Proposed IRS regulations for valuing family entities may curtail discounts for estate, gift, and generation-skipping tax purposes

On August 2, 2016 the Treasury released proposed regulations under section 2704 of the Internal Revenue Code. These proposed regulations, as currently drafted, would produce significant changes to how family-controlled entities are valued for estate and gift tax purposes.

Section 2704 of the Internal Revenue Code, enacted in 1990, addresses family-owned entities and the valuation discounts that are permitted for transfers of these entities to family members. In general, the regulations provide certain situations where restrictions related to control or liquidation of the entity will be disregarded for valuation purposes.

The proposed regulations, if adopted, would vastly expand which restrictions are disregarded for purposes of valuing the transferred interest and would effectively eliminate minority discounts and narrow the scope of marketability discounts for interests in family-controlled entities transferred to family members. The proposed regulations apply not only to non-operating entities, but will affect active operating businesses as well.

There will be a public hearing to discuss the proposed regulations on December 1, 2016, and the Treasury has stated that regulations will not become effective until at least 30 days after this hearing; therefore, the earliest that these regulations would become effective is January 2017.

The impact of these proposed regulations will not be fully understood until they are issued in final form. There will likely be much debate about the regulations at the December hearing and it is not uncommon for proposed regulations to be altered before they become final.

If the regulations are issued in their current form, a significant opportunity to transfer wealth and reduce gift and estate taxes will be lost. Clients who are considering transferring interests in family-controlled entities to other family members should consult with their advisory team as soon as possible to determine whether those transfers should be accelerated to take advantage of this window of opportunity before final regulations are issued.