Updated: Jul 23, 2020
By Sarah Everhart
Are you a member of a family-owned business entity such as a corporation, limited partnership, or LLC? If so, you need to be aware of the proposed change in U.S. treasury regulations to Section 2704 of the IRS Code, which could become final by the end of 2016. If finalized, the regulations will significantly reduce the availability of valuation discounting on certain intra-family transfers of interests in family-owned entities. The regulations will also affect anyone holding a purchase option that calls for the purchase or sale price to be determined using valuation discounts.
Many farm families establish business entities to lessen estate tax burdens and to help with transitional planning. After the business entity is created, interest in the entity is often gifted to family members, allowing the majority owner to reduce his or her taxable assets. It also serves as an effective way to slowly transition ownership of an operation to the next generation. Currently, it is common to apply a discount to interests of a family-owned entity.
In other words, interest in the family entity can be gifted at less than fair market value. This is beneficial because a person is limited by the federal estate tax exemption (currently $5.45 million per person, increasing to $5.49 million in 2017) in the total amount he or she can gift during their life before triggering estate tax consequences. This type of gifted interest is able to be discounted because of its relative lack of marketability and/or the lack of control in the entity it bestows. Under the proposed regulations, these types of discounts would be largely eliminated for intra-family transfers.The U.S. Treasury Department requested comments on the proposed regulations from the public until November 2, 2016. Thousands of organizations and 41 Senate Republications wrote to Treasury Secretary Jacob Lew opposing the proposed regulations. In their letter, the Senators expressed concern about the negative effect the regulations will have on family farms. While a public hearing scheduled for the regulations on December 1, 2016, the regulations could be final in early December.
If your family has this type of corporate structure and makes intra-family transfers, you should call your attorney and/or tax advisor and discuss whether to utilize valuation discounts in your transitional planning before the law is changed.