Advanced estate planning strategies have long included the concept of parents gifting interests in family owned entities to their children using valuation discounts due to lack of marketability and control for those interests. Families whose estate values are in excess of the combined estate tax exemptions for a couple of $10.9 million for 2016 need to take note of recently issued proposed regulations that could significantly impact them.
Proposed Regulations Just Issued
The Treasury (IRS) issued proposed regulations on August 4, 2016 that would eliminate valuation discounts. For those wanting to minimize their future estate tax, this could be critical. Once the proposed regulations are effective, which could be as early as year-end, the ability to claim discounts might be substantially reduced or eliminated, thus curtailing your tax and asset protection planning flexibility.
The proposed regulations could be changed and theoretically even derailed before they become effective. The more likely scenario, however, is that they will be finalized after public hearings and the ability to claim valuation discounts will be severely curtailed.
What are Discounts Anyway?
Here’s a simple illustration of discounts: Bob has a $20M estate which includes a $10M family business. He gifts 40% of the business to a trust to grow the asset out of his estate. The gross value of the 40% business interest is $4M. Since a minority 40% trust/shareholder cannot force a sale or redemption of its interest, the non-controlling interest in the business transferred to the trust is worth less than the pro-rata value of the underlying business. Thus, the value should be reduced to reflect the difficulty of marketing the non-controlling interest. As a result, the value of the 40% business interest transferred to the trust might be appraised, net of discounts, at $2.4M. The discount has reduced the estate by $1.6M from this one simple transaction.
What You Should Do
Contact your planning team to discuss your options. Your estate planning advisor can review strategic wealth transfer options that will maximize your benefit from discounts while still meeting your other planning and cash flow objectives.