On August 2, 2016, the IRS issued proposed regulations that would eliminate or limit the use of certain valuation discounts regularly applied when valuing interests in family-owned entities for gift and estate tax purposes.
Under current law, a business is valued at its fair market value as of the date of transfer for gift and estate tax purposes. In determining the value, the transferor may take advantage of discounts for lack of control and lack of marketability when transferring a non-controlling interest in the business.
The proposed regulations seek to curtail the use of these discounts by disregarding certain transfer restrictions placed on ownership of the entity when valuing the entity for transfer tax purposes.
By way of example, an individual transfers $5,000,000 of stock in a family business, constituting 30% of the business, to the next generation. Under current law, if the transfer is structured correctly, the value for gift and estate tax purposes of the transferred interest may be reduced by as much as 35% due to the lack of control and lack of marketability. The proposed regulations would restrict the use of these discounts so that the value for transfer tax purposes would be much closer to the $5,000,000 value.
A public hearing on the proposed regulations is scheduled for December 1, 2016. The regulations will likely become final in the beginning part of 2017. We cannot predict the rules contained in the final regulations, so we recommend that clients who wish to transfer family businesses to younger generations contact us as soon as possible in order to take advantage of the current valuation discounts.