The proposed regulations disregard restrictions that have been used by valuation experts and acknowledged by the courts to reduce valuations.
If you are an owner of a closely held entity, recently proposed Treasury Regulations may significantly reduce the gift, estate and generation-skipping transfer tax benefits of transferring minority interests in the entity to your family members. After decades of waiting, and hundreds of court cases involving the valuation of transfers of interests in family-controlled entities, on August 2, 2016, the Internal Revenue Service (IRS) issued proposed regulations that are aimed at limiting the availability of valuation discounts in the transfer of interests to family members in certain partnerships, corporations and limited liability companies.
Section 2704 of the Internal Revenue Code was enacted in 1990 to limit the ability of taxpayers and their advisors to place restrictions in partnership and shareholder agreements in order to reduce the value of the interests for transfer tax purposes. Congress authorized the Department of the Treasury to issue regulations more specifically defining the types of restrictions that would be disregarded for transfer tax valuation purposes. The new proposed regulations are intended to provide that guidance. The proposed regulations are designed to limit the valuation discounts applied by appraisers in valuing interests in closely held entities that are transferred to family members for estate planning purposes. The regulations define a new and expanded class of "disregarded restrictions" both in agreements and in state law, which will, if finalized in their current form (and upheld by the courts), have a very significant limiting effect on the benefits of transfers of interests in certain entities to family members for estate and gift tax purposes.
The proposed regulations are now open to public comment, and a hearing is scheduled on December 1, 2016. If adopted in their present form, the limitations on valuation discounts will be effective for transfers of interests in certain entities to family members after the final regulations are published. The proposed regulations may be modified as a result of the comments and hearing, but we anticipate that the final regulations will significantly change the landscape for the valuation of closely held business interests. It will do this by disregarding restrictions that have been used by valuation experts and acknowledged by the courts to reduce valuations. If you are considering transferring interests in a closely held entity to family members or creating a family-owned entity, we urge you to contact us immediately to discuss the alternatives that may be available for a limited time before the final regulations are issued.