The Time to Transfer Entity Interests Is Now - Trust and Estates Update Vol. 2015, Issue 1

Troutman Pepper
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Upcoming IRS regulations may significantly limit and reduce planning opportunities to transfer minority interests in closely held entities to family members and increase the transfer tax cost associated with moving such interests.

The Internal Revenue Service (IRS) is preparing to significantly limit the availability of an important tool used to transfer minority interests in certain partnerships, corporations or limited liability companies to family members. Valuation discounts have long been a powerful means to transfer assets to family members at a significantly reduced transfer tax cost. Generally, the value of a minority interest in an entity transferred to family members would be discounted for “lack of control” and “lack of marketability” because of the minority owner’s inability to exercise any control over the entity or freely transfer the interest for a proportionate share of the entity’s fair market value. The IRS has long attacked these discounts through the courts and through proposed legislation. Now, after losing most of those battles, the IRS is about to take matters into their own hands by issuing regulations to restrict the use of valuation discounts.

Internal Revenue Code (IRC) § 2704 disregards certain restrictions that apply to a family-owned entity for purposes of valuing the interests in the entity. This section does not specifically address discounts. However, in enacting IRC § 2704 in 1990, Congress provided the Department of the Treasury with the authority to issue regulations that would further specify the types of restrictions that will be disregarded. No regulations have been issued to date, but it is strongly rumored that new regulations will be released in summer or fall 2015, and the speculation is that these regulations will contain a significant restriction on the ability to use valuation discounts to transfer entity interests to family members.

Although the details of the proposed regulations remain unknown, they are likely to target a variety of perceived abuses resulting from the discounting of entity values. Potential targets of the regulations include the following:

  • eliminating discounts related to entities that hold only cash and marketable securities
  • disallowing a lack of control discount for any entity that is controlled by family members before and after the transfer
  • disregarding certain “nontax reasons” (e.g., centralized investment management and control, creditor protection, etc.) that have served as the justification for using family entities and taking discounts for transfers of the minority interests.

The details of the regulations will be made known shortly. For now, we can be fairly certain that the new regulations will significantly limit and reduce planning opportunities to transfer minority interests in closely held entities to family members and will increase the transfer tax cost associated with moving such interests.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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