Litigation + Valuation Perspectives

Demystifying Valuation, Economic Damages + Forensic Accounting

Proposed Regulations Could Eliminate Valuation Discounts

On August 2 Mark Mazur, the U.S. Treasury’s assistant secretary, announced that the IRS will implement new regulations that will effectively eliminate valuation discounts.

Background

In an effort to diminish perceived abuses related to valuation discounts associated with transfers of interests in family entities, the IRS enacted Section 2704 of the Internal Revenue Code (the “Code”) in 1990 as part of new Code Chapter 14. Code Section 2704(b) stipulated that if an interest in a family controlled entity is transferred to a family member, an “applicable restriction” should be disregarded by the appraiser when valuing the transferred interest. Code Section 2704(b) defines “applicable restriction” as a constraint that restricts the ability of an entity to liquidate if, after the transfer, such restriction lapses on its own or can be removed by the transferor or any member of the transferor’s family, acting alone or collectively. 2704(b) included other provisions that addressed restrictions related to qualified personal residence trusts, grantor retained annuity trusts and other family entities or family related documents such as buy-sell agreements.

Subsequent to the enactment of Section 2704, the tax courts have consistently ruled that the aforementioned restrictions should be ignored by the tax payer and appraiser and that discounts may be applied to the transferred interest in the context of gift tax or estate tax reporting purposes.

Essentially, the proposed regulations pertain to the application of a discount for lack of control (DLOC) and discount for lack of marketability (DLOM) to noncontrolling, nonmarketable limited partnership and membership interests in FLPs and FLLCs. Depending on the composition of the asset portfolio of the entity and the prerogatives of control vested in the holder of the transferred fractional interest, the blended DLOC and DLOM typically is in the range of 25 percent to 45 percent.

What is the time line for the approval or rejection of the proposed regulations?

The regulations must first go through a 90-day public-comment period. A public hearing is scheduled for December 1, 2016. Comments and outlines of topics to be discussed at the hearing must be submitted by October 31, 2016. We expect a strong negative response from estate attorneys, financial planners, accountants and other professional groups during the public-comment period and IRS hearing.

Should you or your clients make a gift or transact a sale prior to the public comment period and hearing?

The vast majority of commentators believe the new regulations, if approved, likely will apply to gift and sale transactions after the effective date. Furthermore, they opine that any “grandfathering” rule will not be applied to a fractional interest in a limited partnership or LLC formed prior to the effective date of the regulations.

It is likely that many estate planners who represent affluent clients will encourage them to make gifts prior to the public hearing.

We will continue to follow this important story and stay in touch with you.

By Gary Ringel, CGREA

According to an August 2, 2016 Wall Street Journal article authored by Richard Rubin, “Estate and gift taxes apply at a top rate of 40% above the $5.45 million per-person exclusion, which means the estate tax affects about 0.2% of those who die each year.

Republican presidential candidate Donald Trump wants to eliminate the estate tax. Democratic presidential candidate Hillary Clinton says she would make the estate tax apply to about twice as many people. She proposes returning to the law in effect in 2009, when there was an estate-tax exclusion of $3.5 million per person, a $1 million per-person gift-tax exemption and a 45% tax rate.

In fiscal 2016, the U.S. is projected to collect $20 billion in estate and gift taxes, less than 1% of federal revenue, according to the Congressional Budget Office.”