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Proposed New Rules Will Eliminate Discounts on Transfers of Interests in Family-Owned Entities

In September, the IRS announced proposed Treasury Regulations which, when finalized, will make sweeping changes to the way in which ownership interests in family-owned businesses or family-owned investment entities will be valued for federal estate, gift and generation-skipping transfer (GST) tax purposes. Fortunately, the new regulations in most instances will not apply to transfers that occurred prior to the regulations becoming finalized, which likely will occur sometime in early 2017. Thus, if you have been thinking about making transfers of interests in a family-owned business or investment entity, you should consider doing so prior to year-end.

Valuing Family-Owned Businesses
Several factors are taken into account when determining the value of an interest in a closely held or non-publicly traded business entity for wealth transfer tax purposes. Typically, a professional appraiser will determine the value of the business or entity as a going concern before considering whether it is appropriate to apply certain discounts to this value. The two discounts that are most often applied are discounts for lack of marketability and discounts for lack of control.

Discounts for lack of marketability take into account the fact that a closely held business cannot be readily liquidated. Instead, the owner will need to spend time and money to realize the going-concern value in dollars. This additional time and expense is reflected in a discount from the going-concern value as determined by the appraiser. Discounts for lack of control, where relevant, reflect that a non-controlling interest in the business is being conveyed. Minority ownership interests (less than 50%) and nonvoting interests are examples of ownership interests that are entitled to lack of control discounts.

Example: A family-owned business is determined to be worth $1 million as a going concern. Anne owns 100% of the business and would like to make a gift of a 10% interest to a trust for her three children. Under current regulations, the gift tax value of the interest is not simply 10% of $1 million, or $100,000, but instead, discounts for lack of marketability and lack of control can apply. If the value of the 10% interest is discounted by 25%, in this example the value for gift tax reporting purposes is reduced to $75,000.

The new regulations, if adopted as proposed, would effectively eliminate these discounts for all family-owned entities, whether operating businesses or passive investment vehicles. Thus, in the example, the value of the gift of a 10% interest would be 10% of $1 million, or $100,000.

The proposed regulations indicate that these discounts should continue to be available so long as the transfers are completed prior to the issuance of the final regulations. If you have been thinking about making such transfers and would like to take advantage of the lack of marketability and lack of control discounts that currently apply under today’s regulations, we suggest that you consider making these transfers before the end of the year.

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