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IRS Proposed Rules Will Substantially Increase Estate and Gift Taxes

On August 2, 2016 the IRS announced proposed rule changes that may have important consequences for assets that are owned by families.  If the rules are finalized in their current proposed form, they will likely go into effect in December 2016.  As is explained in more detail below, it is imperative that families that are contemplating transferring assets to family members act now to lock in the current more favorable estate and gift tax rules before the new rules go into effect.

The IRS’s proposed rules relate to how certain transactions impacting family-owned assets are valued.  Under IRS rules dating back to the 1990s, transactions such as the transfer of a minority interest of a family-owned business to a family member have been subject to a valuation discount.  This discount has been justified on the grounds that asset transfers to family members are less valuable because non-controlling interests in family-owned asset are less marketable than similar assets that are owned by unrelated third parties.  In addition, transfers of a non-controlling interest in the family-owned asset often exclude voting power.  For example, if ten percent of a family-owned business is transferred to a son, daughter, or cousin, the ability of that family member to sell their share is often quite limited, and the ten-percent ownership interest often doesn’t include the power to vote on issues impacting the business.

Under Section 2704 of the IRS Code, these valuation discounts have been used to reduce estate and gift taxes for families.  These discounts can be substantial, sometimes reducing the applicable estate and gift tax by between 40% and 50%.  For families that have substantial holdings, the discounted valuations can save millions of dollars in estate and gift taxes.

If the proposed IRS rules go into effect, the changes will be dramatic.  The essence of the proposed changes is to eliminate the ability to apply discounted business valuations to a wide range of family-owned assets.  Transfers of ownership to family members will not be discounted for estate or gift tax purposes.  Moreover, in an important change, the proposed regulations would apply to all family-owned assets, including operating businesses.

In light of the proposed regulations, families that are considering making a gift or sale of an interest in a family-owned asset to another family member or a family trust should lock in the benefits of the current business-valuation discounts and finalize and implement estate and tax plans before the end of 2016.

If you have any questions about whether or how these proposed IRS rule changes might impact you, your family, or your clients, please do not hesitate to contact me.