Speculated New Regulations Could Limit / Eliminate Valuation Discounts

by Christopher B. Volz
July 31, 2015

Existing tax regulations have allowed taxpayers to utilize reasonable discounts for lack of control and marketability when valuing transferred interests in family-owned entities to family members.  For years, the IRS has sought to eliminate such discounts, arguing that IRC §2704(b)’s “applicable restriction” includes any restriction that limits, in a manner that is more restrictive than state law, an owner’s ability to liquidate his/her interest in the entity.  They have been unsuccessful with this argument in significant cases in Tax Court, but they may find a way to limit/eliminate these discounts soon, by promoting new regulations.

Recently, the Office of Tax Policy of the U.S. Treasury Department indicated that the IRS plans to propose regulations during this summer or early fall that would restrict or eliminate these valuation discounts for interests in family-owned entities. It is possible, though, that family-owned entities operating active businesses will be exempt from the new regulations and discounts on such interests will still be allowed.

While regulations are usually effective as of the date final regulations are issued (often several years after they are proposed), it is possible that these regulations may become effective retroactive to the date of proposal.  However, even if enactment occurs, there is a chance, considering the Tax Court’s past rulings, that the Court will ultimately reject these regulations.

Another concern is the conflict that the proposed regulations would create with respect to the instructions for Forms 706 (Estate Tax Return) and 709 (Gift Tax Return), which direct the preparer to determine the fair market value of the subject assets.  In many situations, it would be nearly impossible for a value that reflects “the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts” (which is how “fair market value” is defined in Section 25.2512-1 of the U.S. Treasury regulations) to be determined without applying discounts for lack of control and/or marketability.

Time to Take Action

Even though there is currently some speculation about how and when regulations limiting or eliminating valuation discounts might become effective, taxpayers who hesitate to act run the risk of not being able to take advantage of the currently available valuation discounts.  If you or your client is considering transferring interests in family-owned entities (particularly those without active operating businesses) to family members in the foreseeable future, it would be wise to consider taking action now, while we know the valuation discounts are still applicable.  The limitation or elimination of valuation discounts for lack of control and/or lack of marketability would increase, significantly in some cases, transfer tax costs for families.

For more information, please contact:
Christopher B. Volz, CPA/ABV/CFF, ASA 
Director of Business Valuation and Litigations Services






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