Historically, the Internal Revenue Service has closely scrutinized transfers between family members of interests in family-owned entities. Among other actions, the Service has sought to curtail the use of discounts to decrease the estate and gift tax value of such interests. Recent events indicate that the IRS may soon issue new regulations which will reduce (or eliminate) the tax benefit of valuation discounts. If you are considering a gift or sale of an interest in a family-owned entity, you may want to consider acting promptly to implement your planning.

Discounts as a Tax Planning Tool

Under current practice, when an interest in a family-owned entity is transferred between family members, valuation discounts for, among other things, lack of marketability (i.e., the entity cannot easily be sold on the open market) or lack of control (i.e., a non-voting interest), are often applied to reduce the value of the interest being transferred. The discounts are based on the notion that holding an interest in an entity that has restrictions on marketability and control is less valuable than holding the underlying assets directly. 

Valuation discounts have been an effective tool to reduce or eliminate federal estate and gift taxes on transfers of interests in family owned entities. The Service, however, has long sought to limit the benefit of this tool. This has been especially so when the family entity in question is deemed to have no “business purposes”—e.g., a family partnership which holds only marketable securities. Recent informal comments made by a representative from the Treasury’s Office of Tax Policy suggest that new proposed regulations would eliminate the use of valuation discounts in at least some situations. These new regulations may be issued by mid-September.

Review Your Options

For now, both the content and the effective date of any new proposed regulations remains speculative. We do not know if the regulations will prohibit discounts for intra-family transfers of interests in all family entities (including operating businesses) or only for transfers of interests in non-operating businesses—although the latter seems most likely. We also do not know if any new regulations will be effective retroactively—although we consider that unlikely. We therefore recommend that anyone with an interest in a family-owned entity who is considering giving or selling such interest to a family member review the options promptly.

If you would like to discuss these possible regulatory changes further, please contact one of the members of our Family Wealth Management Group.

Copyright © 2015 by Ballard Spahr LLP.
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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.