Many families currently take advantage of the opportunity to discount the value of their closely-held entities when transferring interests as part of their estate plan.  Conceptually, if a family can discount the value of a closely-held entity (sometimes by as much as 25% - 35%), more of the family’s assets may be passed down to the next generation without triggering gift or estate tax.  
On August 2, 2016, the IRS issued proposed regulations under Section 2704 of the tax code to significantly limit such discounts. In particular, the proposed changes would:

  • expand the application of Section 2704 from corporations and partnerships to include limited liability companies and other business arrangements;
  • substantially limit the ability to take discounts for lack of control and minority interests (often used when transferring small pieces of an entity, limited partnership interests or non-voting stock); 
  • eliminate any discount if the recipient of the entity interest is just an “assignee” and not a full-fledged “owner” (whether shareholder, partner or other type of owner); 
  • disregard restrictions in entity documents (related to liquidations) regardless of whether they are more or less restrictive than what Federal or state law would otherwise provide; and
  • disregard some of the “control” held by non-family members for valuation purposes with limited exceptions.  

If implemented, the changes to the valuation discount rules will apply to transfers on or after the date on which the proposals become final regulations.  

A public hearing on the proposed regulations is scheduled for December 1, 2016, and final regulations could come out by year-end.  Given that these changes have been anticipated for a long time, we believe these proposed regulations will likely go into effect (or with limited changes).  As a result, families will lose a very powerful estate and business succession planning technique and will likely pay significantly more in estate taxes. 

For families that own closely-held entities, the time to transfer those interests at a discount is now.  Due to the broad application of the proposed regulations, reviewing the provisions in existing governing documents of family-controlled entities is also advisable to determine if any remaining discounts may be available.  

For more information, please contact David KovskyMelissa Paszamant or Erin McQuiggan of our Private Client Services Group.