Will You Be Impacted by the End of Discounted Family Wealth Transfers?

Filed under: Estate Planning

For decades, you and other American taxpayers have been able to use a primary estate planning strategy for reducing gift and estate taxes. This strategy takes advantage of discounts for transfers of real estate interests and closely held businesses. Generally, these businesses or appreciable assets are owned within family limited partnerships or LLCs. But all of this may change before 2017. Will you be impacted?

Business and finance seriesUntil now the IRS has had limited success in combatting what it believes are often abusive discounted wealth transfers. Any success the IRS did have was usually due to poor planning by the taxpayer or the taxpayer’s failure to follow the required formalities. It now appears that this could be coming to an end.

This August, the U.S. Treasury issued proposed regulations that, when finalized, will significantly increase the transfer tax cost of transferring interests in family-controlled entities between family members. The proposed regulations will affect intra-family wealth transfers during life and upon death. These regulations relate to how the value of the transferred interest is determined for gift, estate, and generation-skipping transfer tax purposes. Under the proposed regulations, these types of discounts would be largely eliminated for intra-family wealth transfers.

If these new regulations are adopted, it will significantly change estate planning and family succession planning for the foreseeable future. Because the proposed regulations will not become effective until final regulations are published, there may still be a limited opportunity to utilize valuation discounts in wealth transfers until the law is officially changed. The Treasury Department has requested public comments on the proposed regulations until November 2, 2016, and there is a public hearing scheduled for December 1, 2016. As a result, final regulations could be issued before the end of the year.

Under current law, valuation methods permit the use of discounts for lack of marketability and lack of control. Partnerships and LLCs are sophisticated vehicles for unifying family investments, allowing for orderly transfer of assets, providing asset protection and maintaining centralized control. Partnerships and LLCs can also afford the opportunity for discounts on asset transfers to family members. The value of the transferred interest is usually in the form of non-controlling limited partnership interest or non-voting LLC membership interest.

For example: Mom places wholly owned real property, with a value of $1,000,000.00 into a limited partnership. Then, Mom transfers a 49% limited partnership interest to her children or to an irrevocable trust for the benefit of her children. Because the limited partnership interest has no control and is not freely marketable, the value of the 49% limited partnership interest for gift tax purposes is $269,500.00, not $490,000, because of a combined 45% discount available for lack of marketability, lack of control and minority ownership.

Depending on the asset or assets transferred and the facts of the particular situation, the discounts can range from 15% to as much as 50%, provided that the discounts are supported with a qualified appraisal.

While discounting can provide a significant benefit, the IRS has taken the position that these discounts are not appropriate within a family setting. The IRS believes that these discounted family wealth transfers are done only for tax planning and the family remains in direct or indirect control of the asset regardless of the amount of wealth transferred or the discount applied.

You may be impacted by the new regulations if the value of your estate exceeds the current estate tax exemption amount ($5.45 million per person) and/or if your estate is comprised of real estate or family-owned business entities (e.g., corporations, partnerships or LLCs). You may also be affected if you are holding a purchase option or are subject to a sale option that calls for the purchase or sale price to be determined utilizing valuation discounts.

Proactive tax planning benefits individuals, families, and businesses. Pay attention to this developing story and of course, contact our office if you have any questions.


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