Potential Changes for Valuing Closely Held Business Interests in Intra-Family Transfers – Limiting the Use of Valuation Discounts


There have been recent rumblings that the IRS might soon publish regulations limiting use of certain valuation discounts for estate and gift transfers of closely held business interests to family members.  While the technical details related to such regulations are complex, the nature of the changes may be of interest.

Background – For a number of years, the Obama administration’s budget proposals included legislative changes to restrict or eliminate valuation discounts on transfers of interests in family owned entities.  The focus area of the budget proposals and the potential IRS regulations surround §2704 of the Internal Revenue Code.  This particular Code section states that certain restrictions limiting the ability of an entity to liquidate are to be disregarded when valuing the transfer of a closely held business interest to a family member (ancestors, lineal descendants, brothers, sisters and spouses).  However, due to exceptions outlined in the Code and the operation of state law in many states, these valuation restrictions are seldom applied.

Potential Changes – The §2704 statute does provide the IRS authority to issue regulations identifying other restrictions which should be disregarded for valuation purposes on intra-family transfers.  It is anticipated that in the regulations which could be issued as early as this Fall, the IRS would specify other restrictions to be ignored for valuation purposes which could have the effect of reducing marketability and minority interest discounts.  While some have speculated that the new changes might only apply to non-operating entities, the scope of the new regulations is really an unknown.

What is also unknown is whether the new regulations will hold up to challenges in the courts.  The IRS has lost a number of court cases related to §2704 and does not have the authority to administratively over-rule those decisions.  Also, the statute says that the disregard of additional restrictions identified in IRS regulations is only to occur if the effect of such restrictions “does not ultimately reduce the value of such interest to the transferee.”    It’s difficult to contemplate transfer or liquidation restrictions that do not have an economic impact on a transferee.  Further, it is uncertain what impact the over-arching state law exception in the statute might have on any new regulations.

What Actions Should Be Considered – For those who are in the midst of planning transfers of closely held business interests, it may be advantageous to finalize such transfers sooner rather than later.  While we don’t know when the potential new regulations will be effective, it could be as early as the date of issuance.  Even if the regulations are ultimately found by the courts to be invalid, they will have to be taken into consideration until the judicial process runs its course, which could be several years.
For those who have not yet started a plan for succession or wealth transfer, let this be a reminder to begin the process.  Despite any new changes the Service might impose on valuation discounts, there are a number of vehicles and techniques that can be employed to facilitate estate planning while achieving your lifestyle and philanthropic goals.

Please contact us to discuss how we can help you navigate the estate and wealth transfer planning process.

About the Authors

Theodore A. Wagner
Theodore A. Wagner
Partner and Executive Committee Member, Taxation Services


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