Estate Planning Update: Is the IRS Ending Valuation Discounts?

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1 Estate Planning Update: Is the IRS Ending Valuation Discounts? Marc Bloostein Kimberly Cohen Geoffrey Mason November 17, 2016 LLP

2 Agenda Background What is 2704 and what are the 2704 Proposed Regs? When will these Regs become effective? What impact might Trump s election have? How does this affect current planning? 2

3 Background I.R.C enacted in 1990 Address a range of potentially abusive arrangements in the family context The IRS had long rejected discounts in the family context IRS lost a significant court case in 1980 Finally abandoned this position in 1993 After 1993 family limited partnerships came into widespread use IRS used many tools to fight FLPs, including the special valuation rules, but met with limited success 3

4 I.R.C Taxable lapse If a voting or liquidation right lapses in a familycontrolled entity the lapse is a deemed transfer subject to tax Certain restrictions disregarded If an interest in a family controlled entity is transferred to a family member, any restriction that limits the ability to liquidate the entity is disregarded if it lapses or may be removed by family members Current Regs temper these provisions 4

5 Overview of the Proposed Regs 2701 control provisions Definition of corporation and partnership Lapse on transfer to assignee New 3-year rule for lapses by transfer New definition of Applicable Restriction New concept of Disregarded Restriction Unrelated parties ignored in assessing posttransfer control 5

6 Case Study: Family LLC Harold and Wilma have three children Harold contributes $5mm to a Family LLC Receives a 100% interest Family LLC formed in DE and provides No Member may withdraw 2/3rds of Members may compel liquidation Harold later transfers 20% interests apiece to each child 6

7 Current Law Transfer of 60% interest results in lapse of Harold s right to liquidate Family LLC No adverse consequence under current Regs Restriction on liquidation not Applicable Restriction No more restrictive than default provision under DE law Lack of withdrawal right not Applicable Restriction Arguably not covered by the current Regs because it limits a Member's right to liquidate the Member's interest, not the entity as a whole In any event no more restrictive than default provision under DE law 7

8 Valuation under Current Law Start with net asset value Net asset value of Family LLC is $5mm Net asset value of a 20% interest is $1mm Take into account relevant discounts Discount for lack of marketability Discount for lack of control Valuation often reflects a combined discount in the range of 25-40% 8

9 Proposed Regs Transfer of 60% interest results in lapse of Harold s right to liquidate Family LLC No problem if Harold survives transfer by 3 years If Harold dies within 3 years then there is a deemed lapse at his death taxing value of lapsed liquidation right Regs not clear on how to value lapse Restriction on liquidation is Applicable Restriction Default provision under DE law is irrelevant Lack of withdrawal right is Disregarded Restriction Default provision under DE law is irrelevant 9

10 Valuation under Proposed Regs Start with net asset value Take into account relevant discounts Lack of liquidation right ignored Lack of withdrawal right ignored Ignoring these restrictions seemingly means no discounts for lack of marketability/control But plenty of uncertainty and significant clarification is needed Not clear how to apply traditional valuation approach once these interests are ignored 10

11 Effective Date Regs effective when published as final Regs 30-day delay for rules relating to Disregarded Restrictions New 3-year rule should not apply to transactions entered into before Regs become effective Public hearing on 12/1/2016 More than 9,500 comments have been received Several significant criticisms will have to be addressed before Regs are finalized Not likely to be finalized before Trump takes office 11

12 Impact of Trump s Election Finalizing the Proposed Regs likely will not be an IRS priority after Trump takes office Climate now right for estate tax reform Estate and GST taxes could be repealed Gift tax likely to remain as backstop to income tax Basis step-up at death likely to be eliminated Could be replaced with tax on capital gains held at death Trump plan calls for tax on gains over $10 million Canada imposes such a tax on a comprehensive basis 12

13 Planning Considerations Effectuate planning now if it makes use of valuation discounts Consider transfers that would eliminate controlling interests in family entities But avoid any planning that would prove unwise if the estate tax is repealed E.g., avoid transactions that could result in a gift tax being due 13

14 Contact Information Marc J. Bloostein Partner, Private Client Group Kimberly E. Cohen Partner, Private Client Group Geoffrey M. Mason Partner, Private Client Group