Long-awaited proposed regulations under section 2704 of the Internal Revenue Code, released on August 2, 2016, would make sweeping and very significant changes to the valuation of interests in many family-controlled entities for estate, gift, and generation-skipping transfer tax purposes. For decades, the IRS definition of Fair Market Value (FMV), which is based on the concept of the hypothetical financial buyer, are typically completed on a control basis (more than 50%, but usually 100%), as most if not all buyers would have no interest in acquiring a minority position.
Many in the business valuation community feel that the proposed regulations introduce a new standard of value, with an unknown definition, that goes against years of accepted valuation theory and Tax Court precedent. In estate planning, which under the current and long-standing IRS FMV standard, provides discounts for lack of control and lack of marketability when minority interests are transferred to family members as part of the family’s estate planning or if a minority percentage of stock is being sold. That’s because in keeping with the FMV standard, the hypothetical buyer would not likely pay the same price for a minority share of a company as they would for a controlling share.
On April 21, 2017, President Donald J. Trump issued Executive Order 13789, a directive designed to reduce tax regulatory burdens. The order instructed the Secretary of the Treasury to review all “significant tax regulations” issued on or after January 1, 2016, and submit two reports, followed promptly by concrete action to alleviate the burdens of regulations that meet criteria outlined in the order. Specifically, the President directed the Secretary, in consultation with the Administrator of the Office of Information and Regulatory Affairs, to submit a 60-day interim report identifying regulations that (i) impose an undue financial burden on U.S. taxpayers; (ii) add undue complexity to the Federal tax laws; or (iii) exceed the statutory authority of the Internal Revenue Service (IRS).
The proposed IRC Section 2704 Regulations have been vigorously opposed by the appraisal community, lawyers, CPAs, wealth planners and business owners who testified before the IRS in unprecedented numbers (in more than 30 years). According to Catherine Hughes, attorney-advisor at the Treasury, “We will make it clear that these regs will not eliminate minority discounts.” This doesn’t mean that discounts won’t be significantly reduced, which they will be under the regulations as currently written. Although the effective date of any such regulations is uncertain, it’s likely that only transfers that are completed prior to the effective date (for example, completed gifts of partnership units or sales of them) will be grandfathered from the new rules.
While the fuss continues, it may be prudent for business owners intending to make such transfers to contact their advisors now rather than later.