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Scott Adams practice focuses on estate planning strategies designed to minimize estate and other taxes, as well as ensure that assets left under a decedent’s will or trust for family members can be effectively and efficiently managed. In addition, Scott has significant experience in advising clients with respect to the administration of trusts and estates, and handling trust and estate litigation matters. View articles by Scott

Update On Proposed Tax Regulations Affecting Availability of Valuation Discounts to Family Business OwnersIn September, we posted a blog discussing the Treasury Department’s issuance of proposed regulations under Section 2704 of the Internal Revenue Code (sometimes referred to as the 2704 proposed regulations) that could significantly impact the valuation of interests in family-owned businesses for estate and gift tax purposes. When first issued, there was significant discussion among business and estate planning advisors, valuation firms and business owners regarding the extent to which valuation discounts (primarily, lack of control and lack of marketability discounts) would be reduced (or even eliminated) when valuing gifts or other transfers of family-owned businesses. In the following months, a consensus emerged that the 2704 proposed regulations would not entirely eliminate valuation discounts, but many questions remained regarding their impact on valuations of family-owned businesses.

On December 1, 2016, the IRS held a much-anticipated hearing on the 2704 proposed regulations. At the hearing, numerous valuation experts, business advisors and taxpayer advocacy groups commented on potential problems and other valuation issues that would result if the 2704 proposed regulations were finalized in its current form. Also at the hearing, the Treasury Department representative confirmed they did not intend to include a “deemed put right” in the 2704 proposed regulations that would eliminate the use of all discounts when valuing transfers of business interests, and that the Treasury Department planned to clarify this when the regulations were finalized. Therefore, while it is likely that the proposed 2704 regulations (if finalized) will still impact how family business interests are valued for gift and estate tax purposes, the impact on such valuations should not be as significant as originally feared.

It is difficult to predict what changes will be included in the final regulations, or when the 2704 proposed regulations will be finalized. The IRS must consider the comments made at the hearing and a very large number of written comments that it has received in response to the regulations. Most advisors believe the earliest the regulations could be finalized is late in the first quarter of 2017. Further, the timing of when the 2704 proposed regulations will be finalized (or whether they are finalized at all) may be impacted by the transition from the Obama administration to the new Trump administration in January 2017, including the possibility of the repeal of the estate tax under a Trump administration.

We will continue to post updates regarding the progress of the 2704 proposed regulations and any activity by the new administration regarding estate and gift tax issues of importance to family business owners. Please let us know if you would like to discuss these developments and their impact on transfers of ownership interests in your family business.

Proposed Tax Regulations Limit Availability of Valuation Discounts to Family Business OwnersFor family business owners who desire to transfer ownership of part of their business to the next generation, the valuation of the business interest is often an important factor to consider. This is especially true for family business owners with sufficient assets who are concerned about minimizing estate taxes at their deaths. Under current tax law, each individual has a gift and estate tax exemption amount of $5.45 million, which allows the individual to transfer (either during life or at death) that amount of assets to younger family members before being subject to estate taxes. For spouses, this combined amount is $10.9 million under current tax law.

Historically, family business owners who transfer ownership of part of their business interests to younger family members have been able to make transfers at values that take into account appropriate valuation discounts. For example, a transfer of a 10 percent interest in a family business from parents to children does not represent a controlling interest in the business. The 10 percent interest is also not readily marketable and cannot be sold quickly like publicly traded stocks and other marketable securities. Discounts for “lack of control” and “lack of marketability” have therefore historically been applied to arrive at the value (for gift or estate tax purposes) of a minority, closely held business interest whenever the interest has been transferred. If a family business is valued at $100 million and a business owner gifts a 10 percent interest to children, then the 10 percent interest would historically be valued at something less than $10 million. In this example, it might be valued at $6.5 million for gift and estate tax purposes (after applying combined lack of control and lack of marketability discounts of 35 percent).

In August 2016, the Treasury Department issued proposed regulations under Section 2704 of the Internal Revenue Code that, if finalized in their present form, would significantly impact the valuation of transfers of family-owned businesses for gift and estate tax purposes. Specifically, the proposed regulations would severely reduce, or even eliminate, a family business owner’s ability to take advantage of valuation discounts (such as the lack of control and lack of marketability discounts described above) when transferring interests in family businesses to other family members. It is especially worth noting that the proposed regulations would apply to operating businesses as well as passive holding companies, and would apply to all types of business entities (whether corporations, LLCs or other entities).

A hearing on the proposed regulations is scheduled for December 1, 2016, and the regulations will likely be finalized and become effective sometime in early 2017. Thus, there is a short window of time for owners of family businesses to make transfers of interests in their businesses and be able take advantage of the valuation discounts applicable under current law. Whenever the proposed regulations are finalized, the availability of traditional valuation discounts will likely be impaired.

If you are interested in making transfers of ownership interests in your family business, we are available to discuss whether these proposed regulations will impact your family business and the various strategies available to you before year-end.