look through the entity to the individual owners. If the owner is a trust, look through the trust to current beneficiaries.

These are complex regulations that determine the impact of changes in voting rights, and restrictions could occur when transferring interests in business entities, either by gift during a taxpayer’s lifetime or by bequest at death. These are generally provsions built into shareholder or partnership agreements that indicate the rights of transferees in the interests they receive. This is compared to the rights, powers and restrictions the transferor might have had prior to the transfer. Changes to these rules will substantially limit the transferor’s ability to reduce the value of the interest transferred.

The new valuation rules will generally apply to transfers occurring after the date the final regulations are published. That date will not occur prior to December 1, 2016.

All individuals who might be affected should identify any potential opportunities for lifetime transfers of property that can still use the discounting benefits before the regulations become final. It is also important to determine the impact of the rules on future estate tax liabilities. Business ownership agreements and your current estate planning documents should be analyzed and reviewed.

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