Wednesday, September 21, 2016

Thrifty Thinking: Top 3 Immediate Considerations for Wealth Transfer Valuation Discounting from McManus & Associates

Proposed Internal Revenue Service (IRS) regulations were recently issued that would eliminate discounting opportunities related to wealth transfer planning. McManus & Associates, a top-rated estate planning law firm with offices in New York and New Jersey, today issued the “Top 3 Immediate Considerations for Wealth Transfer Valuation Discounting” as part of its Educational Focus Series. During a new conference call with clients, the firm’s Founding Principal and AV-rated Attorney John O. McManus shed light on how the proposed regulations could significantly limit discounting opportunities, as well as what can be done now to immediately take advantage of the various planning strategies using valuation discounting. To listen to McManus’ commentary on the topic, go to
McManus added, “Of interest, the results of the Presidential election will not affect the implementation of these regulations, as the IRS is trying to eliminate a concept that has been frustrating it for years, an area where the IRS has consistently lost in the Courts.”
Top 3 Immediate Considerations for Wealth Transfer Valuation Discounting
1)     What Changes Are on the Table?
a)     Issuance - As mentioned, on August 2, the IRS issued proposed IRC §2704 regulations related to valuation discounting in an effort to reduce or eliminate the size of valuation discounts being applied to intra-family transfers by gift or inheritance.
b)     IRS Scrutiny - Valuation discounting has been an area of IRS scrutiny for many years, and these proposed regulations were anticipated; the question has always been the extent to which the regulations would limit discounting.
c)     Major Impact to Valuations - The proposed §2704 regulations, if adopted in their current form, will have a major impact on the way assets can be discounted for estate planning purposes.
i)      Family Partnerships and LLCs (as holding entities) with minority ownership would be disallowed a discount for “Lack of Control,” which has a median of 27% and would suppress a discount for Lack of Marketability, which has a median of 35%.
ii)    Non-family Partnerships and LLCs with minority ownership would most likely still be allowed to take such a discount, however, the burden of proof for business legitimacy may be more stringent moving forward.
iii)   For Holding Companies, it appears that the elimination of the lack of control discount will impact and suppress the lack of marketability discount if the owners are family members. For operating companies (operating a trade or business), the elimination of the lack of control discount might not impact their ability to take a discount for lack of marketability.
iv)   Perceived Abuse of Discounting – In the proposed regulations, the IRS is attempting to eliminate what it perceives to be an abuse of discounting by taxpayers using controlled family entities. Their rationale is that, if family members voting together can change the terms of the entity’s governing document, then the entity is controlled by the family. Thus, it follows that any restriction on liquidation of an ownership interest in the family entity is designed to generate a valuation discount.
Note: There are valid reasons for discounting. The IRS scenario presented in the proposed regulations ignores the fact that restrictions can be imposed for independent, non-tax reasons, and not merely to generate a valuation discount.
2)     Planning Priorities to Protect Your Wealth
a)     Closing Window of Opportunity - The window of opportunity for using these discounting strategies before the final regulations go into effect will soon close. We recommend that those who would benefit from this type of valuation discounting act quickly.
b)     Removing Future Appreciation - Discounting can be incredibly valuable for estate planning purposes. The transfer removes future appreciation from your estate, and assets entitled to a valuation discount use less of the $5.45 million lifetime gift tax exemption. This helps to preserve the gift and estate tax exemption for future transfers of wealth during lifetime or after death.
Example: If a gift of $15.6M in assets is discounted to $10.9M by funding two $5.45M trusts, that would save $2.5M. If that number is compounded over 20 years by growing in tax-efficient grantor trusts, that amount could triple, which would result in $7.5M of tax savings. Also, if the trusts purchase additional family assets at a discount (possibly originally valued at $100M, for example), then that gift could be discounted by approximately $28M and save $14M in current estate taxes. Compounding over 20 years, the strategy would save $42M in taxes.
c)     Methodology for Discounting Closely-held Businesses - There are multiple ways to value a business. Private businesses, however, are usually valued lower than equally-sized public companies for two common reasons:
i)      Lack of Marketability - Ownership in private businesses is much harder to convert to cash than public shares, because there is no consistent market like the NYSE, for example.
ii)    Lack of Control (also called a minority discount) - Private business interests are commonly non-controlling interests in the business, as opposed to stock in a public company in which all owners have a number of votes proportional to the number of shares owned.
iii)   Family Limited Partnerships - Family limited partnerships can hold many different types of assets but are especially valuable for consolidating the management of illiquid investments, such as hedge fund and private equity interests and closely-held businesses.
a.      Using a family limited partnership is a common strategy for structuring closely-held businesses.
b.     The interests are held between general partner interests, which possess the power to make all decisions related to the partnership and limited partner interests that are non-controlling and only participate in the partnership’s profits.
c.      You can create a Family Limited Partnership to own a portion of your assets; one of our recommendations is that you move assets out of your name and off your balance sheet without surrendering control. The partnership would create a 1% controlling interest and a 99% non-controlling interest. You can continue to manage the business through the 1% interest, but the non-controlling interest would be gifted and/or sold to an irrevocable trust.
d.     Since a non-controlling interest would be transferred, the value of the FLP interest that is gifted or sold would be reduced for gift tax purposes under the current IRS regulations. 
e.      This discounting allows you to preserve a greater portion of the $5,450,000 lifetime gift exemption for use in future wealth transfers without imposition of the gift tax.
d)     Discounting Requires Qualified Appraisers – The appraisal needs to come from either an accounting firm or a professional valuation firm specializing in valuation of closely-held business interests. According to the IRS, a “qualified appraiser”:
                 i.          Has earned an appraisal designation
               ii.          Regularly prepares appraisals
             iii.          Demonstrates verifiable education and experience in valuing the type of property
              iv.          Is NOT someone who is the donor or recipient of the property
e)     Discounting with Real Estate
                 i.          Ownership of a tenant in common interest justifies a valuation discount that is not available with joint tenancy ownership. In a Tenancy in Common, each owner has an equal right to the property and separate fractional percentages of ownership interest in the property.
               ii.          It is well established that there is a very limited market for buyers who are interested in purchasing a fractional interest in real estate (lack of marketability discount). Lack of control over the property and historic costs associated with partition justify a 15% discount in these instances.
3)     Other Estate Freezing Strategies That Are Hot Opportunities – To decrease your taxable estate, these strategies transfer future growth in the asset to the next generation. Using these freezing strategies earlier during your lifetime could help offset the loss of discounting.
                         i.          Grantor Retained Trusts - One frequently used strategy utilizes grantor retained trusts, including a grantor retained annuity trust, a grantor retained unitrust, and a qualified personal residence trust.
                       ii.          Defective Grantor Trusts - Another strategy is to sell appreciated assets to an irrevocable trust. This freezes the current asset value being sold. Although it is a grantor trust for income tax purposes, it is considered an irrevocable trust for gift and estate tax purposes.
                     iii.          Philanthropic Planning - Charitable gift planning can also achieve tax-efficient wealth transfer planning, including charitable remainder trusts, charitable lead trusts, and private foundations.
“The fuse is lit; valuation discounting is now time-sensitive,” McManus emphasized. “Discounting is still available for existing family partnerships and for partnerships that are set up for gifting purposes, but McManus & Associates is advising clients to act now – consider creating a family partnership or making additional transfers of family partnership interests, with the opportunity potentially expiring soon.”
Before the IRS-proposed regulations become permanent, call McManus & Associates at 908-898-0100 for trusted advice on wealth transfer valuation discounting strategies. To learn more about award-winning McManus & Associates, go to
About McManus & Associates
Twenty-five years ago, McManus & Associates was founded to deliver the highest quality estate planning services that the largest firms promise with the more intimate, personalized relationships that a boutique firm can offer. Since that time, some of the most prominent families in finance, media, academia and medicine — both domestic and international — have relied on the firm to serve as their advisor in wealth and family mission planning.

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