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New IRS Proposed Regulations Slam the Breaks Down on Valuation Discounts

New IRS Proposed Regulations Slam the Breaks Down on Valuation Discounts

On August 2, 2016, the Internal Revenue Service (“IRS”) issued the long-awaited proposed regulations under Internal Revenue Code (the “Code”) Section 2704.

If enacted, the new proposals are designed to curtail perceived abuses in the Code that would strike a fatal blow to the transfer tax planning efforts of many high net worth individuals.   The proposed regulations would effectively eliminate the ability to gift interests in family limited partnerships and closely held companies at a discount for lack of marketability or control.  The proposed regulations would close certain loopholes, such as those relating to lapsing rights and restrictions on liquidation, for owners of closely held businesses who have regularly used these planning techniques for decades. More specifically these new rules would change the current regulatory landscape in some of the following ways.

Current law disregards certain rights of equityholders to liquidate an entity as a whole in valuing equity interests for transfer tax purposes. The proposed regulations would extend current law to require the disregard of certain rights of equityholders to liquidate an individual equity interest being conveyed too. The new rules would also expand the scope of the restrictions that must be disregarded of an equityholder’s ability to liquidate an entity as a whole.

Under current law restrictions on the ability to liquidate an entity as a whole may be considered for valuation purposes if the restrictions are not more restrictive than the limitations that generally apply to the entity under federal or state law. The proposed regulations would only permit consideration of such restrictions if they cannot be waived or modified under the entity’s governing documents.

Current law treats the lapse of a voting or liquidation right in an entity as a taxable gift or an event subject estate tax (if a transfer occurs at death) if the holder of the lapsed right and members of her family control the entity before and after lapse. An exception applies to lifetime transfers of minority voting interests by a majority voting holder. The new rules would disallow that exception for transfers that occur within three years of the holder’s death.

If adopted the proposed regulations could have far-reaching effects on individuals who hold interests in closely held entities including holding companies, such as family partnerships and active businesses. An open comment period on the proposed regulations is scheduled for December 1, 2016. Treasury has announced some of the new rules would not take effect before 30 days after the regulations become final. Therefore, there is still time for making gifts of limited partnership or closely held stock utilizing discounts for lack of marketability and control, but the deadline for taking action before the law changes may be fast approaching.

Please contact your local Withum tax advisor to discuss how these proposed rules would apply to you.

Marcus-Dyer Marcus E. Dyer, CPA, JD.
609-520-1188
mdyer@withum.com

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