IRS proposed regulations impact estate planning - by John Varella

John Varella, Lourie & Cutler

Recently the IRS proposed regulations that would significantly impact the valuation of limited liability company interests, partnership interests and stock in family-controlled businesses for estate and gift tax purposes.

Often parent-owners of family businesses transfer their equity interests in the business to their children through gifts of LLC interests, partnership interests or stock. To determine the value of the gift, the taxpayer-parent takes into account restrictions on the partnership interests or stock, such as restrictions on transfer or the fact that the interest is a minority interest. These factors, among others, result in a reduction, or discount, in the gift’s value for gift tax purposes. The IRS proposed regulations would disregard certain restrictions in determining the fair market value of the transferred partnership interests or stock. As a result, the value of the gift would be higher, and, the imposition of the gift tax more likely.

The proposed regulations attempt to prevent the gift tax reduction in multiple ways. First, the regulations would disregard restrictions on liquidations that are not mandated by federal or state law. Second, the regulations would disregard the ability of nonfamily member owners to prohibit the removal of certain restrictions unless the nonfamily member had held the interest for more than 3 years and owns a substantial interest in the business. Third, the regulations would eliminate a discount for an equity interest that did not convey voting rights with it. Fourth, the regulations would disregard transfers of interests that did not also convey the right to liquidate the business. The regulations will apply to transfers occurring after the date that final regulations are published.

The impact of these regulations on the manner in which family businesses are passed down from one generation to another cannot be understated. The limitations would significantly limit the taxpayer’s ability to take discounts for lack of control and/or minority interest on the transfer of an equity interest to a family member. Family business owners may want to consult their tax lawyers regarding these proposed regulation.

John Varella is an attorney with Lourie & Cutler, Boston, Mass.