IRS Proposal May Affect Value of Gift and Estate Transfers in Family-Owned or Closely Held Businesses

On August 2, 2016, the IRS issued proposed regulations (REG-163113-02) that may affect the valuation of gift and estate transfers of interests in family-owned or closely held businesses, placing limitations on discounts to the overall value that reflect lack of control or marketability.

According to Bloomberg, the proposed regulations are meant to end certain tax planning conventions seen as abusive by the IRS. Many estate planning and valuation professionals have expressed concerns that the regulations overstep IRS authority, as well as established state and federal laws. Some also argue the proposal is an attempt to reverse Tax Court decisions unfavorable to the IRS. There have been previous similar proposals by the IRS, also aimed at such valuation discounts, with limited success.

As stated in the Bloomberg BNA article, “IRS Expected to Face Pushback Against New Estate Tax Rules”:

“Let’s say my family has a business and my dad gives me a 10 percent interest in the business. The issue is what is that worth relative to the underlying asset value?” Dyer [Stephen Dyer, partner at Baker Botts LLP] asked. “Usually you would say it’s worth less than the underlying asset value because you can’t get” the full value out of it and it isn't marketable, he told Bloomberg BNA Aug. 4.

The way the statute is written, if there is a restriction on the value of an interest in a family-owned entity—meaning it can't be liquidated—then the restriction has to be reducing the value for tax purposes but not the value in the transferee's hand, in order to be ignored, he said. In the example, both of those requirements are not being met because “I’m still stuck with a 10 percent interest,” he said. “So that’s an argument that suggests that the statutory authority doesn’t mean as much as the Treasury thinks it does,” Dyer said.

Robert Kovacev, a partner at Steptoe and Johnson LLP, states:

“If you talk to anyone in business valuation, like someone who appraises businesses for a living; anyone who appraises businesses with partnerships, they’ll tell you that you really should have some sort of discount” on the valuation of an asset in a closely-held business because of the restrictions and lack of marketability that make the interest harder to sell, Kovacev said. If members of industry submit comments to the IRS expressing these concerns, the agency will be pressured to respond or risk being out of compliance with the APA.”

The proposed regulations are currently in the public comment phase, with a hearing scheduled for December 1, 2016.

Source: Bloomberg BNA