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Valuation Discounts – “Will They Stay or Will They Go”

Valuation Discounts - “Will They Stay or Will They Go”

This week’s guest blogger is Al LaRosa, CPA, a trust and estate specialist in the New York Office of WithumSmith+Brown.

A common and effective technique for transferring wealth to the younger generation is the use of Family Limited Partnerships (“FLP”) or Limited Liability Companies (“LLC”). These entities are a great way to consolidate and manage family assets. They provide for a more orderly transition and, as an added benefit, enable the grantor to benefit from valuation discounts when determining the fair market value of the assets being transferred for estate and gift tax purposes.  As you can imagine, discounting taxable value is not something the IRS is particularly keen on and has resulted in litigation over the years as well as legislative and administrative proposals to limit or eliminate it.  Valuation discounts are threatened again (read on….) so, now may be the time to consider using this technique if it makes sense for your overall estate plan.

How it Works: When assets are transferred, the taxable value is the “fair market value,” a somewhat nebulous amount defined by law as the price at which the property would change hands between a willing buyer and willing seller, neither being under any compulsion to buy or to sell and both reasonably knowledgeable of the facts.  Sometimes, that value is obvious – if you give away marketable securities with no strings attached, the gift tax value would be the exchange value of the securities on the date of transfer.  Other times, like with FLPs and LLCs, the valuation is a bit murky.  A whole industry exists to determine, as objectively as possible (without an actual sale), what that value is.  There is, let’s say, some wiggle room.

If you have any questions or request assistance, please contact a member of the Withum Wealth Management group.

Ownership of an interest in an entity such as an LLC or a FLP that holds assets will generally result in a lower valuation for transfer tax purposes than the outright ownership of those same assets outside the entity.  Lower valuations result because minority interest and lack of marketability discounts are allowed when valuing these transfers.  Here’s the wiggle room – if you give an interest in a properly structured LLC or FLP to your child, you will continue to control the entity and s/he will be along for the ride.  If s/he can’t control the internal investments or sell the LLC or FLP units, are they really worth as much?  And how much will this save the family?

Turns out, it can be plenty.  For example, an effective valuation discount of 35% would allow a senior family member to transfer a 30% interest in a $25,000,000 controlled entity to younger family members at a reduced gift tax value of $4,875,000, rather than $7,500,000.  If available, the value of the transfer will be sheltered from any gift or estate taxes to the extent of the taxpayer’s remaining lifetime gift/estate tax exemption.

As noted, there have been numerous proposals and continued discussions to eliminate or reduce the benefits associated with valuation discounts for FLPs and LLCs.  Recently, these talks have become quite concerning.  At a recent American Bar Association’s Tax Section meeting, Cathy Hughes, from the Department of Treasury’s Office of Tax Policy, hinted that proposed regulations might be released real soon (possibly in September 2015) that would limit the availability of valuation discounts for FLPs, LLCs and other family entities.

Given the increased likelihood that the window of opportunity to utilize valuation discounts may be coming to a close, it may be prudent for those individuals who intend on utilizing valuation discounts to transfer assets take action now (prior to the release of any future regulation that restricts their benefits).

Remember, obtaining a professional valuation appraisal is critical to substantiate these discounts that are being used to adjust the value of the transfers.

Withum Wealth Services

Important Disclosure: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Withum Wealth Management. [“WWM”] or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article/newsletter serves as the receipt of, or as a substitute for, personalized investment advice from WWM. Please remember to contact WWM in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. WWM is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the WWM current written disclosure statement discussing our advisory services and fees is available for review upon request.

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