Estate Tax Discounts Likely to Change for Family-Owned Businesses

Family business owners may want to revisit their estate plan and consider gifting before the new year if the proposed IRC 2704 regulations are finalized as expected this December.

In August, the IRS proposed a change that could drastically affect the estate plan of business owners. This proposed regulation specifically deals with IRC Sec. 2704, commonly used in estate planning strategies to discount the fair market value of closely held businesses.

For those unfamiliar with valuation discounts, some clarification may be helpful. A common concern among successful business owners is how to decrease the value of their estate for tax purposes when the majority or significant portion of their net worth is the value of the business. The IRS, aware of business owner’s concerns and the reality of small private business valuation, have acknowledged that it is particularly hard to sell a portion of an interest in a privately held business because there may be relatively few potential buyers at any given time and those buyers typically want full (or at least majority) control of the business that they are acquiring. For this reason the IRS looks to lack of marketability and lack of control as two important considerations in valuing a business interest. Depending on the degree of these two factors, the IRS will offer valuation discounts for tax purposes – sometimes as high as 40%!

As you can imagine, this attractive discount has garnered the attention of sophisticated planners and as a result has led to many recommending to their clients to sell or gift minority and non-controlling interests of the business to their children or other related parties. The result being that the business owner has significantly reduced the value of his gross estate, but still has effectively retained control of the company. Plus, the children who have the minority, non-controlling interests may get a piece of the action in a more tax efficient manner.

While the IRS believe business owners should be given valuation discounts for legitimate non-tax reasons (i.e. business succession planning), they are not particularly fond of such transactions being used solely for tax reduction purposes. In response to closing this loophole, the proposed regulation will disregard lack of control or marketability in certain situations. There is an exception if the transfer of ownership involves non-family members, but stipulations apply to limit this loophole.

If you’re interested in learning more about closely held business valuation discounts or would like to discuss your estate planning options with an experienced attorney at Simmons & Schiavo, call (781) 397 – 1700.