IRS Regulations to Limit Gift and Estate Tax Valuation Discounts

Jason ThompsonBy Jason S. Thompson, CPA/ABV, ASA, CFE, CFF
Partner, Director of Valuation and Litigation Services
[email protected]

In August 2016, the Internal Revenue Service (IRS) followed through with its threats to impose new regulations affecting the valuation of closely-held business interests for gift and estate tax purposes. The net effect of these changes is to limit valuation discounts in the case of the transfer of family-owned businesses and assets.

Such discounts reduce the amount of the estate tax exemption applied in a transfer of an ownership interest, such as commonly made to children, grandchildren or other family members.

There has been a flurry of activity in the business valuation and estate and gift tax communities since the issuance of these proposed regulations. Much of it has been focused on understanding the impact of the proposed regulations and organizing the fight to prevent the proposed regulations from becoming final.

The American Society of Appraisers has recently issued talking points for use in expressing opposition to the proposed regulations. These serve to highlight the controversy the proposed regulations have sparked among the business valuation community, estate and gift tax advisors and family business owners.

The following is a listing of the ASA’s talking points:

  • The Proposed Regulations Unfairly Increase the Values of Fractional Interests in Family Controlled Businesses and Holding Companies for Estate and Gift Tax Purposes.

The result is a “stealth” tax increase of 25 to 50 percent (or more) in taxes. The root cause of the tax increase is the IRS’ institution of the discredited notion of “family attribution.”

  • IRS Replaces Fair Market Value with a New and Unknown Definition of Value – Counter to Its Own Standard.

Revenue Rulings 59-60 has long been clear on the issue of what standard of value is to be applied: The price at which a hypothetical willing buyer and seller at arm’s length would agree to buy/sell an interest for. Based upon the realities of the marketplace, the fair market value of a minority interest is not worth as much as that interest’s pro-rata share of the whole entity. This is because such interests do not enjoy control or marketability. These required valuation adjustments are referred to as “discounts.” The IRS now proposes the use of a new valuation theory for taxing intra-family estate and gift transfers, with the seller and buyer allowed to be known parties. Because of the lack of clarity in the proposed regulations, valuation discounts will either be reduced substantially or disregarded altogether. This renders useless all accumulated prior knowledge built up by decades of Tax Court precedent, appraisal education and experience and academic research.

  • The IRS’s Return of “Family Attribution” Has Been Rejected by the Supreme Court and the IRS Itself.

In Estate of Bright v. United States, the Supreme Court dismissed the IRS’s position that families will always work in concert and always agree on business and financial matters. A subsequent Revenue Ruling, 93-12, makes clear that discounts for lack of control cannot be denied simply because the interests are passed from one family member to another.

  • The Rule Treats Intra-Family Transfers Differently Than Those Involving Non-Family Third Parties.

The proposed rule applies only to transfers from one family member to another; meanwhile, non-family third parties can still claim the same discounts on similar estate or gift transfers. The IRS does not provide any reasoning as to why this disparate treatment exists.

  • The Proposal Would Override Limitations Placed on Interests in the Business – Including Those Imposed by State Law.

The IRS proposes – by regulatory fiat – to overturn both existing private party contractual agreements and various state laws by ignoring the marketability restrictions placed on interests when valuing them for taxation purposes.

  • The Impacts to Family-Owned Businesses Will Be Significant.

At a minimum, these businesses will delay capital investments or hiring as the available cash will go toward paying an increased tax bill. Worse, these businesses may take on more debt simply to pay the IRS. Finally, business owners may decide to sell or liquidate the business rather than continue on as a family-owned going concern. The last outcome is highly destructive, especially for small businesses.

  • Support the Protect Family Farms and Business Act!

The House bill proposed by Rep. Warren Davidson (R-Ohio) is H.R. 6100. The Senate bill proposed by Sen. Marco Rubio (R-Florida) is S-3436.

These talking points illustrate what is at stake for the family business should these proposed regulations become final.

If you have any questions about how the new regulations on estate and gift tax valuations could affect your business succession plans, please call Jason Thompson at (317) 608-6694 or email [email protected].