5 August 2016
The US Internal Revenue Service (IRS) has issued proposed regulations concerning the valuation of interests in family-owned entities for gift, estate and generation-skipping transfer (GST) tax purposes under Section 2704 of the Internal Revenue Code. The proposed regulations would effectively eliminate the valuation discounts that are currently available in determining the value of a family business interest transferred to a family member for transfer tax purposes. The expectation was that these changes would only be applicable to transfers of interests in investment partnerships and LLCs. However, the proposed regulations appear to apply to family-owned operating businesses as well, although there are certain exceptions for operating businesses in the regulations.
The proposed regulations change the treatment of certain rights and restrictions on transfers and liquidations in determining the value of interests in family-owned entities. These changes apply to both gifts made during life and transfers made at death.
To understand the impact of the proposed regulations, consider a limited partnership created by parents that owns marketable securities and real estate valued at $10 million. The partnership agreement includes restrictions on transfers of partnership interests and upon liquidation. Under current law, if a parent gives a 10-percent limited partnership interest to a child, the value of the interest for gift tax purposes would be discounted by up to 30-40 percent of the pro rata value of that interest, for a value of $600,000-$700,000 instead of $1 million. However, under the proposed regulations, these discounts would be unavailable and so the value of the interest for transfer tax purposes would be equal to the pro rata economic value of the interest of $1 million.
The changes set forth under the proposed regulations will go into effect after final regulations are published. The IRS has scheduled a public hearing on the proposed regulations on December 1, 2016, meaning the regulations will likely not be effective until the end of 2016 at the earliest.
If you own interests in an existing family-owned company, LLC or limited partnership, you should consider transferring the interests before the regulations take effect to take advantage of currently available valuation discounts. Additionally, if you own an operating business, you should review the transfer and liquidation restrictions under the business’s operating agreement to determine if or how the business will be affected by the proposed regulations.