Proposed IRS Regulations May Limit Tax-Favorable Estate Planning Strategies

estatetaxplanningThe IRS recently announced new proposed regulations which may eliminate or significantly reduce valuation discounts on transfers of family entity interests (e.g., LLCs, limited partnerships, and corporations).  Although there are several uncertainties regarding the scope of these new rules, the proposed regulations, if enacted, could result in substantial increases in estate, gift, and generation-skipping transfer taxes for many taxpayers.  This post provides a general description of valuation discounts, and the recommended action.


The transfer tax value of business entity interests is measured by what a willing buyer under no compulsion to buy would pay to a willing seller under no compulsion to sell.  This value has historically taken into account the owner’s lack of control and/or inability to presently benefit from the interest.  The “minority interest” discount reflects that the holder of a non-controlling interest in a business entity cannot compel distributions, or force a redemption or liquidation of the entity to realize the value of his or her interest.  The “lack of marketability” discount reflects that, in contrast to publicly-traded stocks, there is no established market for selling interests in closely held, family-owned businesses.  These combined discounts frequently range from 25% to 40% or more.

For example, assume the value of an entire business entity is $4 million.  Absent any discounts, a 25% interest in that entity could be valued at $1,000,000 (i.e., 25% of the entire business value).  However, if a certified appraiser examines the interest and deems it eligible for a 40% discount, the interest would be valued at $600,000 (a $400,000 valuation reduction).  The discount thus saves up to $160,000 at the current 40% gift and estate tax rates.

The Proposed Regulations

Although the IRS has criticized valuation discounts in the family-entity context for decades, it has just recently taken action.  The proposed regulations under Internal Revenue Code Section 2704 may significantly reduce the size of transfer tax discounts for entity-interest transfers to family members (or to trusts for the benefit of family members).  The proposed regulations apply to transfers of interests in business entities that are at least 50% owned (or the vote is at least 50% controlled) by the transferor and/or the transferor’s family.  As a result, taxpayers may no longer benefit from the tax savings that historically resulted from valuation discounts (e.g., the $160,000 tax savings in the example above would be lost).  The proposed regulations will not become effective until they are finalized by the IRS, which could occur as early as December 31, 2016.  This provides a limited window of opportunity for taking advantage of valuation discounts before the proposed regulations are potentially finalized to take effect.  Clients with estate tax exposure and/or those that wish to make significant gifts to family members should strongly consider doing so prior to December 31, 2016.

Recommended Action

If you (1) have ever considered transferring interests in family-owned entities, (2) currently own a family-owned entity you wish to transfer to your children or other family members, and/or (3) believe you have a potentially taxable estate you wish to reduce by gifting, please contact us as soon as possible. Failure to do so could result in the permanent loss of significant tax savings.

If we may assist you with implementing a family-business transfer plan before the end of the year, or if you have other estate and gift planning needs, please contact MPBA.