Time May Be Slipping Away to Discount Valuations

Time May Be Slipping Away to Discount Valuations

Proposed regulations to limit tax planning strategies in connection with valuation discounts could be implemented later this summer. Traditionally, owners of closely held businesses have sought independent valuations to help determine gift and estate tax liability. The valuation of closely held entities for gift and estate tax purposes, particularly with the utilization of family limited partnerships (FLPs) and limited liability companies (LLC) that are implemented as estate planning vehicles, has continually been challenged by the IRS . The discounts available from such vehicles have become a major element of estate planning. The two primary discounts include “lack of marketability” and “lack of control”. A discount for lack of marketability reflects the inability of a minority shareholder in a private company to maximize the opportunity associated with the disposal of such an investment in a timely manner. Additionally, the discount for lack of control (or minority-interest discount) is the result of considerations such as a minority investor’s inability to control or significantly impact financing, investment or operating decisions, or dividend policy, as well as the tax consequences of realizing or not realizing built-in gains on assets. The aforementioned discounts, when combined with other estate tax planning strategies, can significantly reduce gift and/or estate taxes for high net-worth individuals and their families.

Section 2704 was originally legislated to limit the use of valuation discounts with gift or estate interests. The IRS has been dependent on Section 2704 to challenge valuation discounts, but has had limited success. As expected, the use of valuation discounts has grown and so have the IRS’ efforts in eliminating these income and tax saving techniques. The proposed amendment to Section 2704 would create an additional category of restrictions in valuing an interest in a closely held business. There has been speculation in the past, but this time it appears that the use of valuation discounts for closely held businesses may be severely restricted or even entirely eliminated.

On May 10, 2015 Catherine Hughes spoke at the ABA’s Tax Section Meeting. Ms. Hughes is the Estate and Gift Tax Attorney-Advisor in the Office of Tax Policy of the U.S. Department of the Treasury. She advises the Assistant Secretary of the Treasury (Tax Policy) on all estate, gift, and generation-skipping transfer tax matters. She commented in regards to the proposed Section 2704 regulation, in which the IRS is attempting to change the methodologies used when valuing closely held businesses for gift and estate purposes, as follows: the proposed Section 2704(b)(4) regulations expect to “restrict or eliminate” discounts for transfers of family owned entities. Additionally, Ms. Hughes specified that the 2704 regulation is imminent and could be issued later this summer prior to the ABA Tax Section meeting, which is to take place on September 17-19 in Chicago.

Houlihan Capital will be monitoring the anticipated new regulations and will act accordingly with the potential rule change. For those considering utilizing family partnerships and/or limited liability companies as part of their estate-planning strategy, it may be judicious to discuss the impact of these potential changes with their tax advisors.

About Houlihan Capital

Houlihan Capital is a leading, solutions-driven valuation, financial advisory, and boutique investment banking firm committed to delivering superior client value and thought leadership in an ever-changing landscape. The firm has extensive experience in providing objective, independent and defensible opinions of value that meet accounting and regulatory requirements. Our clients include some of the largest asset managers, private equity funds, hedge funds, fund administrators, and both public and private operating companies, who benefit from our comprehensive valuation and financial advisory services. Houlihan Capital is SOC-compliant, a Financial Industry Regulatory Authority (FINRA) and SIPC member, and is committed to the highest levels of professional ethics and standards.

***Disclaimer: IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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