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.

Tax Basis

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!

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