Proposed Changes to Family Partnership Tax Discounts
Last month, the Treasury Department proposed new draft regulations that, if they become permanent, will impact how many taxpayers approach estate planning and wealth transfer.
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The proposed regulations would restrict valuation discounts for interests in family controlled businesses for gift and estate tax purposes. The change essentially eliminates a common estate planning tool that CPAs and taxpayers have relied upon for gift, estate, and generation skipping tax purposes. The proposal impacts key areas including deathbed transfers, applicable restrictions and expansion of control, designed to address so called “loopholes” that allow taxpayers to reduce tax owed. To help clients, prospects, and others understand the proposed regulations and the impact to their family business and estate planning approach, Hanson & Co. has provided a broad summary below.
- Applicable Restrictions – To take advantage of valuation discounts, taxpayers would transfer restricted - non-voting, non-marketable – interests to, say, their children or a trust to reduce the value of those interests in the family-controlled business (and thereby reduce applicable taxes). To counter, the proposed regulations require that when a business interest is transferred within the family, certain “applicable restrictions” will be ignored when determining the value of the transferred interest. This applies to a restriction that will lapse at any time after the transfer or if the family retains the ability to eliminate the restriction after the fact. The proposed regulations remove the exception for restrictions that are less restrictive than generally applicable state law and also provide a new exception for restrictions where all of the parties have a right to liquidate or “put” his or her interest to the entity and receive cash within six months.
- Disregarded Restrictions - While applicable restrictions apply to complete or partial liquidations of the entity, a new “disregarded restriction” category looks at the value of what the interest holder (not the holders of the entity in general) would receive if they did liquidate their interest. Discounts will be disregarded for restrictions that limit the ability of the holder of the interest to liquidate, limit the liquidation proceeds to an amount that’s less than a “minimum value”, defers payment of the liquidation proceeds for more than six months, or allows for payment of the liquidation proceeds in any form other than cash, other property, or certain secured notes. The regulations also permit the IRS to issue regulations providing for other disregarded restrictions if it reduces the value of the transferred interest but does not ultimately reduce the value of that interest to the transferee.
- Expansion of “Control” - The regulations clarify that control of a limited liability company or any other entity or arrangement that is not a corporation, partnership, or limited partnership means ownership of at least 50% of either the capital or profits interests. Control also constitutes ownership of any equity interest with the ability to cause the full or partial liquidation of the entity or arrangement. For interests held by family members, the interests of an individual, the individual’s estate, and members of the individual’s family are aggregated, whether held directly or indirectly through a corporation, partnership, trust, or other entity.
- Deathbed Transfers - Under current rules, it’s possible for a majority stockholder in a family entity to make a late-in-life gift to a family member of just enough stock to break his or her majority, allowing the estate to claim a lack of control discount on the now-minority share of the company. The IRS has argued that “deathbed transfers” are meant only to depress the transfer tax value of the assets. To stop taxpayers from abusing the exceptions applying to the lapse of control or liquidation rights through deathbed transfers, the proposed regulations contain a three-year look-back period during which these transfers or lapses would be considered to happen at death. This change means that the transfer would no longer trigger a minority interest discount leaving taxpayers in a less than advantageous position.
Since these are only draft regulations there is a possibility that changes will be made to accommodate taxpayer needs and demands. This happens on a regular basis. Next there is a 90-day comment period during which taxpayers and others can submit written comments for consideration. The public hearing on the proposed regulations will be held December 1, 2016, and the regulations will not become effective until 30 days after the Treasury Department publishes them as final. Given the nature of the changes and impact it will have on taxpayers it’s expected there will be a strong showing with feedback and criticism. So, for the immediate future it’s unclear what change will come, but it’s important to be prepared.
Although these are just proposed regulations it’s clear the impact could be significant. If you believe your family business or estate tax planning strategy will be impacted or have questions, Hanson & Co. wants to help. For additional information please call us at (303) 388-1010, or click here to contact us. We look forward to speaking with you soon.