Recent proposed legislation (HR 436, introduced on Jan. 9, 2009, by Rep. Earl Pomeroy (D-ND)) could impact certain estate planning techniques that are often implemented by clients by eliminating certain discounts associated with valuing ownership interests in closely held family entities such as family limited partnerships (discussed in detail below). In addition, the proposed legislation would make permanent the federal estate tax exemption amount at $3.5 million and sets the tax rate for estates exceeding that amount at 45 percent (50 percent for estates between $10 million to $23.5 million).
Although this proposed legislation is not part of a current bill, it may be indicative of things to come later in 2009. Ending or limiting discounts has been on the Treasury`s revision list for some time.
Families create investment partnerships and the like for many business and non-tax reasons, including the consolidation of family assets for unified management, protection from creditors, protection of separate property assets in the event of a divorce, and the ability to control family investments for future generations. Another key consideration for families in deciding to create such an entity is the ability to transfer wealth between family members in a tax efficient manner due to the discounts typically allowed in valuing interests in such entities for gift and estate tax purposes.
Under current law, when an individual transfers an interest in a closely held family entity, whether by gift or at death, the transferred interest is valued at the price that a willing buyer would pay a willing seller for such interest. In determining the value of such interests, appraisers often apply significant discounts due to the lack of marketability and/or lack of control associated with such interests. For example, a 10 percent limited partner interest in a family limited partnership that holds $1 million worth of cash and marketable securities would not necessarily be valued at $100,000 (i.e., 10 percent x $1 million) under current law. Instead, because a limited partner cannot readily sell his or her interest on the open market, control how the partnership assets are invested, and/or force the liquidation of the partnership, valuation discounts would typically be applied to determine the price that a willing buyer would pay a willing seller for such interest. Assuming that valuation discounts of 30 percent are appropriate, the fair-market value of the 10 percent limited partner interest would be $70,000 [$1 million x 10 percent x (1-30 percent)] for gift tax and estate tax purposes. These valuation principles generally apply to any non-publicly traded entity, even if that entity owns publicly-traded securities.
If HR 436 (or similar provisions) become law, no valuation discounts would be allowed with respect to ``non-business`` assets held by partnerships or other entities. Instead, such assets would be valued for gift and estate tax purposes as though they were transferred directly to the recipient. In the foregoing example, if the $1 million held by the partnership were limited to cash and marketable securities, a 10 percent limited partner interest therein would be valued at $100,000 (i.e., 10 percentx $1 million) for gift and estate tax purposes, even though the price that a willing buyer would pay a willing seller for such interest may be significantly less than that amount. In addition, if a family controls a business entity which is not ``actively traded,`` no discount will be allowed for the transferee`s lack of control of the entity, although the discount for lack of marketability, if applicable, would still be allowed.
The proposed legislation, as drafted, would be effective for transfers occurring after the date of enactment. However, this could be changed so that the new rules are effective at an earlier date such as the date the bill comes out of committee. In addition, it is possible, although unlikely, that the bill could be applied retroactively to all transfers occurring after Jan. 1, 2009.
If this proposed legislation should pass, there are still planning steps that can be taken to try to ensure the transfer of wealth from one generation to the next with transfer costs measured by current law. Planning steps would include, but not be limited to, (i) gifts to an existing or newly-created family partnership, trust or corporation (``Family Entity``), (ii) sales to a Family Entity, or (iii) transfers to a newly-created grantor retained annuity trust (also known as a ``GRAT``).