The regulatory assault continues – this time in the form of newly proposed rules out of Treasury to increase valuations – and taxes – on family businesses when they are transferred as part of an estate.
These are the long-awaited rules Treasury officials foreshadowed as far back as the Spring of 2015, and they appear to be consistent with the Obama budget proposal offered back in 2012 that was estimated to raise $18 billion over ten years!
While the rules were just released yesterday, their impact on family partnerships and estate plans is already the hot topic of debate with tax planners nationwide. Are they narrowly limited to certain revocable ownership restrictions? Or are they more broad and targeted at the core “lack of control and marketability” discounts that have been the bedrock of family business valuation since the dawn of time?
According to Mark Mazur– the head of Tax Policy at Treasury – who wrote a blog post that accompanied the release, Treasury is just going after loopholes in the rules:
It is common for wealthy taxpayers and their advisors to use certain aggressive tax planning tactics to artificially lower the taxable value of their transferred assets. By taking advantage of these tactics, certain taxpayers or their estates owning closely held businesses or other entities can end up paying less than they should in estate or gift taxes. Treasury’s action will significantly reduce the ability of these taxpayers and their estates to use such techniques solely for the purpose of lowering their estate and gift taxes.
What sort of restrictions? According to the rules:
Under §25.2704-3 of the proposed regulations, in the case of a family-controlled entity, any restriction described below on a shareholder’s, partner’s, member’s, or other owner’s right to liquidate his or her interest in the entity will be disregarded if the restriction will lapse at any time after the transfer, or if the transferor, or the transferor and family members, without regard to certain interests held by nonfamily members, may remove or override the restriction.
Types of restrictions described in 2704-3 include:
- Limitations on the ability to compel the liquidation or redemption of an ownership interest;
- Limitations on the amount received when liquidating or redeeming their ownership interest;
- Limitations requiring the deferral of those payments; and
- Limitations requiring the payment in a form other than cash or property.
But the fact that these “disregarded” restrictions are limited to ownership interests in a “family-controlled” business should raise red flags in the valuation world. The IRS has a long history of fighting, and losing, the battle to value family-owned businesses significantly higher than businesses owned by unrelated parties. We’ve battled the “family attribution” concept in the past and we may have to battle it again here too, depending on just how broadly these rules are written.
Broad or narrow, the new rule will, by Treasury’s own estimates, raise taxes significantly on the family business community and will, when coupled with the pending 385 regulations and other administrative actions, continue to hurt its ability to invest and create jobs. With the economy barely growing at the moment, that’s exactly what we don’t need.