Last week the IRS issued proposed regulations designed to curb valuation discounts for operating businesses as well as family limited partnerships holding securities. The proposed regulations could mean increased estate taxes on the death of family business owners, possibly causing them to liquidate the business or sell to outsiders.
Valuation discounts, which include discounts for lack of control and lack of marketability, can be a substantial tax savings. For example, if you give a 10% interest in your $100 million business to your child, it can currently be valued at less than $10 million for estate and gift tax purposes. Potential investors can’t control factors such as the timing of distributions or officers’ compensation for ownership interests below 50%. Likewise, potential investments in private, closely-held businesses may be illiquid relative to other investments such as Wal-Mart stock. Thus, discounts for lack of control and lack of marketability are generally applied by business appraisers. In this example, a well-written valuation report could hypothetically support the use of discounts totaling 40%, valuing the $10 million business at $6 million for estate and gift tax purposes – a significant tax savings opportunity for individuals and their families.
However, the proposed IRS regulations must first go through a 90-day comment period. Hearings are scheduled for December 1, 2016. If approved, the regulations could become effective 30 days after the government issues final regulations.
For 2016, the federal estate tax exemption is $5.45 million per individual or $10.9 million for a married couple. Additionally, Democratic presidential nominee Hillary Clinton has stated her desire to reduce the individual exemption to $3.5 million and to raise the now 40% tax rate to 45%.
Closely-held business owners should consider this strategy immediately as we may only have only a few short months before final regulations are issued. As always, the Pugh team of tax advisors and business appraisers are ready to assist you.