New Regulations Expected this Fall May Limit Valuation Discounts in Certain Asset Transfers
For high-net worth individuals – particularly those whose assets include closely-held business interests or family investment entities – anticipated changes in the valuation of those assets for estate and gift tax purposes suggest that immediate action on certain gifting transactions is warranted. It is expected that the Treasury Department will release regulations effective late this summer that may prohibit certain family owned business entities, including family limited partnerships or limited liability companies, from utilizing the lack of control and lack of marketability discounts in transferring assets.
Valuation discounts can be an effective tool in estate planning. For purposes of the estate and gift tax, assets must be valued at fair market value. However, when calculating the fair market value of an asset, the lack of marketability of an interest in a business entity and the lack of control associated with that interest may be taken into consideration. Estate and gift tax discounts for lack of marketability and lack of control can be significant, often ranging between 20% and 40%.
Estate planners have used these valuation discounts in combination with the transfer of interests in closely-held businesses, family limited partnerships, and limited liability companies (LLCs) to mitigate the effect of the estate and gift tax on asset transfers. Individuals will transfer assets that are expected to appreciate significantly to children or entities for their children. The asset transfer to the LLC freezes the amount of gift tax cost, while the minority interest gift provides for the lack of control and lack of marketability discounts.
Section 2704(b) was enacted to curb this practice. That section contemplates the enactment of regulations to restrict the valuation discounts claimed for such transfers. Judicial decisions and state statutes, however, have limited the applicability of § 2704(b).
However, it now appears that proposed regulations under section 2704(b)(4) are set for release in Fall 2015. These proposed regulations will likely be effective at their release date. "Grandfathering" may be available for preexisting transfers of interests in family-owned entities, but not for the entities themselves. Actual operating companies may potentially be exempt from the regulations, but holding companies will likely be subject to the requirements.
Thus, taxpayers considering transferring assets or interests to family members may want to consider planning to take advantage of the valuation discounts sooner rather than later. Before the new regulations materialize, it is important to consider reviewing planning documents and operating agreements with your advisors.