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Uncertainty for Valuation Discounts on Transfers of Family-Controlled Entities

CPAs & Advisors


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Imagine working a lifetime in hopes of one day passing on the many fruits of your labor to those who you love, but in the blink of an eye as much as 40 percent of it is taken away in the form of estate taxes. While there are many strategies to help protect your estate or at the very least mitigate the effects of the high estate tax rates, the door may soon slam shut on one of the most frequently used strategies. The IRS has proposed regulations that would disallow a discounted valuation method used in valuing assets in family limited partnerships and therefore no longer allow a lower taxable asset value for estate taxes, gifts, and transferring assets.

To utilize this strategy, a family limited partnership is often formed to help manage a family’s wealth and is a tremendously helpful tool in transferring the wealth from one generation to the next through tax-free gifts at a discounted valuation. The partnership is normally formed when senior family members contribute assets to the family limited partnership in exchange for an ownership percentage of the entity. These members most often will retain the role of the general partner and therefore can retain control of the partnership assets, control cash flow and management decisions, and determine and limit the ability of limited partners to transfer their interests. Upon formation, the general partner will transfer partial ownership of the partnership and ultimately their assets to their children, other family members, or trusts for their benefit over time.

In order to transfer ownership interest, the partnership would analyze the fair market value of the partnership assets to arrive at the overall value of the company. This would be used to determine the percentage of ownership that could be transferred as a tax-free gift each year. In the past, a family limited partnership was able to discount this value due to influencing factors such as a non-controlling minority interest and lack of marketability. For instance, without a majority voting percentage, a minority stakeholder is unable to single-handedly have a significant impact in making business decisions and as a result the value of that minority stake in a company would be discounted. Likewise, having a minority stake in a company such as a farm or family business would make it very difficult to find a buyer who would be interested in joining the partnership, which also justifies a discounted valuation due to lack of marketability.

However, with the proposed regulations, widely used discount valuation methods would be drastically limited. As a result, the business assets would have a higher valuation which would have a significant impact on the way businesses are able to plan the transfer of their family business. This most likely would lead to an increased estate tax burden on many of these families and in some cases, the passing of a majority family member could lead to liquidation of all or part of the business to pay the significant estate taxes due. This proposed regulation has been met with quite a bit of pushback and is scheduled for a comment period to begin on December 1, 2016, but final regulations could come out by year-end.

So what can you still do in 2016?

  • Keep in mind that the federal estate tax exemption is $5.45 million dollars per individual, but make sure your estate plan reflects the new “portability” provision allowing spouses to inherit each other’s unused exemptions.
  • If you have been considering transferring closely held business interests either through lifetime gifts or at death, we recommend that you consult with your estate planning attorney and other advisors quickly to determine if action before December 1 is advisable.
  • Make annual gifts of up to $14,000 per beneficiary by December 31, as it will not count against your lifetime estate/gift tax exemption of $5.45 million.

Contact the professionals of Yeo & Yeo’s Agribusiness Services Group to discuss the estate and gift tax strategies that are most beneficial for your situation.

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