On Aug. 2, the IRS issued proposed regulations under Section 2704 that are intended to disallow or significantly curtail many valuation discounts used in estate planning. The new rules would apply to the valuation of gifts to family members and the value of any business entity owned at death if the entity is controlled by members of the same family.
The entities covered by these rules include not only family limited partnerships, but also domestic and foreign corporations, partnerships, limited liability corporations, and disregarded entities. The rules apply not only to entities that hold just passive investments, such as real estate or marketable securities, but also to operating businesses.
The proposed rules will apply when family members own either more than 50 percent of the voting rights or 50 percent of the equity of the entity. Attribution rules apply for stock or partnership interests held inside other corporations, partnerships, or trusts. Under the proposed rules, members of the same family include:
- The donor of a gift (or decedent at death)
- The donor’s spouse
- Ancestors and lineal descendants of either the donor or spouse
- The brothers and sisters of the donor
- Any spouse of an ancestor, lineal descendant, brother, or sister
Under the proposed rules, certain provisions of the partnership agreement or any comparable agreement or provision that limits the rights of a corporate stockholder would be disregarded and ignored when determining the value of the entity. For example, assume a limited partnership agreement specifically provides that limited partners do not have the ability to force a redemption of their ownership interest. Under the proposed regulations, that restriction would be ignored, and value would be determined as if the limited partner did have the ability to force a redemption of the units. Therefore, there would be very little, if any, marketability or minority discounts with respect to the limited partnership interest.
Another type of provision that will be ignored under the proposed regulations is one that limits the value of an entity to an amount less than what the IRS calls the “minimum value” for the units. The “minimum value” is the net equity of the entity (fair market value of the assets minus liabilities) multiplied by the percentage ownership of the units. This has the effect of disallowing all discounts for lack of control (“minority discount”) or lack of marketability of the units.
There also are other proposed rules that increase the value of the property in situations where redemption proceeds will be either:
- Paid using a promissory note
- Paid over a period greater than six months
The proposed regulations also contain a provision that would increase the value of a decedent’s estate if, within three years prior to death, the decedent engaged in a transaction that had the effect of changing the decedent’s ownership from a majority control to a minority ownership position.
In general, the new rules will apply only to transfers made and to lapses of voting or liquidation rights that occur after the regulations are finalized. An IRS hearing is scheduled for Dec. 1, 2016, which means the effective date is likely to be sometime in early 2017. Therefore, taxpayers who are considering making gifts of family owned entities (whether partnerships, corporations, or operating businesses) that would be eligible for valuation discounts should act quickly to make those transfers prior to the regulations being finalized.