New Law To Change Valuation Discounts For Gift & Estate Tax Purposes in Family Owned Entities

In August of 2016, the IRS issued proposed regulations concerning Internal Revenue Code §2704.  This internal revenue code section addresses the treatment of gifting matters.  These regulations provide major restrictions on the ability to utilize valuation discounts for gift and estate tax purposes for family partnerships, limited liability companies, and corporations.  It appears that these final regulations may be effective either in December of 2016 or sometime in early 2017.  Therefore, families who have family-controlled businesses should consider making gifts and utilizing valuation discounts for gift and estate tax purposes before these proposed regulations are finalized. 

Currently, if a parent who is an owner in a family-controlled entity wants to gift shares of stock to other family members, the process usually begins with having a valuation completed for the business by a CPA for the classes of stock in the business.  Let’s assume that there are two classes of stock of the corporation; voting and non-voting.  The parent may wish to retain control of the corporation and, therefore, retain the voting shares.  However, the parent may be willing to gift non-voting shares to his children and, thus, reduce his equity position in the Corporation. This type of estate plan is appropriate when trying to freeze the value of the business and to allow for corporate growth to occur outside the parent’s estate.  This would save estate taxes on the parent’s estate.

Any gift in excess of $14,000 made per person, per year, is a taxable gift.  The excess amount over $14,000 reduces that individual’s federal gift and estate tax exemption of $5,450,000.  For example, if I make a gift to a child of $20,000, the $6,000 excess would simply reduce my federal gift and estate tax exemption from $5,450,000 to $5,444,000.  Upon my death, if my estate was more than $5,444,000, my estate would pay federal estate tax. 

In the example above, after the appraisal is completed for the corporation, a valuation is also performed to determine the value of the non-voting stock.  Usually, a valuation discount of between 30% and 40% is used when valuing the non-voting shares because of a lack of marketability, and since the non-voting share does not have voting rights, a minority discount is also appropriate.  For example, if a non-voting share of stock is valued at $100 per share before discounts, after applying the discounts, the non-voting share of stock maybe $60 per share.  Thus, this allows the parent to gift more of the non-voting shares of stock to a child in order to reduce their estate.  This will then reduce the amount of federal estate taxes that will be due upon his death.

Under the proposed regulations, the new rules will basically do two things:

1. An imposition of a three-year look-back will be used to determine whether a minority valuation discount should apply.  Therefore, if a gift is made within three years of death, the valuation discount will not be recognized by the IRS, and the gift will be at the full non-discounted value.  This can create a gift and/or estate tax issues; and
2. Provide for the introduction of new disregarded restrictions in situations where the family retains control after the transfer.  Therefore, if the stock is transferred to a family member, you may not be able to use valuation discounts to reduce the per-share value of the stock.

If you and your family are in a situation in which a federal estate tax would be imposed upon the death of a family member and your family has a family-controlled business, it is very important that you contact your estate planning attorney to discuss these matters immediately to review your estate planning options before the imposition of these proposed new regulations.  By proceeding with this type of planning before the regulations take effect, your family may be able to save significant federal estate taxes upon your passing.

NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.

James F. Contini II, Esq.
Certified Specialist in Estate Planning,
Trust & Probate Law by the OSBA
Krugliak, Wilkins, Griffiths & Dougherty Co., LPA
158 North Broadway
New Philadelphia, Ohio 44663
Phone:  330-364-3472
Fax:  330-602-3187
Email:  jcontini@www.kwgd.com