Keeping It in the Family

Estate

Keeping It in the Family

Proposed U.S. Treasury rules could mean a bigger estate tax bite for your family-owned entity.

October 26, 2016

The U.S. Treasury recently proposed regulations that, if implemented in its current form, could mean higher valuations – and reduced valuation discounts – for family-controlled entities, meaning increased estate and gift taxes for families with large taxable estates that include active businesses or real estate.

Who’s Affected?

For a single person, a “large taxable estate” means that the total value of his or her assets, including life insurance, is greater than $5.45 million, the estate and gift tax exemption for 2016 ($5.49 million for 2017). For a married couple, it means the total value of their assets, including life insurance, is more than $10.90 million in 2016 ($10.98 million for 2017).

What’s Driving the Change?

Prior to 1990, families and individuals were subject to a 55% maximum estate tax and the gift tax exemption was just $600,000. In an effort to avoid that 55% maximum, techniques were devised to drastically lower the value of family-owned businesses. Congress considered some of these methods illusory and undesirable and, in 1990, enacted legislation that permanently eliminated the truly illusory value-reduction techniques. The result was that more family-owned businesses became subject to estate and gift taxes when transferred among family members.

In 1992, the U.S. Treasury issued regulations interpreting and implementing the 1990 legislation that, in large part, were tied to existing state laws. Since 1992, changes to those state laws – many in response to business owners’ desire to transfer their businesses to family members while reducing estate and gift taxes – have diminished their effectiveness.

Proposed Regulations for 2016

In an effort to put teeth back into the original legislation, the U.S. Treasury indicated in 2003 that it would issue new regulations to modify the existing rules. Those new regulations appeared in proposed form in August of this year.

They are aimed at eliminating “valuation discounts” that apply when ownership of a family-controlled business, such as a family limited partnership or limited liability company, is transferred to other family members by gift or at death. Using valuation discounts effectively reduces estate and gift transfer taxes while providing increased value to the family’s next generation.

To Illustrate…

Parents own all of the interests in a family limited liability company with $20 million in assets. They make a taxable gift in the form of a 45% non-voting, non-controlling interest in the entity to a trust that benefits their children. Without the valuation discounts, the value of the gift would be $9 million. Assuming a 30% total valuation discount, the value of the gift would be $6.3 million. That’s a 42.857% increase in the value of the taxable gift, and assuming a 40% gift tax, an additional $1.08 million in gift taxes if the valuation discounts cannot be utilized.

Deadline to Act

The IRS public hearing for the proposed regulations is on December 1, 2016, and the final regulations could be in effect as early as the end of 2016 (though some time in 2017 is more likely). To take advantage of the valuation discounts available under the current regulations, individuals and families should reach out to their tax and other professional advisors and act as soon as possible.

Raymond James financial advisors do not render advise on legal or tax matters. Any examples are hypothetical and for information purposes only. Regulations are subject to change.



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