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 www.mcmanuslegal.com.
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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