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Act Fast To Get Discounts On Business Valuations

Time may be running out on the chance to discount the valuation of business interests that are transferred by majority shareholders. Prompt action now, before current tax rules are changed, could result in potentially enormous savings.

Much about this likely change remains up in the air. The new regulations that have been proposed won't take effect officially until final rules are issued, and there could be modifications between now and then. Court challenges could further muddy the waters, and the outcome of this fall's election also might make itself felt.

Still, it's important to know what could happen and to understand the impact the proposed rules could have on you, your business, and your family.

Under the old rules, owners of family limited partnerships (FLPs) and limited liability companies (LLCs), among other business entities, often have been able to transfer minority interests in the company to other family members at a significant discount. The specific rules are complex, but the basic idea is that the values of those interests were reduced because they would be difficult to sell on the open market.

You could transfer minority interests to other family members. Although such transfers would be subject to gift tax, that liability would be covered, at least in part, by the annual gift tax exclusion and the unified estate and gift tax exemption. Currently, you can make gifts of up to $14,000 per recipient, with an additional $5.45 million for transfers ($5.49 million in 2017).

Because you have been able to discount the value of the shares you transfer to family members, such transactions take up less of your exemptions and reduce the tax you owe if you exceed the exempt amounts. Depending on the circumstances, the discount might be as large as 50%.

But the IRS has worried that taxpayers have abused the rules through approaches that may include:

  • Transfers of minority interests during the lifetime of the majority owner in which the owner loses the right to liquidate the business. This often happens through "deathbed gifts" made late in life.
  • Working through taxpayer-friendly states such as Nevada to create exceptions to "applicable restrictions" that could limit discounts.
  • Other transfers of nominal interests made to charities or other third parties that restrict the ability to liquidate the business.

The IRS contested these estate planning techniques several times in the courts, but taxpayers usually prevailed, most notably in a landmark 2003 case. The tax agency also lobbied Congress to change the laws, without success.

Now the IRS has overhauled the rules on its own. Under the proposed regulations, a transfer that results in a restriction or termination of a right or power associated with the transfer is treated as a "lapse," eliminating discounts.

There also will be a "three-year rule" that would affect transfers made within three years of the death of the majority owner making the transfer. In addition, the new regulations limit the ways that transfers can be restricted in order to permit discounts, requiring that the least restrictive state laws be used in such cases.

Finally, the regulations create a new list of "disregarded restrictions," effectively curtailing valuation discounts on the majority of transfers.

Individuals who want to take advantage of the current rules should speak to their estate-planning attorney.


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This article was written by a professional financial journalist for Houston Asset Management and is not intended as legal or investment advice.

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