On August 4, 2016, the U.S. Treasury Department issued proposed regulations under Internal Revenue Code Section 2704. If finalized as proposed, the new regulations will eliminate many valuation discounts that currently apply to certain transfers of closely-held entities (including family-owned corporations and limited liability companies) between family members.
Under current regulations, when a family member gives another family member a portion of the family-owned entity, the value of the gift may be reduced from the full enterprise value because the recipient is usually unable to liquidate the business or transfer the interest to third parties outside the family. The amount of the reduction (valuation discount) is typically determined by a certified appraiser and often ranges from 25% to 40%. Under the proposed regulations, the same transfer between family members would be valued without applying these discounts.
The potential impact for families with closely-held businesses is dramatic. Assume that the full enterprise value (value without discounts) of a business is $5,000,000 and is owned by a widower who wants to transfer the business equally to each of his three children. With typical valuation discounts applied under current law, the adjusted valuation of the business could very well drop to $3,000,000. Assuming the father otherwise has a taxable estate (that is the value of his assets is above the current exemption amount of $5.45 million), then estate tax savings because of the valuation discounts could easily be upwards of $800,000.
As with most changes to the tax laws, whether this change is good or bad will depend on each family’s unique circumstances. Those taxpayers who have an estate under the current estate, gift and generation-skipping tax exemption amounts (typically $5.45 million without prior lifetime gifts) may benefit from the new regulations. The benefit comes from having heirs inherit assets from a deceased taxpayer with a tax basis equal to the fair market value at the time of death. So, if the taxpayer holds on to the closely-held business until death so that the children (or other heirs) inherit the asset with a higher tax basis, then the heirs may have less capital gain to pay if they later sell the business. (See the side bar article about tax basis adjustments for more information.)
For procedural reasons, the regulations cannot be finalized until December 2016 at the earliest, giving taxpayers a window of opportunity through the end of 2016 to plan under current law. While each situation is unique, if your estate may exceed your current estate tax exemption amount, then you should consult with your estate planning attorney and other tax advisors to review your planning options.
Basis is a concept used to track your investment in a certain asset for tax purposes. For example, assume you purchased a share of Apple Inc. in 2006 for $11.00. Your basis in that share of stock would be $11.00. If you sold it today for $108.00, then you would have a capital gain of $97.00 (sale price minus your $11.00 basis). If you give your share of Apple Inc. stock away during your life, the recipient would also get your basis of $11.00 in the stock. If, however, you hold onto your stock until you pass away, then whoever inherits the stock from your estate will have a basis in the stock equal to the value on your date of death. So, if on the day you died the Apple Inc. stock was worth $108.00, then your heir who receives the stock would have a basis equal to $108.00 and could sell it at that price without any capital gain!
With significantly higher estate tax exemption amounts now a “permanent” part of our tax code (see the discussion on page 1 for details) you may wonder if you should even bother considering a trust as part of your overall estate plan. While trusts are used extensively as tax planning tools, there are many non-tax reasons that a trust may be right for you and your family.
If you ever become incapacitated, a properly drafted and funded trust could help your family avoid the need to seek a guardianship through the court system. Instead of a court-appointed guardian, the trustee you have previously selected will be able to manage your financial affairs through the trust. Upon your passing, the trust serves as the primary estate planning tool that will help your family carry out your wishes. A well-designed and implemented trust plan will help avoid the time and expense of state court probate proceedings while still maintaining a structured approach to settling your final affairs.
If you are married, then chances are that you and your spouse want to implement a “joint” estate plan. While you and your spouse would each have your own Will, you can implement a “joint revocable trust” which will help ensure that the overall plan will continue on the course that was charted together, even when the surviving spouse remarries.
Remember, claims against a beneficiary can arise in many different contexts and can entangle even the most responsible of beneficiaries. Transferring assets in trust can provide significant protection from claims of your beneficiary’s creditors. Similarly, holding assets in trust for your beneficiary will make it less likely those assets are divided by the court during divorce proceedings.
Do you want what took you a lifetime of thrift to accumulate to be spent in an extravagant or reckless manner? If the answer is no, then a trust may be appropriate for you! Remember, just because assets are held in trust for your beneficiary does not mean they won’t have access. In fact, common trust language allows for payments to be made for a beneficiary’s health, education, maintenance and support.
Other reasons to consider using a trust as part of your estate plan include simplified management of assets in other jurisdictions, providing benefits to multiple generations, protecting government benefits of a disabled beneficiary, and helping to ensure an equitable distribution of assets across a group of beneficiaries.
If you would like to learn more about the use of trusts and other estate planning tools, please contact our office. You can also visit our website for more information and for details on upcoming estate planning seminars.
With the passage of the American Taxpayer Relief Act (ATRA) on January 1, 2013, Congress avoided the worst of the so-called “fiscal cliff.” While some of the tax measures included in the ATRA are temporary, certain provisions were also made “permanent.” This article describes some of the major changes made to both the individual income tax rules and the gift/estate tax provisions.
Income Tax Highlights
Without this legislation, income tax rates would have reverted to the levels from the late 1990s across the board. Instead, only the top marginal rate has increased from 35% to 39.6%. This higher rate only applies to income that is above the “applicable threshold.” (See the chart for the threshold level for this rate and other income tax rates in effect for 2013 for single and married couples filing jointly.)