Press Room: Tax Release

August 12, 2016

IRS Issues Proposed Regulations Limiting Discounts on Transfers of Closely-held Interests

On August 2, 2016, IRS issued long-awaited proposed regulations pertaining to valuation discounts on transfers of closely-held family entities. Such interests include closely-held interests in corporations, partnerships, and other entities. The proposed regulations would affect the value for federal tax purposes of transfers of interests to family members. In general, they aim to limit the amount of discounts that can be factored into the value of the transferred interests.

As part of estate, gift and generation-skipping transfer tax (transfer tax) planning, taxpayers who hold interests in closely-held entities frequently transfer all or a portion of their interests during their lives, to younger family members. Such a transfer has two benefits: first, it removes the asset from the taxpayer’s transfer tax base, and second, any increase in value of the transferred asset will not be subject to the transfer tax for the taxpayer who has transferred the interest.

The entity’s governing documents and/or state law frequently impose certain restrictions that reduce the overall value of the interest for transfer tax purposes. Frequently, the restrictions limit the ability of a transferee to transfer or liquidate their interest which, in turn, results in various discounts that apply when the interest is valued for transfer tax purposes. After applying the discounts to the value of the property transferred, the transfer tax liability associated with the transfer can be significantly reduced. Examples of discounts include valuation discounts for lack of control (own a minority interest in the entity) or lack of marketability (no readily available market for selling the interest to unrelated third parties), voting rights restrictions, and restrictions on the ability to liquidate the interest.

In 1990, Congress added provisions to the Internal Revenue Code that were designed to limit valuation discounts for transfers of interests in closely-held family entities to other family members. Subsequently, the Treasury Department issued regulations that it determined to be ineffective in implementing the purpose and intent of the statute. As a result, the Treasury Department has proposed a new set of regulations that are intended to significantly affect the value of transfers of closely-held family entities to other family members. If the proposed regulations are finalized in their current form, certain restrictions would no longer be considered in determining the value of the transferred interest. Without the restriction, the value of the transfer would be greater for transfer tax purposes. The increased value would likely produce a significantly greater transfer tax liability than would occur if the interest were transferred under the current regulations.

The Takeaway

The proposed regulations are subject to a 90-day public comment period. The Treasury Department has scheduled a hearing on the regulations for December 1, 2016. With some exceptions, the regulations would apply to transfers of closely-held interests to other family members after the regulations are issued as final regulations. Therefore, taxpayers who are considering transferring interests in their family-owned entities should consider making those transfers as soon as possible.

Please contact your Andersen Tax advisor if you are planning on making a transfer to a family member or would like to discuss the impact of the proposed regulations on your individual wealth planning situation.