IRS Curbs Some Estate Planning for Taxes of the Wealthy

The IRS never has liked estate planning strategies that result in what are known as valuation discounts. In August, it issued proposed regulations that would curb many of these strategies.

Only a small number of estates will be affected by the new rules, since most estates avoid the federal estate and gift tax. After indexing for inflation the lifetime estate and gift tax exemption is $5.45 million in 2016 for an individual and $10.9 million for married couples. But the top estate tax rate is 40%, so the tax can impose a heavy load on estates subject to it.

In a valuation discount strategy, a taxpayer transfers valuable assets to an entity such as a corporation, limited liability company (LLC), or partnership. Then, ownership shares of the entity are distributed to family members, usually the children and grandchildren and usually by making gifts. After the ownership is distributed, because no person owns more than 50% of the voting rights, the shares given to each person as well as those owned by the original owner are valued at less than the net asset value of the assets. This is known as a liquidity or minority discount. A business that isn’t listed on a stock exchange is difficult to sell, and a minority ownership interest is even tougher to sell. Discounts typically are 30% and higher. The discount reduces the value of gifts made to the children and also reduces the value of any shares included in the parents’ estates.

The most popular of the strategies involve family limited partnerships and LLCs, but there are many strategies available.

The proposed regulations don’t eliminate all valuation discount strategies. They prohibit discounts when the assets were transferred fewer than three years before the original owner passes away. Discounts also are prohibited when limits on rights to vote, liquidate the entity and transfer ownership lapse at some point or can be removed by the new owners when those owners are family members.

The regulations are long and complicated, because they are meant to cover a wide range of situations. The regulations don’t take effect until at least 90 days after they were officially published in August. The IRS will hold a public hearing, receive comments and decide if the regulations should be amended. Taxpayers who have been considering valuation discount strategies should meet with their estate planning specialists soon to see if the strategies would be affected by the regulations and can be executed before the regulations become final.