Tax Alert: New Proposed IRS Regulations on Valuation Discounts of Family Owned Entities for Estate Tax Purposes

August 25, 2016

Summary of Provisions in the Proposed Regulations for Section 2704

On August 2, 2016, the Treasury Department and IRS released proposed regulations dealing with valuation discounts for estate and gift tax purposes. These regulations have been anticipated for several months and now finally are here. Valuation discounts have long been used as a tax-saving strategy to reflect the reduction in value of certain closely-held businesses as the result of lack of control or lack of marketability. The IRS considers the ability to use these strategies a tax loophole and has sought to change the rules in a manner that will prevent what they assert is an undervaluation of such transferred interests. The proposed regulations target the valuation of interests in corporations, limited liability companies and partnerships transferred for estate, gift and generation-skipping transfer (GST) taxes.

These rules deal primarily with the treatment of certain lapsing voting or liquidation rights and certain restrictions on liquidation in valuing intra-family transfers of business interests. The proposed regulations restrict the ability to use these factors in determining the value of a transferred interest and will significantly impact the use of valuation discounts for transfer tax purposes.  Among the specific provisions in the proposed regulations are the following:

  • A rule addressing deathbed transfers which would remove the ability to use such transfers made 3 years or less before death as a means of obtaining a discount for certain lapses of voting or liquidation rights;
  • Creating a new set of specific “disregarded restrictions” which essentially results in the transfer of family business interests being valued as though the recipient has a put right to sell that interest to the entity for a “minimum value” (generally the fair market value of the assets less liabilities);
  • Prevents the interests of unrelated parties from being considered in assessing whether a family has the ability to remove certain disregarded restrictions and thus avoid the application of those rules, unless it can be shown that the interest is “economically substantial” based on a bright-line test;
  • Specifies “applicable restrictions” (those that limit the ability of a business to liquidate) as being disregarded for purposes of valuing an interest where the transferor or family has the ability to remove those restrictions;
  • Restricts the use of certain state law default restrictions from being used to support valuation discounts where the family can remove or override those restrictions;
  • Provides a safe harbor to permit valuation discounts for certain “commercially reasonable restrictions” imposed by unrelated persons (e.g. banks);
  • Clarifies that buy-sell agreements which impose restrictions on transfers of interests and meet certain conditions can still be considered in determining if a valuation discount is appropriate.

Effective Date

The proposed regulations would generally apply to transfers made after the regulations become final and most of the more restrictive provisions would apply to transfers made at least 30 days after that date.  Some of the new rules could apply to certain transfers made before that time where the transferor dies after the regulations become final, but before 3 years from the date of the transfer.

Observations

Until the regulations become final, valuation allowances may continue to be used for transfer tax purposes based on current authority. For this reason, it may make sense to accelerate anticipated transfers of interests in family businesses so that valuation allowances can be used in determining the value for transfer taxes.

We Can Help

The proposed regulations are quite complicated, however, and this alert is only a high-level summary of the provisions. In order to perform a thorough analysis of the impact of these rules on intra-family transfers, you should contact your Elliott Davis Decosimo tax advisor or a member of our team at elliottdavis@elliottdavis.com as soon as practical to evaluate your unique situation.