This year’s biggest news in estate and gift tax planning is the IRS’s recent release of proposed regulations that seek to limit, and perhaps eliminate, discounts for lack of marketability and control in connection with gifts of interests in family-owned entities.
At this time, the major points for consideration are as follows:
- Effective Date Not Known: Except for the new three-year rule discussed below, the regulations will not apply to transfers that take place prior to the issuance of the final regulations. The process of finalizing regulations can take many months, even years. It starts with a comment period, followed by a public hearing, which, in this case, is scheduled for December 1, 2016. Even if these regulations are a top priority for the IRS, we do not expect final regulations to be issued until the first quarter of 2017.
- New Three-Year Rule: A new three-year rule may prohibit certain discounts taken for transfers made within the three years prior to the transferor’s date of death.
- Applies only to Family-Owned Entities: The regulations will apply only to transfers of interests in entities that are mainly or exclusively owned and/or controlled by members of the same family. Entities include limited liability companies (LLCs), partnerships, and corporations. The regulations should not apply to transfers of interests in other assets, like real estate or art, unless the IRS, through a strained argument, prevails in characterizing such assets as entities.
- GRATs, Grantor Trusts, and Installment Sales: The good news is that the proposed regulations do not include restrictions that were somewhat anticipated concerning the use or effectiveness of “zeroed-out” GRATs. Nor do the proposed regulations eliminate the use of grantor trusts, which provide for effective estate, gift, and income tax planning. These planning techniques will continue to be effective in transferring wealth, particularly during low interest rate environments, as we have now. The proposed regulations would, however, reduce, if not eliminate, the advantages of using discounted interests in family-owned entities with these techniques.
- Validity and Application are Unclear: If finalized, the proposed regulations would limit the advantages of using family-owned entities to transfer wealth, but the precise application of the regulations is unclear. The final regulations may or may not provide more clarity. In addition, we expect legal challenges to the IRS’s authority to issue the regulations, adding to the uncertainty of their application over the next few years.
- Will Affect Primarily Wealthy Individuals and Families: The proposed regulations target estate planning techniques used primarily by individuals who likely will pay estate taxes, that is, people whose estates exceed the estate and gift tax exemption amounts: for 2016, $5,450,000 for individuals, and $10,900,000 for married couples. The regulations will impact individuals and couples whose estates are in excess of these amounts.