CHANGES TO IRC 2704
Since 1990, IRC Section 2704 of the tax code has allowed the use of discounts when determining the fair market value of an ownership interest transfer in a privately held company (in particular, Family Limited Partnerships or Limited Partnerships). Typical discounts include the lack of control discount and the lack of marketability discount. Currently, these discounts are applied to the fair market value of an ownership interest from the viewpoint of a “willing seller” and “willing buyer,” both of whom would consider the valuation impact of:
- Not having control of the company (if a non-controlling or minority ownership interest is being transferred); and
- The absence of a public market to readily sell an ownership interest.
In August 2016, the Department of the Treasury and the Internal Revenue Service proposed significant changes to Section 2704 which would effectively eliminate consideration of any valuation discounts when gifting ownership interests to family members.
For a Limited Partnership, a common tax planning strategy for transferring wealth is to make gifts of minority interests to later generations of family members. By applying a valuation discount, a greater portion of value and ownership in a company can be transferred before exceeding the federal gift and estate tax exemption, which currently is around $5.45M. The proposed changes to Section 2704 could significantly reduce the amount of value that can be transferred without owing federal estate and gift taxes to the federal government. Or, in other words, the proposed changes could raise the taxable portion of an ownership interest transfer.
In this example, the discounts taken for lack of control and lack of marketability can save the taxpayer $14,360 ($50,000 less $35,640), or about one third of the tax liability if the asset were distributed through a Family Limited Partnership.
STATUS OF PROPOSED CHANGES
On December 1, 2016, the IRS will hold a hearing regarding the proposed changes to finalize the new regulations. The enactment of the new regulations would not be effective until 30 days after finalization. This means that the window on taking valuation discounts on gifts of ownership interests could close shortly after December 31, 2016. Although finalization could be delayed, predicting when the new regulations will take effect is beyond people’s control and could be risky for those business owners who would benefit from a family partnership.
Business owners should discuss the potential impact of the proposed regulations with their attorneys and valuation experts. By assessing their current personal financial situations, a business owner can determine whether it makes sense to begin an ownership transfer through a gift on a discounted basis before these changes are enacted.
The valuation experts at Brinker Simpson & Co. will be closely monitoring the situation. In addition, we will be attending a valuation industry webinar on September 29, 2016 entitled “The IRS’ Proposed Section 2704 Regulations: The Impact on and the Future of Estate and Gift Valuation” to learn more about these complex regulations. If you are interested in more information, please contact us.
We hope you enjoyed reading this issue of Business Valuations Letter. Whether you are planning your estate, settling a dispute or selling/buying a business, it is critical to have a sound, professional valuation opinion from a firm that will stand behind its conclusions. Lenders, insurers, the courts and government agencies are increasingly insisting on expert opinions to support claims where value is concerned.
Brinker Simpson's expert valuation consultants specialize in providing confidential business valuation services for closely-held and family owned companies, professional practices and partnership interests. We will work directly with you or one of your other trusted business advisors.
Whether you're planning for the future or dealing with a situation at hand, through careful analysis we will develop an independent, unbiased valuation report for your business.
For any questions regarding this newsletter or any valuation issues or concerns you may have contact our leaders of valuation services who are members of The National Association of Certified Valuation Advisors and Analysts (NACVA):
Michael Simpson, CPA, CVA
Albert A. Lazo, MBA, CVA