Estate valuation discounts soon could be at risk

If asked to name tax-related discussions in the news over the past few months, you would have a lot to cover. The presidential campaigns and debates have highlighted whether candidates should disclose their personal income tax returns, what income tax rates should be for individuals and businesses and how much estate tax should be paid at death. On this last point, Donald Trump is in favor of eliminating the estate tax, while Hillary Clinton would like to revert to 2009 laws that would apply to estates exceeding $3.5 million per person (instead of the now $5.45 million), a 45 percent transfer tax rate (rather than the current 40 percent) and only a $1 million per person gift tax exemption amount. Clinton’s proposal would roughly double the number of Americans who pay an estate tax, from 0.2 percent of the population to 0.4 percent.  

Amidst these hotly debated issues, you may have missed a recent Treasury Department proposal to modify through regulation (rather than legislation) Internal Revenue Code Section 2704. Although seemingly obscure, if you own a business and have a taxable estate, this may be the most important tax news of the year.

One particular technique families have employed to reduce gift and estate taxes on their family businesses or other wealth has irked the IRS. The technique involves transferring portions of a family business or family limited partnership through a gift or sale, typically to younger family members. By transferring non-controlling stock or partnership interests over a period of time, families have discounted the value of their transfers. Discounts are applied when valuing each transferred interest because each transfer is of a minority, non-controlling amount, and such an interest could not be easily sold to others. Suppose the owner of a business worth $1 million transfers 25 percent to four children.  Is each child’s share worth $250,000 or something less? The amount of the discount, typically determined by an independent appraiser, can reduce the value of the transferred interest by as much as 40 percent. Thus, a $1,000 gift becomes $600 for transfer tax purposes.

The proposed Section 2704 regulations are intended to root out what the IRS views as abuses in the use of discounts. But the proposed regulations are complex, and there is no general agreement on how these new regulations will be applied. Many experts interpret the proposals to be so far reaching as to eliminate all discounts for family-controlled entities (family corporations, limited liability companies and limited partnerships). This view is based on the belief after the regulations take effect, the IRS will deem recipients of gifted or sold business interests to have the ability to sell back the interest received for its full and undiscounted value, even if the possibility of such a sale is completely fictional. If true, this will radically alter the long-standing valuation method used when business interests are transferred during life or at death, namely, what a willing buyer is willing to pay a willing seller for the interest transferred.

Other experts, however, do not believe the new proposed regulations go so far as to take away all discounts or fundamentally alter the willing buyer and willing seller analysis to determine value. Those in this camp believe while the IRS may want to restrict discounts dramatically, it does not have the authority to impose a full and undiscounted value into the value determination. According to these experts, the most significant change after the new rules take effect will be a new rule that will add back any minority discounts taken for lifetime transfers into the donor’s gross estate if the donor dies within three years from the date of the transfer. 

Also unknown is the effective date of these new regulations. A hearing for public comment on the proposed regulations is scheduled for Dec. 1. Final regulations will be issued sometime after that. The fact these proposed regulations are controversial may be reason for a quick implementation before a new White House Administration, or it could be reason for a drawn-out period before being imposed.

With so much unknown, it is wise to plan for a possible major change and assume that change is coming sooner rather than later. The new rules could drastically change the valuation of family-controlled companies. For those interested in making gifts or sales of interests in family-controlled entities, the window of opportunity to have discounted values apply may be short and closing soon.

Daniel W. Borst is an attorney with Warner Norcross & Judd LLP.  He focuses his practice on estate planning for individuals, families, and family-owned and closely held businesses.  Dan can be reached at 616.752.2735 or

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