Family-controlled entities may lose estate-planning discount

The Treasury Department and IRS released proposed regulations on Aug. 4, 2016, which, if finalized, will reduce the availability of valuation discounts when transferring interests in family-controlled entities among family members.

Valuation discounts are frequently used to lessen the value of interests in closely held entities for estate, gift and generation-skipping transfer tax purposes. These discounts allow a greater amount of property to be transferred to younger generations by utilizing less of one’s estate/gift lifetime exclusion. The proposed regulations affect the value of the interests transferred, but not the entities themselves, by reducing or eliminating the ability to apply valuation discounts in certain circumstances.

Who may be affected? (All three below must apply)

  1. Family member owners of entities (as determined by state law, not how the entity is taxed) which are corporations (C or S), partnerships, LLCs or other arrangements deemed to be a business entity;
  2. Entities which are controlled by family members before and after a transfer:
    1. Corporations:
      1. at least 50 percent of the total voting power of the equity interest of the entity; or
      2. at least 50 percent of the total fair market value of the equity interests of the entity.
    2. Partnerships:
      1. at least 50 percent of the capital interest in the partnership; or
      2. at least 50 percent of the profits interest in the partnership; or
      3. a general partner in a limited partnership regardless of their ownership percentage.
    3. LLCs or other entities:
      1. at least 50 percent of the capital interests in the entity or arrangement; or
      2. at least 50 percent of the profit interests in the entity or arrangement; or
      3. an equity interest with the ability to cause the liquidation of the entity or arrangement in whole or in part.
  3. Controlled by the transferor and/or family members. Family includes, for this purpose, the spouse of the transferor, any ancestor or lineal descendant of the transferor or their spouses, and any brother or sister of the transferor and their descendants and spouses. If the owner is an entity, look through the entity to the individual owners. If the owner is a trust, look through the trust to current beneficiaries.

If the entity has nonfamily member owners, their ownership may affect the application of the new rules for transfers of entity interests by family members, depending on the size of the nonfamily interests in the entity. In addition, if you are a nonfamily member owner, these rules will not apply to your transfer of interests in these entities to your family members.

How might I be affected?

These are complicated rules that determine the impact of changes in voting rights and or restrictions that might occur when transferring interests in business entities, either by gift during your lifetime or by bequest at your death. These are generally rights, powers or restrictions built into shareholder agreements or partnership agreements that dictate the rights of transferees in the interests they receive compared to the rights, powers and restrictions the transferor might have had prior to the transfer. The changing of these rights and restrictions has historically had the influence, for valuation purpose, to reduce the value of the interest transferred. Changes to these rules will substantially limit the transferor’s ability to use changes to these rights, powers and restrictions to reduce the value of the interest transferred.

When might they be effected?

The new valuation rules will generally apply to transfers occurring after the date the final regulations are published. That date will not occur prior to Dec. 1, 2016, which is the end of the period people have to comment on the proposed regulations and the date a public hearing on them will occur in Washington.

What should you do?

All individuals who are affected potentially by the proposed regulations should have a qualified professional review their estate plans immediately. This is to identify any potential opportunities for lifetime transfers of property that can still use the discounting benefits before the regulations become final and to determine the impact of the rules on future estate tax liabilities. Business ownership agreements and your current estate planning documents should be reviewed in light of these coming changes. Although the benefits of discounting have been significant, there are still many powerful things that you should consider when planning to reduce your taxable estate.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.