Client Alerts / 08.04.2016

Is it Goodbye to Valuation Discounts for Family Businesses?

By Patrick J. Tulley

Are you a business owner considering transferring your business to a family member?   In light of recent action by the United States Treasury Department you may not want to wait any longer. After months of speculation, the Treasury has issued proposed regulations under Internal Revenue Code § 2704 to curtail certain valuation discounts related to the transfer of family owned businesses, including family limited partnerships or “FLPs”.

Currently, when an individual makes a gift or sells a fractional interest in his or her business to a member of the family, the value of the transferred interest is typically discounted for federal gift and estate tax purposes.  The family business could be an active operating business, or could be a family limited partnership (FLP) or family limited liability company (FLLC) holding more passive investments.  In any case, the value of the interest is generally discounted due to a lack of marketability.  In other words, there isn’t a ready market for the purchase of the stock or business interest, because it is a closely held business as opposed to a publicly traded security.  Moreover, if the interest is a minority or limited partnership interest it is also often discounted for a lack of control as well. As proposed, the new regulation would appear to eliminate nearly all valuation discounts for closely held business interests.

Basically, the effect of the proposed regulations is that it will be more costly from a gift and estate tax perspective to transfer an interest in a closely held business to a family member.  With the expected elimination of these valuation discounts, the value of the interest will be greater, thereby requiring the individual to use a greater portion of their exemption from gift and estate taxes than he or she would have prior to effective date of the proposed regulations.

The Treasury has scheduled a hearing about the proposed regulations for December 1, 2016 and has stated that the final regulations won’t be effective until at least 30 days after they become final.  This means, the new regulations may become effective for lifetime and testamentary transfers shortly after the end of this calendar year.  Considering the potential impact of the new regulations, those considering a transfer of business interests may want to seriously consider taking action before year end.

If you are contemplating any transfer of an interest in a closely held business to a family member, you are urged to contact the head of the firm’s Wealth Planning Group, Patrick J. Tulley, at (216) 736-7226 to discuss how best to transfer the interest before the proposed regulations come into effect.