New Proposed Regulation Affects Transfers of Family Business Interests

Kegler Brown Estate Planning Alert

Smart Summary for Business Owners

  • The Treasury recently issued Proposed Regulation 2704, which is intended to eliminate valuation discounts in family transfers during life or at death.
  • A valuation discount allows you to transfer a larger portion of non-controlling interest to the next generation.
  • Without valuation discounts, the value of gifts and your taxable estate and resulting gift tax and estate tax exposure could be significantly higher.
  • Proposed Regulation 2704 could go into effect as early as January 1, 2017.

Do you have a family business?

Have you been thinking about transferring interests to the next generation?

Is your gross taxable estate over $5.45 million?

If you’ve been thinking about transferring any portion of your family business to the next generation, the time to act is now. The Treasury recently issued Proposed Regulation 2704, which can dramatically impact your estate planning by eliminating valuation discounts. Valuation discounts have been an important part of an effective strategy to leverage your gift tax exemption and protect family businesses from the risks of future divorce, lawsuits or creditor claims.

Who is Affected?

If you own any interest in a family-controlled corporation, partnership or limited liability company, Proposed Regulation 2704 will apply to any transfer of such interests to family members.

What Will the Proposed Regulations Do?

The major issue facing family-controlled businesses is the ability to transfer non-controlling business interests to the next generation at a discounted price. A valuation discount allows you to transfer a larger portion of non-controlling interest to the next generation. If Proposed Regulation 2704 is enacted, discounts will no longer be available to interfamily transfers. The result may be a substantial reduction in your estate tax and asset protection planning flexibility.

Why is This Important?

Valuation discounts have been a key element to transferring substantial interests to the next generation in a tax-advantaged manner. Valuation discounts allow one to transfer a greater portion of non-controlling business interest to the next generation in several tax-advantaged ways.

For example, assume a family business is worth $10 million. The transfer of 30% of the company has a gross value of $3 million. However, an independent third party buyer will not purchase a 30% interest for $3 million because the buyer is not able to force a sale or redemption of its minority interest. Due to this lack of control and marketability, the value of the 30% interest is discounted.

If the transferor’s goal is to give $5 million worth of non-controlling interest to a child, either directly or in trust, the valuation discount will allow the transferor to gift a larger portion of company interest than is otherwise possible without discounting. If combined with the gift tax exemption (currently $5.45 million), such a transfer would not incur any gift tax. Additionally, any growth or appreciation in the company after the date of transfer will pass to the child free of estate tax (currently a 40% tax rate).

When Must I Act?

Immediately. Proposed Regulation 2704 will go into effect as early as January 1, 2017. The time required to analyze your particular circumstances and to obtain the necessary business valuations can take several months. It is imperative to initiate the process immediately before this window of opportunity is permanently closed by the IRS.