Valuation Discounts for Intra-Family Transfers of Family-Held Business Interests are Proposed to be Curtailed – Act Now!
On August 4, 2016, the Treasury Department issued proposed regulations that would, if implemented, significantly curtail valuation discounts applied to intra-family transfers of family business interests. Final adoption of these regulations is expected in December 2016. Clients who would like to take advantage of discounted valuations of family business interests for estate, gift and generation-skipping transfer tax purposes are urged to act before these regulations become final.
Estate planning techniques using so-called family limited partnerships (FLPs) and similar entities, such as limited liability companies (LLCs) have been used to shift significant value from one generation to the next by freezing asset values and transferring minority interests at a discount for transfer tax purposes. Valuation discounts ranging from 20 percent to 40 percent (depending on the mix of assets) have been routinely applied to these minority interest transfers for lack of marketability and control. For example, at current estate and gift tax rates, and assuming prior full utilization of estate and gift tax exemptions, if an FLP/LLC holds family business assets worth $10 million as a whole, and the owner transfers 60 percent of the ownership interests in the FLP/LLC to his children, assuming a 30 percent valuation discount for lack of marketability and control, the value of the 60 percent interest transferred for transfer tax purposes would be $4.2 million, resulting in a transfer tax savings of $720,000 (40 percent of $6 million or $2.4 million vs. 40 percent of $4.2 million or $1.68 million).
The Treasury Department has determined to limit the use of valuation discounts with respect to family business transfers in three ways. First, transfer of majority control, whereby the family member holding a controlling interest transfers just enough of his or her holdings to create minority position, must occur more than three years prior to the death in order for the estate to take advantage of minority interest discounts, thus effectively eliminating the efficacy of the so-called death-bed transfer. Second, customary restrictions on transfer or liquidation of interests, if such restrictions can be lifted by combined family member action to amend the restrictive provision, are disregarded. Third, giving nominal interests to charities or unrelated third parties to avoid having such restrictions disregarded for valuation purposes is ineffective unless the interest transferred is “economically substantial and long-standing.” If such unrelated party interest does not meet the bright-line test proposed in the regulations, the non-family member interest is disregarded for valuation discount purposes. It is expected that the proposed regulations will be finalized before year-end.
Owners of closely-held or family-owned businesses that were considering using the FLP/LLC for intra-family gifting purposes but have not yet finalized their planning are urged to contact their personal tax advisors regarding the appropriateness of using this technique before the proposed regulations are finalized.