The IRS has proposed new regulations that will substantially impact family-controlled entities. Specifically, the regulations will affect determining the value of certain assets for gift, estate and generation-skipping transfer tax purposes.
The Way It Is
Under current law, the standard for determining the value of an asset for transfer tax purposes is simply the value a willing buyer would pay a willing seller. In determining transfer taxes, a lower value is advantageous as it results in reduced transfer taxes. Non-voting ownership interests and minority ownership interests are worth less than their voting or controlling counterparts due to a lack of control. Non-publicly traded ownership interests also are discounted for their lack of marketability. Combined discounts for lack of control and lack of marketability can decrease the value of the interests often by as much as 40 percent.
The Impact of the Proposed Regulations
The proposed regulations introduce a concept called “disregard restrictions” and ignore certain restrictions on an owner’s ability to liquidate an interest in an entity and receive a minimum value (as determined under the regulations). By removing or limiting the discounts for lack of marketability or lack of control, an owner of a family-controlled business may have to pay transfer taxes on the undiscounted value. For example, under the current law, a 50% non-voting interest in an entity that has an overall value of $2 million could be valued at $600,000 instead of $1 million, due to the lack of control and lack of marketability of the interest. The $400,000 decrease in value could result in a gift or estate tax savings of $160,000. Under the proposed regulations, that same 50% non-voting interest could be valued at $1 million.
Still Time for Tax Savings
The new regulations could go into effect as early as the beginning of 2017. However, the disregarded restrictions portion of the regulations will not apply to any transfers occurring before the regulations are effective. Thus, there is still time for tax savings if you act this year. If you have an operating business, consider transferring non-voting interests to a trust for the benefit of family members or a trust created for your benefit. If you do not have an operating business but own real estate or marketable securities, consider creating a family investment entity and transferring non-voting interests to a trust for family members or a trust created for your benefit. The rules are complex, as is drafting the trust documents to navigate the tax laws. Give us a call to learn what you can do to take advantage of the current laws before they are changed.