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Legal Update

Change Brewing for Valuation Discounts on US Family-Owned Entities?

8 July 2015
Mayer Brown Legal Update

If you are considering making gifts of interests in family-owned entities in the United States, then now may be the time to act. Recent speculation is that a change in IRS regulations may be brewing regarding valuations for gift tax and estate tax purposes that may limit minority interest and lack of marketability discounts for certain family-owned entities.

When valuing a closely held company, limited partnership or limited liability company for US gift tax and estate purposes, discounts for lack of control (also referred to as a minority interest discount) and lack of marketability are often applied based on the rights and restrictions under the operating documents for the entity and the market for such interests. These valuation discounts can result in significant gift tax and estate tax savings.

The use of valuation discounts has resulted in IRS scrutiny and challenges to limit perceived abuses. In some cases, the IRS has relied on Section 2704 of the Internal Revenue Code to challenge valuation discounts for transfers to family members, with limited success.

The recent speculation is that proposed regulations under Section 2704 may be issued before mid-September. Those proposed regulations may limit minority interest and lack of marketability discounts when valuing certain family owned entities. Commentators have suggested that the proposed regulations will target family limited partnerships and limited liability companies that primarily hold publicly traded securities or other passive investments and not actual operating companies. If issued, the proposed regulations could be immediately effective and apply to all transfers after the date of issuance.

As a result, the current valuation discounts applicable to family-owned entities may be reduced or eliminated, effectively making transfers of such entities among family members more costly. If you are considering these types of gifts, you should complete the transfers before the proposed regulations are issued.

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