Anticipated IRS Regulations Could Impact Use of Valuation Discounts

The business valuation and estate and planning community have heard the same type of rumors every few years – the IRS would be looking to make changes to try and eliminate or reduce the use of valuation discounts when analyzing the transfers of ownership interests for estate gift or generation-skipping tax purposes. As of August 2016, the IRS has moved one step closer to turning that rumor into a reality.

New Proposed Rules (REG-163113-02)
The U.S. Department of Treasury has just released a new regulatory proposal that attempts to close perceived loopholes that it maintains to allow taxpayers to understate the fair market value of assets or ownership interests for estate and gift tax purposes.

The proposed rules (REG-163113-02) contain certain regulations regarding the valuation of interests in the context of estate, gift, and generation-skipping tax purposes. These new rules address the treatment of certain lapsing rights and restrictions on liquidation when determining the underlying value of a transferred interest.

Changes or Amendments Related to Section 2704
Specifically, the proposed regulations includes changes or amendments related to Section 2704 of the Internal Revenue Code, which addresses certain valuation rules for valuing intra-family transfers of interests, and includes the following:
An amendment to address what constitutes control of an LLC or other entity that is nor a corporation, partnership, or limited partnership.
An amendment to address deathbed transfers that result in the lapse of a liquidation right and to clarify the treatment of a transfer resulting in an assigned interest.
An amendment to refine the definition under the Section of “applicable restriction” by eliminating the comparison to liquidation limitations of state law.
Creating a new section to address restrictions on the liquidation of an individual interest in an entity and the effect of insubstantial interests held by persons who are not members of the family, including the creation of a new class of restrictions known as “disregarded restrictions.”
Under the proposed rules, the various amendments are proposed to apply to lapses of rights and transfers of property subject to restrictions created after October 1990. As with any other Treasury Regulations, these new rules will move through three different levels: proposed regulations, temporary regulations and final
regulations.
Proposed regulations, which is the current state of the discussed amendments, provide insight into how the IRS may take a certain position regarding an issue while also allowing practitioners to have input into the process via a publication and notice period (90 days for these proposed changes).  While proposed regulations may be helpful in illustrating the IRS’ stance, they are generally not binding on the IRS or taxpayers, and a taxpayer cannot rely on such proposed changes unless the IRS clearly states otherwise.
Temporary regulations provide guidance until final regulations are adopted and generally occur subsequent to the comment and public hearing timeframe for proposed regulations.  Temporary regulations have the same authority as final regulations.
Treasury Decision is issued by the IRS that formally adopts and issues the text of the final regulation, which then becomes the ultimate authority on the respective issue.

Prepare for Regulation Changes 
While the IRS has made attempts in past years at proposing changes related to valuation discounts, such proposals have failed to be approved. It is difficult to predict exactly what may happen in the months ahead. However, business owners, as well as their professional advisors, may need to make some decisions regarding their estate planning needs and goals in order to effectively comply with the current rules in place as well as what may lay ahead.

Should you have any questions on these developments or your estate planning needs, please a contact a valuation or tax advisor for further information.

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