Is This the Last Year for Valuation Discounts?
If your entire business is worth $1,000,000, then how much is a 20% interest in your company worth? If you said $200,000, then you are right. And wrong.
It is well established that the value of a minority interest in a business is worth less than a proportionate share of the entire company. In other words, a 20% interest in a $1,000,000 company actually is worth less than $200,000. This is because a minority owner has no say in how the business is run and often cannot force the return of his or her investment. A minority owner cannot force the company to distribute profits or to fire an underperforming CEO. A minority owner has no right to a position on the board of directors, and no ability to prevent the company from making a bad investment. Because of the many limitations on the rights of a minority owner, the value of a minority interest is discounted in the marketplace.
When the value of a minority interest in a business is discounted, there is a corresponding reduction in the amount of gift, estate, and generation-skipping transfer tax assessed upon transfer of the minority interest. Taxpayers and their professional advisors have long taken advantage of valuation discounts to reduce gift, estate, and generation-skipping transfer taxes. While most of this work is empirically defensible, some of the discounts taken by taxpayers and their advisors have pushed the limits.
In the last two decades the IRS has used a variety of methods to challenge the validity and extent of valuation discounts. While the IRS has had some success in these efforts, today valuation discounts remain a powerful tax reduction strategy. That’s about to change.
On August 2, 2016 the IRS published proposed regulations that would virtually eliminate valuation discounts in transfers of business interests between family members. The stated goal of the regulations is to prevent the undervaluation of transfers of business interests among family members. But the regulations actually go well beyond preventing undervaluations and might actually cause artificially high valuations of interests in family businesses.
Keep in mind that the August 2, 2016 regulations are not final. The IRS is accepting comments on the proposed regulations, and will host a hearing on December 1, 2016. Final regulations could be published any time after that hearing.
If you or a family member owns interests in a closely-held business, we suggest that you contact a member of Ice Miller’s estate planning team
to discuss whether the new rules are likely to affect you and to determine whether you should take some action before the regulations become final.
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.