Proposed Regulations May Signal the End of Certain Valuation Discounts

New proposed regulations will have a severe impact on estate, gift and generation-skipping tax planning and could be made permanent as early as the end of 2016.

For years, the Internal Revenue Service has attempted to challenge the application of valuation discounts commonly used for estate planning. In August of 2016, the IRS issued proposed regulations under Section 2704 that were specifically designed to limit or remove the application of valuation discounts involving family-controlled entities. The proposed regulations will have a severe impact on estate, gift and generation-skipping tax planning currently available. These proposed regulations could be made permanent and effective as early as the end of this year.

Practitioners often lament the difficulty they sometimes face with getting their clients to move forward on estate planning strategies. After all, in many instances these strategies involve taxpayers relinquishing ownership of assets, with the goal of generating estate tax savings many years down the road. For this reason, families sometimes struggle to see the urgency in moving forward with estate planning strategies. In issuing the proposed regulations under Section 2704, the IRS has imposed an urgency that should not be ignored. The window to take advantage of valuation discounts is closing and may soon be gone. If made permanent, these proposed regulations will have a significant effect on popular estate planning strategies used today, such as family limited partnerships, sales to defective grantor trusts, grantor retained annuity trusts (GRATs) and other estate planning strategies.

Why are valuation discounts so important? Currently, each of us has a $5.45 million lifetime combined gift and estate exemption. For married couples, the combined exemption is $10.9 million. Gifts during life, or asset values at death, that exceed these exemptions are subject to a 40 percent estate/gift tax and potentially additional generation-skipping taxes. For this reason, the reduction in value inherent in valuation discounts results in lower tax liabilities for families. Here is an example of how valuation discounts work:

Assume that a husband and wife own a business currently valued at $20 million, and they would like to transfer 20 percent of the business to a trust for the benefit of their children. Because of restrictions placed on the 20 percent ownership in the business, the value of the business would be discounted on the grounds of lack of control and marketability. If we assume a combined discount rate of 30 percent, the discounted value of the 20 percent interest transferred is $2.8 million ($4 million less the 30 percent discount). Given the 40 percent estate/gift tax rate, the $1,200,000 discount results in potential estate/gift tax savings of $480,000.

The good news is that these discounts are still currently available as these proposed regulations are not final. However, the window is short. The regulations could be made final any time after a public hearing scheduled for Dec. 1, 2016. Once final, the regulations would take effect 30 days later. Although likely to occur sometime in early 2017, the regulations could be final by the end of 2016. Thus, you should discuss these tax savings strategies with your tax advisor now so that you don’t miss this opportunity.

If you have any questions, please contact Chris Davis at chris.davis@aprio.com or 404-898-7485.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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