IRS Proposes Eliminating Valuation Discounts

Earlier this month, the IRS released proposed regulations that would eliminate discounts used when valuing assets held by certain types of family entities being transferred by gift or sale to family members, an estate planning technique that, though complicated, has been common practice among high net worth families for decades.

Anyone who has attended the Heckerling Institute on Estate Planning in recent years knows that this has been on the IRS docket for some time (dating back to the Clinton administration); so that it has finally come to pass will be no real surprise to seasoned estate planners.

The basic idea of the technique is first for a family member (usually the matriarch or patriarch) to create an entity (partnership, LLC, or S-Corp) which would hold contributed assets, and then to transfer ownership interests in the entity to other family members (usually children).  Because the ownership interest is normally restricted by the entity, valuation discounts for lack of marketability, lack of control, and/or lack of transferability are taken, thus reducing the taxable value of the transfer. Historically, these discounts have amounted to between 20% and 30% (or more) of the value of the underlying assets, so the potential transfer tax savings can be substantial.

Over the years, the IRS has aggressively challenged in the tax courts the validity of the entities and/or the amount of the discounts – creating several landmark and precedent-setting rulings along the way (both in favor of and opposed to the taxpayer).

The proposed regulations would eliminate the ability to discount these transfers in any way, meaning that the value will be 100% of the share of the underlying assets owned by the interest, as of the date of transfer – and thus negating a key reason the technique is used in advanced estate planning for high net worth clients.

Still, there is a period of public comment and a December 1, 2016 hearing to get through first, with the final regulations to follow some time thereafter – which means that things could change between now and then.  But once the final regulations are released, they will go into effect 30 days later. So there is still time for families to act if they wish to use what may be a disappearing tax-savings technique.

For more detailed information and other views about this, please refer to the list of sources below.

JDJ has worked with families and their estate planning practitioners on these kinds of transfers.  As always, we stand ready to assist any of our clients who wish to do this kind of planning.  We handle all the administrative details involved: from helping to create the entity, to processing the transfer itself, to providing the regular, ongoing post-transfer bookkeeping and administration.