IRS to Limit Family Business Valuation Discounts   

Family businesses have long been a popular tool for transferring wealth between relatives without bearing the full brunt of gift and estate taxes and generation-skipping transfer rules. That strategy may be coming to an end – or at least losing some of its charm – with proposed transfer discount restrictions that the U.S. Treasury is putting into law in the coming weeks.

Expected to go into effect in September or soon after, new regulations are designed to cut donors’ ability to claim substantial discounts on the valuation of gifts made through family businesses, such as limited partnerships and limited liability corporations.

Typically, valuation discounts as high as 40% are applied in ownership transfers of family-owned business entities based on one or both of two factors:
1.    lack of control when the transfer is to a child or grandchild (the minority interest discount), and
2.    lack of marketability.

The amount of the discount varies with the specific assets the transfer represents and their relative liquidity.

This isn’t the first time the IRS has attempted to limit the use of valuation discounts to reduce tax liability acquired through family business wealth transfer. Before 1993, the agency disallowed minority interest discounts for valuation of transferred interests in family-owned entities. Revenue Ruling 93-12 made in that year conceded that family control was not a factor when establishing the value of partial ownership of these entities and since then, this type of gift has been frequently used to achieve tax-free transfers between generations.

In multiple years, the Obama administration included plans to restrict or even eliminate the current valuation discounts that apply to intra-family wealth transfers made through LLPs or LLCs in its annual budget proposals. However, Congress never took action to change the law. As a result, the IRS is now seeking to implement the changes the administration sought by means of a change to the tax code itself.

Though the details of the updated rules are not yet known, they are likely to closely resemble what has been suggested by the administration in previous budget proposals.

No matter what form the final rules may take, taxpayers who can benefit from such gifting strategies should take immediate action to avoid missing out on significant tax savings opportunities. Since the IRS and current administration have wanted these changes for quite a while, they are likely to go into effect immediately once finalized.

Sensiba San Filippo tax and estate planning specialists are keeping a close watch on the impending restrictions and are ready to help you adjust your estate plan to take advantage of the brief remaining window of opportunity. If a family LLC or LLP is part of your total asset package, you are strongly encouraged to call us at (925) 271-8700 or to determine if you can take advantage of tax savings through valuation discounts before they disappear.