Estate Planning in the Face of Proposed Valuation Rules

Written by Cherion Sibley, CPA, CFP®

Contemplating the transfer of closely held family business interests? Consider making those gifts as soon as possible before new valuation rules are enacted.

If you have been considering transferring your family business to your heirs, now may be the time to act.  Earlier this month, the IRS issued proposed regulations that, if finalized, would have a far-reaching impact on the valuation of family-controlled entities.  Specifically, the proposed regulations could reduce or eliminate the discounts that have historically been allowed in valuing interests in a family-controlled corporation, partnership or limited liability company, resulting in a higher tax burden in cases where the transferor’s estate is at a taxable level.

A primary focus of the proposed regulations is to limit the effect that certain restrictions have on the value of the family business.  In addition to the clarification of applicable restrictions as they compare to state law, the regulations as proposed would add guidelines defining “disregarded restrictions” which cannot be considered as a factor reducing the value of the business.  The “disregarded restrictions” rules are so broad, they could effectively end most lack of control discounts and may impair marketability discounts in cases where a family maintains control of the entity after the transfer. The true economic effect of the inability to redeem or liquidate an interest will not be considered in valuing family business interests.

As these proposed regulations likely would translate into the increase in the value of a family-owned business, the bottom line effect is an increase in estate and gift tax for owners wishing to transfer their interest to their family.  For example, assume D owns a family-controlled business valued at $5,000,000.  If D wishes to transfer 20% of his interest to his child, C, he could transfer the interest at a value of $700,000 assuming eligibility of a 30% minority discount under current law.  Under the regulations as proposed, the minority discount would not apply, and the 20% interest would transfer at its full proportional value, or $1,000,000.  The $300,000 difference would effectively increase the value of D’s taxable estate, creating additional tax for families with taxable estates.

After a 90-day comment period and a public hearing scheduled for December 1^st, the regulations will likely become final sometime in 2017. Therefore, there is a limited window of opportunity to plan under the current, more favorable, rules.  Although we cannot know with certainty that the final regulations will mirror the proposed regulations, it is important for you to consider your situation and plan now while discounts may still be merited.

To determine how the changes discussed above, as well as other provisions of the proposed regulations could affect you and your overall estate plan, please contact a BMSS Estate Planning advisor at (205) 982-5500.