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Using valuation discounts to determine the value of a closely held enterprise for estate and gift tax purposes has seemingly been a hotly contested arena over the years between taxpayers and the IRS, frequently requiring Court intervention. Many a Court case showed that that these valuations have been judgment calls that rely on appraisals by valuation experts. There have been numerous proposals and continued talk to eliminate or reduce the benefits associated with valuation discounts for Family Limited Partnerships (FLPs), Limited Liability Companies (LLCs) or other family enterprises.
In August 2016, the IRS issued proposed regulations on the valuation of closely-held business interests for estate, gift, and Generation-skipping Transfer (GST) tax purposes. Among other things, the proposed rules disregarded certain noncommercial restrictions on the ability to dispose of or liquidate family-controlled entities (HOLY DISCOUNT BATMAN!).
GOOD NEWS FOLKS! On October 4, 2017, in response to President Trump's Executive Order, which directed the Department of the Treasury to identify burdensome tax regulations, the IRS withdrew their proposed Section 2704 regulations. Comments from many of our legal, accounting and valuation colleagues indicated that the regulations went too far and could actually serve to eliminate legitimate discounts and harm operating businesses, rather than entities that had been established solely for the purpose of achieving discounts. According to the IRS, the regulations, as written, "would have compelled taxpayers to master lengthy and difficult rules on family control and the rights of interest holders." As such, the burden of compliance would far outweigh the potential policy gains. The proposed regulations provided an unworkable approach to what the IRS might have considered "artificial valuation discounts".
For many of us in the appraisal and planning community, the threat posed by the Proposed Regulations was considerable. If the regulations were to be finalized "as is", the traditional valuation rules applicable for federal transfer tax purposes to equity interests transferred between family members would have been dramatically changed. Given the increased likelihood that the window of opportunity to utilize valuation discounts may have been coming to a close, we were advising many a client and professional, especially in 2016, that it may be prudent for those individuals who intended on utilizing valuation discounts to transfer assets prior to the release of any future regulation that restricts their benefits. The effect of the amended and expanded regulations would have eliminated discounts for lack of control and lack of marketability for privately-held businesses and partnerships that are family controlled.
A minority interest discount results from the owner's lack of control over management, including the inability to compel distributions, and the inability to force liquidation and receive a proportionate share of the entity's net asset value. The lack of marketability discount reflects the lack of a ready market for the valued interest.
For example, an effective valuation discount of 35% would allow for a senior family member to transfer a 30% interest in a $5,000,000 controlled entity to younger family members at a reduced gift tax value of $975,000, rather than a mere pro-rata $1,500,000 (i.e. 30% of the full enterprise value of $5,000,000). If available, the value of the transfer will be sheltered from any gift or estate taxes to the extent of the taxpayer's remaining lifetime gift/estate tax exemption. For 2017, the amount of the lifetime exemption is $5,490,000 per individual, which is increased annually for inflation.
Remember, obtaining a professional valuation appraisal is critical to substantiate these discounts that are being used to adjust the value of the transfers.