Estate planning: Proposed regulations could change valuation rules for family-owned businesses

The Department of Treasury recently issued proposed regulations that may affect ownership transition plans for closely held family business or investment entities and the estate plans of their owners. If the proposed regulations are finalized in their current form, the ability to discount the value of transfers of certain business interests for gift and estate tax purposes may be greatly reduced or eliminated.

Here's a quick example

Let’s say Jim and Judy own Mom & Pop Corp., and they want to give 20 percent of the business to their child, Kelly. Today, they’d conduct a valuation for gift tax purposes of the interest in the business to be transferred. That valuation would consider the fact that, without control of the business or the ability to liquidate the interest, the value of 20 percent of the business in Kelly’s hands may be significantly less than 20 percent of the total value of the business — meaning the amount Jim and Judy will report for gift tax purposes will be discounted for lack of control and lack of liquidity.

If you’ve been considering implementing a plan to make an intergenerational transfer of your family-owned business, you should start the planning process soon. 

Under the proposed regulations, however, these valuation discounts would be diminished or even eliminated, and family business owners would be forced to use a higher value for intra-family sales and to report a higher value for gift and estate tax purposes. The loss of the ability to apply these traditional principles to the value determinations of closely held business and investment entities may also make it more expensive for family members to buy into the family business. This risk of increased estate or gift tax liability or the burden of paying a higher purchase price may force some families to consider selling the family business to unrelated buyers, rather than keeping it in the family.

The timing and content of the final regulations are uncertain, but the risk to family business owners is clear: The cost to keep your business in the family may go up significantly.

Tax and valuation planning, however, are only two of the issues you’ll want to consider in your business’s succession plan, and your business’s succession plan is only one aspect of your comprehensive personal financial plan. Rushing into a transfer to avoid a potential negative tax or valuation impact could have unanticipated consequences that might be avoided by carefully planning and structuring your transfer.

The cost to keep your business in the family may go up significantly.

If you’ve been considering implementing a plan to make an intergenerational transfer of all or part of the ownership of your family-owned business, you should start the planning process soon to avoid being too late if the current, proposed regulations move forward.