Recently, our office, sent a client alert regarding IRS news that hit the estate and financial planning communities late this summer. If you or someone you know has a small business, the information below will probably be of interest.
What Is Given Can Be Taken Away
In August, the Internal Revenue Service (“IRS”) issued Proposed Regulations that could have a dramatic impact on estate and business succession planning by eliminating valuation discounts traditionally available to closely held businesses. Discounts are currently used to help protect a family or closely held small business from the risks of future divorce, lawsuits, or malpractice claims while maximizing the value of the underlying assets.
When a Valuable Business Can’t Be Sold: Discounts Explained
Consider this example: Thomas has a $7M estate that includes a $5M family business. He gifts 40% of the business to a trust to grow the asset out of his estate. The gross value of the 40% business interest is $2M. Since a minority 40% shareholder (the trust) cannot force a sale or redemption of its interest, the non-controlling interest in the business transferred to the trust is worth less than the pro-rata fair market value of the underlying business. Thus, the value of the business interest should be reduced to reflect the difficulty of marketing the non-controlling interest.
As a result, the value of the 40% business interest transferred to the trust might be appraised, net of discounts, at $1.2M. The discount has reduced the estate by $600,000.
From another perspective, consider the issue if Thomas’ children buy the business and the taxes they would have to pay for a business interest that isn’t “marketable” were it not for the valuation discount.
Timing Is Everything
Once the Proposed Regulations eliminating or decreasing discounts are effective, which could be as early as December 31 of this year, the ability to obtain discounts might be substantially reduced or eliminated, thus curtailing wealth planning flexibility. Furthermore, as the 2016 year–end gets closer, it will become more difficult and, at some point, will become impossible to have banks and trust companies create trust accounts.
If you’re unsure of what you might wish to do, you may want to take the preliminary steps as soon as possible. For example, if you don’t already have trusts that could serve as appropriate receptacles for 2016 discounted gifts, it would be wise to establish trusts immediately. You can always determine later which assets and how much to transfer.
Get in the Kitchen
Make that alphabet soup, i.e., contact your planning team. A collaborative effort is essential to solid, effective wealth planning. Your wealth transfer strategy team, i.e., your attorney, CPA, CFP, and insurance professional, can review strategic wealth transfer options that will maximize your benefit from discounts while still meeting other planning objectives. Projections completed by your wealth manager could be essential to confirming how much planning should be done and how.
***Disclaimer*** The Law Offices of Max Elliott advises clients on legal strategies regarding estate and wealth planning issues; we do not provide financial planning or tax planning advice. We’re only one letter – albeit a good one – in the alphabet soup.
