For decades, wealthy individuals have engaged in estate planning transactions to pass their accumulated wealth to their desired heirs and avoid imposition of federal estate taxes. An important item in the toolkit of estate planners is the valuation discount.
Discounts exist principally in two forms: lack of control, or minority interest, and lack of marketability. The IRS has suggested that it will issue regulations in the near future that could restrict the usage of these discounts for transfers between family members.
The Internal Revenue Service has indicated it will issue new regulations this fall that could become effective immediately.When a non-controlling (typically 50 percent or lower) interest in an entity such as a limited partnership or limited liability company is sold, the buyer will typically not pay a price equal to the pro rata value of the underlying assets. For example, assume a partnership owns a piece of land that should sell for a price of $100,000. If an individual were to buy a 10 percent interest in the partnership, he likely would be unwilling to pay $10,000 (10 percent of $100,000) for the interest. He would demand a lower price because, as a 10 percent owner, he could not independently control the usage of the land or compel a sale of the land and a distribution of proceeds. This behavior is seen over and over in exchange transactions between unrelated buyers and sellers and is the basis for the use of discounts by valuation professionals.
The Internal Revenue Service has fought the usage (and the magnitude) of valuation discounts applied to gift and estate transactions. While they have won a number of cases regarding the magnitude of discounts in particular fact patterns, it is now well established that valuation discounts are an appropriate and legal means to determine the value of assets. Due to their lack of success in the courts, the Treasury Department (the "parent" of the Internal Revenue Service), has sought to have legislative changes made that would curtail the use of discounts in the context of transfers between family members.
Since their request for legislative action has gone unfulfilled for a number of years, IRS is seeking to use their administrative ruling powers to meet their objective. On May 10, 2015, Cathy Hughes from the Treasury's Office of Tax Policy spoke at a meeting of the Tax Section of the American Bar Association. She indicated that proposed regulations limiting the use of valuation discounts could be issued by mid-September. Further, it has been suggested that these proposed regulations could be effective immediately upon their issuance instead of, as is usual protocol, when they are issued in final form. This news sent shock waves through the estate planning community.
As of the mid-October writing of this article, no action has been taken yet by Treasury regarding issuance of these regulations. However, individuals with taxable estates may want to consult their estate planning advisors soon to see if it is possible to take advantage of valuation discounts before they are eliminated or curtailed.
Kelly Hein is a partner at Rylander, Clay & Opitz, and is writing this column on behalf of the Fort Worth CPAs, a regular contributor to FW Inc.