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August 1, 2016 / Publications

Proposed Regulations Affect Valuation Discounts for Intra-Family Transfers

On August 2, 2016, the IRS and the Treasury Department issued new proposed regulations under Internal Revenue Code Section 2704. The proposed regulations target routinely applied valuation discounts for transfers of ownership interests in family-owned business entities, such as corporations, limited partnerships and limited liability companies (LLCs). The “2704 regulations” could become effective in early 2017, and would dramatically reduce the tax benefits arising from the use of common planning strategies for those with larger estates.

While the proposed 2704 regulations are extremely complex, the following is clear: they dictate that certain restrictions, whether imposed by state law or set forth in a partnership agreement, shareholder agreement or LLC operating agreement, must be disregarded when valuing the ownership interest that is being transferred to a family member. By forcing an appraiser to disregard these restrictions, the discounts for lack of control and lack of marketability of the ownership interest could be significantly reduced or even eliminated. The result: the subject business interest will be valued much higher than it would have been under prior law, resulting in a larger gift tax or estate tax obligation.

Currently, in many cases, appraisers apply a 35% or higher discount for transfers of non-controlling interests in family-owned business entities. While these discounts are not completely eliminated by the proposed regulations, the consensus among our appraiser colleagues is that discounts could be cut in half or more and, in some cases, almost eliminated.

The first hearings on the proposed regulations are scheduled for mid-December, 2016. Therefore, we believe that the regulations could become final, at the earliest, in early 2017. It is possible (and very likely) that the proposed regulations will go through major changes before they reach final status.

Valuation discounts are unaffected for now. Therefore, we are advising our clients with larger estates to consider planning which incorporates valuation discounts and to contact us to discuss implementing these strategies while they remain available.

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