For family business owners who desire to transfer ownership of part of their business to the next generation, the valuation of the business interest is often an important factor to consider. This is especially true for family business owners with sufficient assets who are concerned about minimizing estate taxes at their deaths. Under current tax law, each individual has a gift and estate tax exemption amount of $5.45 million, which allows the individual to transfer (either during life or at death) that amount of assets to younger family members before being subject to estate taxes. For spouses, this combined amount is $10.9 million under current tax law.
Historically, family business owners who transfer ownership of part of their business interests to younger family members have been able to make transfers at values that take into account appropriate valuation discounts. For example, a transfer of a 10 percent interest in a family business from parents to children does not represent a controlling interest in the business. The 10 percent interest is also not readily marketable and cannot be sold quickly like publicly traded stocks and other marketable securities. Discounts for “lack of control” and “lack of marketability” have therefore historically been applied to arrive at the value (for gift or estate tax purposes) of a minority, closely held business interest whenever the interest has been transferred. If a family business is valued at $100 million and a business owner gifts a 10 percent interest to children, then the 10 percent interest would historically be valued at something less than $10 million. In this example, it might be valued at $6.5 million for gift and estate tax purposes (after applying combined lack of control and lack of marketability discounts of 35 percent).
In August 2016, the Treasury Department issued proposed regulations under Section 2704 of the Internal Revenue Code that, if finalized in their present form, would significantly impact the valuation of transfers of family-owned businesses for gift and estate tax purposes. Specifically, the proposed regulations would severely reduce, or even eliminate, a family business owner’s ability to take advantage of valuation discounts (such as the lack of control and lack of marketability discounts described above) when transferring interests in family businesses to other family members. It is especially worth noting that the proposed regulations would apply to operating businesses as well as passive holding companies, and would apply to all types of business entities (whether corporations, LLCs or other entities).
A hearing on the proposed regulations is scheduled for December 1, 2016, and the regulations will likely be finalized and become effective sometime in early 2017. Thus, there is a short window of time for owners of family businesses to make transfers of interests in their businesses and be able take advantage of the valuation discounts applicable under current law. Whenever the proposed regulations are finalized, the availability of traditional valuation discounts will likely be impaired.