By:  Brett Dale

On August 4, the Treasury Department issued long-awaited Proposed Regulations regarding valuation discounts for family-owned assets and businesses under Section 2704 of the Internal Revenue Code.  The Proposed Regulations will be discussed at a public hearing on December 1, 2016, and may become effective shortly thereafter.

The Proposed Regulations introduce significant changes that eliminate almost all valuation discounts in the family context.  Therefore, certain family assets will be valued at a higher value causing greater Estate Tax liability.

The most troubling aspect of the Proposed Regulations is the limiting of liquidation restrictions which will directly impact powerful valuation discounts.  Valuation discounts for family-held assets exist in two basic forms:  discounts for lack of control and discounts for lack of marketability.  Under current rules the fair market value of an interest in a family-held asset or business where no current market is available is based on the “willing-buyer/willing-seller” test. This test establishes the value a willing buyer would pay a willing seller for that family asset.  Such value is taxed for estate tax purposes at 40% – 50%.

Lack of Control Discount
When a family member receives a portion of a family-held asset or business that is a minority ownership, that portion of the business can be valued lower than a majority ownership share because a willing buyer would not have control over managerial issues.  This lack of control makes the minority interest less valuable to a willing buyer than the majority share.  Hence a lower estate and gift tax value for that minority share.

Lack of Marketability Discount
Lack of marketability discount applies when the interest in a family-held asset or business is not easily convertible to cash.  While lack of control does create a lack of marketability, there are several other reasons an interest cannot be easily sold that reduce the value of that interest.  Any barrier to easy liquidation makes an asset less valuable to a willing buyer, and results in a lower estate and gift tax value.

Proposed Regulations to Section 2704
The Proposed Regulations disregard any restrictions on liquidation or redemption a family member uses to claim a valuation discount if that restriction either lapses after the transfer or the heir or heir’s family has the ability to remove the restriction after the transfer.  The new rule change significantly limits your ability to utilize historically available discounts, and thereby creates significantly greater Estate Taxes at death.