Pasternak & Fidis Reporter

August 26, 2016

CLIENT ADVISORY: New Proposed Treasury Regulations

The Treasury Department recently issued proposed federal regulations that could have a dramatic impact on your estate planning options by eliminating valuation discounts.  For wealthy people looking to minimize their future estate tax, this development is critical.

Time is of the essence.  Once the proposed regulations are effective, which could be as early as year-end 2016, the ability to claim valuation discounts might be substantially reduced or eliminated, thus curtailing your estate tax planning flexibility.

Here is a simple illustration of how valuation discounts have historically reduced estate tax.  Henry, a Maryland resident, has a $20M estate, which includes a $10M family business.  He gives (or sells) 40% of the business to a trust for the benefit of his family to allow the expected post-transfer appreciation in the business to occur outside of his estate.  The undiscounted value of the transferred 40% business interest is $4M.

  • Discount for Lack of Control. As a minority (40%) owner, the trust cannot force a sale or redemption of its interest in the business.  Accordingly, the trust’s non-controlling 40% interest in the business is worth less than a pro rata 40% share of the value of the underlying business.
  • Discount for Lack of Marketability. In addition, if there are restrictions on the trust’s ability to sell or otherwise transfer its interest in the business, the value of the interest would be reduced further to account for its lack of marketability.

Assume that a 25% discount for lack of control is applied first, and then a 20% discount for lack of marketability is applied to the pro rata $4M interest.[1]  The effective (or combined) discount rate applied to the interest would be 40%.  As a result of these lack-of-control and lack-of-marketability factors, the value of the 40% business interest that Henry transferred to the trust would – after application of the valuation discounts – be appraised for estate/gift tax purposes at $2.4M.

In this illustration, the discounts reduced the combined value of Henry’s estate and the trust by $1.6M from this one simple transaction.  This reduction would save approximately $800,000 in federal and Maryland estate taxes at Henry’s death.[2]  Valuation discounts also have historically been applicable to transfers of interests in entities that own marketable securities, real estate, and other assets.

The proposed regulations seek to eliminate valuation discounts for intra-family transfers by disregarding restrictions that apply to partial interests in family-controlled entities.

The proposed regulations will be the subject of comments and hearings, and it is impossible to know how the final regulations will read.  It is also difficult to anticipate when the regulations will become effective.  We believe that the window of opportunity for planning with valuation discounts will be available for the remainder of this year (and perhaps beyond).  Accordingly, if you are interested in discussing such planning, we encourage you to contact us as soon as possible.

[1]              Applicable discount rates are determined through a valuation analysis performed by a qualified appraisal expert.

[2]              Assuming federal and Maryland estate tax rates applicable to 2016 decedents.