By: Larry Pullen
There is a recent proposal to amend Section 2704 of the Internal Revenue Code which would eliminate or reduce valuation discounts associated with transfers to family members. Valuation discounts have long been utilized as a popular estate planning tool when transferring ownership interests in family-controlled entities. The new proposed regulations may be issued in September 2015; however, the timing and extent of the proposed regulations are uncertain.
By way of background, valuation discounts in privately-held entities typically relate to lack of control and lack of marketability. Lack of control discounts account for the fact that a noncontrolling ownership interest has no control over corporate decisions, cannot effectuate certain corporate actions or cannot control cash flow of the entity. Lack of marketability discounts account for the fact that a privately-held ownership interest is unlike entities which are publicly held with a ready market available for purchase or sale. As such, a privately-held ownership interest in a private entity would be entitled to both a lack of control and lack of marketability discount. As a result, the value of a noncontrolling ownership interest in a privately-held entity is worth less than owning the same equivalent ownership directly in the entity’s underlying assets. It is these valuation discounts that the IRS is trying to eliminate.
The Internal Revenue Service (IRS) has long been challenging and scrutinizing the use and validity of valuation discounts. The use of valuation discounts effectively reduces the federal estate and gift taxes on transfer of interests in privately-held entities. The IRS has had limited success in the past on it challenges and appears to be trying another angle with this proposal. The IRS appears to be targeting the application of valuation discounts on transfers in family controlled entities.
It is uncertain (1) whether valuation discounts will be eliminated completely or just reduced, (2) as to the timing of when the proposed regulations will go in effect (whether retroactive or not), and (3) whether the proposed regulations will apply to entities owning passive assets or active. While it is unknown what these new IRS proposed regulations may bring, you and your clients should be proactive in their estate planning. In order to take advantage of the existing application of valuation discounts, the time to make the family transfers is prior to September 2015.
As a Principal in Ellin & Tucker’s Forensic and Valuation Services Group with more than 15 years of experience in public accounting, Lawrence M. Pullen, CPA/ABV/CFF, CVA, is well versed and dedicated to providing services in all types of business valuation, commercial damages and forensic accounting matters. He has valued numerous ownership interests in family limited partnerships and limited liability companies owning real estate or various other investments. These valuations were completed for many different purposes, including the purchase or sale of a business interest, bankruptcy buy-sell agreements, estate and gift tax planning/reporting, corporate restructuring, divorce litigation, shareholder disputes, and other matters.