Passing the family business on to other members of the family is a longstanding American tradition, if not part and parcel of the American Dream. Employing discounts when transferring interests of the family business to other family members can be an effective estate planning technique since it will reduce your gross estate and potential estate taxes.
Conducting a formal business valuation of a closely held family entity is often a necessity as part of estate planning. If prepared in the context of gifting or bequeathing the company (or partial interest), it is a common practice for valuators to employ discounting factors such as “lack of marketability” and “lack of control” to determine the company’s value. These discounts are an acceptable way to lower the value of a business, which in turn lowers the potential gift and estate taxes.
However, these discounts for family owned companies have been a long-time source of contention for the IRS. IRC Section 2704 was passed in 1990 and was intended to limit the aggressive use of valuation discounts. However, a number of Tax Court cases and changing state laws have created “loopholes” and undermined the IRS’ ability to enforce those rules.
After many failed attempts by Congress and the Obama Administration to close the loopholes, the Treasury Department has finally decided to pursue its own crackdown, in the form of the recently proposed 25.2704 Treasury Regulations. In summation, the new rules would include the imposition of a three-year lookback to determine whether a minority valuations discount should apply, the introduction of new “disregarded restrictions” in situations where the family will retain control post-transfer, and a shift away from only looking at restrictions that are “more restrictive” than available state law.
As proposed, the new regulations would end most forms of the lack of marketability and control discounts for intra-family transfers of businesses.
Although the proposed regulations are now in a 90-day public comment period, followed by a hearing in December and by a re-evaluation before final issuance, which would take effect 30 days thereafter, it is very likely that some form of these rules will be finalized sometime in 2017. These new rules would only apply to transfers after the effective date of the final regulations. Therefore, if you have been considering gifting a partial interest in the family business, act quickly to take advantage of the current valuation landscape.
Please contact us if you would like to discuss further.