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With the recent issuance of proposed regulations under Section 2704 of the Internal Revenue Code, the IRS continues to widen its net – this time focusing its efforts on ending, what some have long-perceived to be, preferential estate and gift tax treatment for owners of family-held business interests. Considering that the estimated estate tax revenues cover less than 1% of current federal spending, it comes as no surprise that the US Treasury would be looking for new and exciting ways to fill the coffers.
Unlike the IRS, the Tax Court has historically taken a more realistic approach to valuing portions of closely held corporations and partnerships, recognizing that when interests are transferred from one generation to the next, minority or restricted interests in family businesses will likely fetch little value on the open market. For this reason, closely-held family business owners have been allowed to discount the value of such interests when transferring them to their heirs, thereby limiting the ultimate tax liability to their estates. The reduced value, thus, allows for increased estate tax savings under the lifetime exclusion (in 2016, $5.45 million for individuals; $10.9 million for married couples). At the current federal estate tax rate of 40% for any overage, the potential tax savings can be substantial.
While the overall purpose of the changes appears to target wealthy taxpayers who attempt to funnel assets into family-owned entities for non-business purposes, in a very broad stroke the proposed changes to 2704 could eviscerate this legitimate discounting tool for many family businesses. Instead of permitting the continued use of discounted valuations under the current scheme, the IRS proposes a three-year “look back” period, whereby transfers made within three years of death stand to be set aside for the purpose of calculating estate taxes. In such cases, the un-discounted market value of the shares will be includable in the transferor’s gross estate. In effect, this would ignore the market realities of public investor demand (or lack thereof) for partial shares of a closely held family business.
The IRS will hold a public hearing on the proposals on December 1, 2016. Opposition to these revisions continues to mount in the House and Senate, not to mention the private sector. However, it remains to be seen whether these proposals, or iterations thereof, will come to pass. (Any new rules adopted will not take effect until 30 days after the regulations are published as final). The proposed changes to 2704 are extensive, and this article touches on only one facet. Family business owners who are considering transferring non-controlling interests may wish to act quickly and should keep in touch with their estate planning and tax professionals to stay ahead of these developments.
David Stallings advises clients in the areas of estate planning and estate and trust administration. His litigation background makes him uniquely qualified to handle conflicts that can sometimes arise in probate and other fiduciary matters. Mr. Stallings has provided his counsel and guidance to some of the firm’s largest institutional clients, as well as regional businesses and individuals.see all Estates and Trusts articles »
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