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Archive for December, 2016

Business Transfers and Changing Tax Rules

Wednesday, December 7, 2016 @ 10:12 AM
Author: Steven Ness

Last Thursday, December 1, 2016, there was a hearing before IRS regulators concerning the potential elimination of discounting the value of transferred business interests, a significant estate planning business succession technique often used in the transfer of closely held or family owned businesses.
In October, the IRS has issued proposed regulations to Section 2704 of the Internal Revenue Code that could dramatically reduce the ability to utilize well accepted discounting techniques used in valuing business interests being transferred. Specifically, these proposed regulations would likely restrict the application of “lack of control” or “lack of marketability” discounts when determining the value of the business interest being transferred. The loss of this technique creates serious tax implications, affecting taxation of capital gains, gift tax exemptions and estate taxes.
Although the 2016 federal estate tax exemption is $5,450,000, per person, that cap is subject to change by either congressional or Presidential pressure. If long recognized discounting method, relating to the accepted value of transferred business interests is lost, owners of family and closely held business could be paying more taxes as a result of a business transfer.
Since 1990, when Section 2704 was enacted by Congress, the IRS has attempted to close estate and gift discounting. Until now, that attempt by the IRS has been unsuccessful. The new proposed regulations use the authority granted under Section 2704(b)(4), which gives the IRS the authority to provide in regulations in determining the value of the transfer of any interest in a corporation or partnership to a member of the transferor’s family, if such restriction has the effect of reducing the value of the transferred interest . . . but does not ultimately reduce the value of such interest to the transferee.”
There are questions as to whether the proposed regulations exceed the regulatory authority of the IRS, and while the promulgation of these regulations will likely be challenged, that challenge would be well after the proposed regulations are effective.
If these changes are adopted as written, they will have a direct impact on estate planning considerations for owners of family controlled entities. These new regulations will effectively eliminate discounts for lack of control or marketability in valuing these interests. While there may still time to complete transfers before the proposed regulations become effective, that preemptive planning may be for naught. If planning individual dies within three years of the transfer and after the new regulations are effective, the transfer could still be taxed under these new regulations.
It is however, a double-edged sword. Given that the current federal estate tax exemption is $5,450,000, there is only a limited population that will ever be subject to this federal estate tax. That limited application of federal estate taxes, coupled with the current step-up in basis rules, benefits tax payers, who cannot be subjected to the taxing authorities attempts to apply discounts to that stepped-up bases. As an example, a business owner who dies and passes his or her business interest to the next generation, passes along a business interest with a higher value, providing an increased step-up in basis.

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