Estate and gift taxes, or transfer taxes, are taxes on the transfer of assets from one person to another either by gift during his or her lifetime or by inheritance at death. In 2016, only transfers by an individual or their estate in excess of $5.45 million are subject to tax. For married couples in 2016, no tax is collected on the first $10.9 million transferred. For purposes of the estate and gift tax, assets must be valued at fair market value. For transfer tax purposes, the term is defined in the regulations as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. See Treasury Reg. §§20.2031-1(b), and 25.2512-1. Estate taxes are based either on the “fair market value” of the property at the date of death or alternate valuation date. See Internal Revenue Code (the “Code”) Section 2031. According to Code Section 2512(a), gift taxes are based on such value at the date of transfer, and GST taxes are based on such value at the date of transfer if transferred during lifetime or value at date of death or alternate valuation date if the transferred property was included in the transferor’s gross estate. See Section 2624. It is common for certain taxpayers and their advisors to use certain tax planning tactics to lower the taxable value of their transferred assets. One such tactic involves the transfer of closely held business interests for less than fair market value utilizing certain discounts.
On August 2, 2016, the U.S. Department of the Treasury announced new proposed regulations to place new limits on a common technique used to transfer interests in closely-held businesses or entities for estate and gift tax purposes. The proposed regulations under Sections 2701 and 2704 of the Code concern the treatment of the lapsing of rights and restrictions on liquidations for purposes of determining the fair market value of transferred interests
A minority interest in a corporation, partnership or LLC limits the ability of the holder of the interest to liquidate the interest due to the lack of control. See Douglas K. Moll, Shareholder Oppression and “Fair Value”: Discounts, Dates, and Dastardly Deeds in the Close Corporation, 54 Duke L. J. 293, 315 (2004). Most corporations, partnerships, and LLC owners enter into contractual provisions providing for the valuation and liquidation of their equity. These restrictions may give rise to a minority discount. The proposed regulations would create the concept of “disregarded restrictions” on the disposition of transferred business interests. Under § 25.2704-3(b)(1)(i) of the proposed regulations, such a disregarded restriction includes a restriction that limits the ability of the holder of the interest to liquidate the interest. If a shareholder (Corporation), partner (Partnership) or member (LLC) interest is restricted and the restriction will lapse after the transfer, or if the transferor, or the transferor and family members, may remove or override the restriction, the restriction would be disregarded. This implies that any family business interest held by a minority owner would not qualify for valuation discounts.
The proposed regulations are subject to a 90-day public comment period. The regulations themselves will not go into effect until the comments are carefully considered and then 30 days after the regulations are finalized. Accordingly, as one leading estate planning lawyer has already proposed, anyone considering a transaction involving valuation discounts might want to move up their timetable for implementing the transaction.