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Proposed Treasury Regulations Could Increase Wealth Transfer Tax for Family Business Owners


August 31, 2016

By: Meghan M. Linvill McNab

On August 2, 2016, the Treasury Department issued proposed regulations under Internal Revenue Code Section 2704. If adopted as currently drafted, changes to the valuation of interests in family-controlled business entities for estate, gift and generation-skipping transfer (GST) tax (“transfer taxes”) could be significant. 

The proposed regulations would significantly reduce or eliminate the availability of valuation discounts on the transfers of interests in business interests to family members, both during life and at death.  The value of interests involved in such transfers have historically been subjected to discounts (such as lack of marketability and lack of control), thereby decreasing the value of such interests for transfer tax purposes.  This reduction in value enabled family business owners to transfer more interests to their family members because of the reduced transfer tax cost. 

Restrictions on the use or transfer of business interests played a significant role in those discounts, making the interest less valuable than an otherwise, identical interest without such transfer restrictions.  However, the proposed regulations under Section 2704 provide that certain restrictions on the use or transfer of a business interest will be disregarded when determining the value of those interests for transfer tax purposes.  The proposed regulations will also impact any effect on value from certain lapsing rights and restrictions on liquidation.  These proposed regulations are intended to correct certain perceived flaws in the application of Section 2704 and, specifically, to prevent the undervaluation of transferred interests. 

A hearing on the proposed regulations will occur on December 1, 2016, with the proposed regulations becoming final regulations as early as thirty (30) days following that hearing. 

What should family-controlled business owners do in light of the proposed regulations?  That depends on many factors, including but certainly not limited to, whether a business owner has federal estate tax exposure.  There is a limited amount of time in which family business owners might have an opportunity to transfer business interests to their family members and still take advantage of the current system of valuation discounts.  While we encourage that consideration, clients should also note that the proposed regulations, as currently drafted, also contain a three (3) year “look-back period” in which transfers made prior to the date the regulations are final may still be impacted by the regulations if the transferor dies within three (3) years of making the transfer. Likewise, family business owners who have already made transfers and die after the regulations are final may also be impacted by the three (3) year look-back period. 

Every family business owner has unique business and family considerations, and likewise has unique transfer tax issues that need to be considered when contemplating any business interest transfer.   This is an excellent time to contact one of the business succession attorneys of Krieg DeVault LLP to discuss your unique family business considerations.  Whether a review of your current estate and business succession planning strategy is in order, or a review of your business and governing instruments, our attorneys look forward to the opportunity to help you make decisions for the continuing success of your family and business.