Looming IRS Proposal Would Curtail Valuation Discounts for Family-Owned Entities

The Internal Revenue Service has signaled it intends to curtail the estate planning strategy of using partnerships and limited liability companies to pass a family business or securities to children at a discounted value. Catherine Hughes, Office of Tax Policy of the US Treasury Department, recently indicated at the American Bar Association Conference that proposed regulations under IRC Section 2704 will likely be introduced in the fall of 2015. These proposed regulations would limit the availability of lack of control and lack of marketability discounts for transfers of closely held interests among family members.

Family limited partnerships and limited liability companies long have been used to help pass family-owned businesses to younger generations in a way that is designed to reduce gift or estate taxes. They also have been used in recent years to pass down portfolios of publicly traded securities at a discount, something the IRS is looking to end, some tax attorneys say.  The IRS plan would ignore the economic reality that what is being transferred is a non-controlling, non-marketable interest in an entity, not the underlying assets, and the assets held in the entity may not be accessible to the interest-holders for many years.

In a typical arrangement, a family limited partnership is set up by a husband and wife to own a business or securities that they expect will increase in value over time. The couple acts as general partners and makes gifts of limited-partner interests to their children. Those gifts remove the assets from the couple’s estate for estate-tax purposes even though the couple retains control of the assets. The limited partners’ interests are devalued due to their lack of control and inability to gain access to the assets.

Estate planning advisors agree that they expect to see an attempt to limit, if not an end, discounts on entities holding liquid assets such as marketable securities and cash. It’s not clear whether the proposed regulations would also limit the use of discounts in valuing entities holding operating businesses, real estate, or other illiquid, hard-to-value investments, but business valuators fear the worst. If you are contemplating the transfer of closely held business interests, consider making those gifts as soon as possible, prior to the issuance of the proposed regulations likely to be introduced this fall.

BEAR, founded in 1986, is a business valuation firm working through a nationwide network of valuation experts, CPAs, business brokers, and consultants. Among our staff we have the major valuation credentials, including ASA, CPA/ABV, CVA, CFA, and MVS.