Internal Revenue Service and the Department of Treasury Withdraw Estate Valuation Regulations

by Monte L. Schatz

Historically, valuation discounts have been used as an estate planning tool to minimize estate, gift and generation-skipping taxation.  The ability to minimize taxation of ownership interests in closely held corporations, limited liability companies and partnerships has been critical in helping to assure the preservation and continuity of those businesses by legally avoiding tax obligations that would adversely affect the liquidity and cash flow of operating businesses.  The use of valuation discounts has been in a state of uncertainty for the past several months. Proposed regulations published by the Internal Revenue Service would have restricted valuation of discounts previously recognized under Internal Revenue Code § 2704.

The 2704 valuation discount provisions allow for statutorily recognized reductions in value resulting from the restrictions, illiquidity and reduced marketability of closely held business interests.  The 2704 discounts were particularly helpful for entities that were family owned businesses.  The proposed regulations published on August 4, 2016 would have provided for disregarding restrictions placed upon shareholders, partners or members for sale of their interest.  The practical result of disregarding those business entity restrictions would be elimination of any discount from the fair market value for those interests.  The entity would be taxed at fair market value thereby potentially increasing estate, gift or generation-skipping taxes for holders of those interests.

On April 21st, 2017 the President issued Executive Order 13789 instructing the Secretary of Treasury to review all significant tax 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 IRS.

The Secretary of Treasury submitted a final report to the President on September 18, 2017 recommending a complete withdrawal of the proposed regulations that would have eliminated certain valuation discounts for closely held businesses.  The report has been filed as of October 17th and is set for Publication on October 20, 2017.

§ 2704 Valuation discounts have been preserved for taxpayers who own closely held businesses.   The continued recognition and reaffirmation by the Treasury Department and Internal Revenue Service of valuation discounts preserves a critical estate planning tool for legal professionals to assist minimizing taxation of their client’s estates and helping to preserve the continuity and preservation of taxpayer’s ownership interests.

SOURCES:  https://www.gpo.gov/fdsys/pkg/FR-2016-08-04/pdf/2016-18370.pdf
https://s3.amazonaws.com/public-inspection.federalregister.gov/2017-22776.pdf

© 2017 Vandenack Weaver LLC
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Inherited IRAs Are Not Protected From Creditors

By Mary E. Vandenack.

On June 12, 2014, the Supreme Court ruled that inherited IRAs are not “retirement funds” within the meaning of the federal bankruptcy exemption for retirement funds. In making its decision, the Court distinguished inherited IRAs from IRAs established and held by the owner who originally deposited the funds.

Heidi Heffron-Clark (“D”) became the owner of an inherited IRA in 2001 when her mother died designating Heidi as sole beneficiary of an IRA account. D and her husband filed bankruptcy in 2010 claiming the inherited IRA as an exempt asset under 11 U.S.C. §522(b)(3)(C). The Bankruptcy Court disallowed the exemption. The District Court reversed. The Seventh Circuit reversed the District Court. The Supreme Court granted certiorari to resolve a conflict between the Seventh and Fifth Circuits.

The Court based its conclusion that an inherited IRA is not a retirement fund on three legal characteristics of inherited IRAs. First, the holder of an inherited IRA cannot invest additional funds into an inherited IRA. Second, holders of inherited IRAs are required to withdraw money from the accounts regardless of their age when they inherit the IRA. Third, the holder of an inherited IRA can withdraw the entire IRA, without penalty, at any time whereas original IRA owners are subject to penalties on withdrawals before the age of 59 1/2.

The Court rejected the argument that the bankruptcy definition of retirement funds could be construed as any funds that were set aside for retirement simply because such funds were set aside for retirement by the original owner. The Court noted that such a definition would have the result of treating funds that had been set aside for retirement at some point in time being treated forever as retirement funds regardless of the withdrawal of such funds and later form. By way of example, the Court suggested that such definition would mean that an original IRA owner could withdraw funds, give the funds to a friend who would put the funds in a checking account and then later claim exemption based on the concept that the funds had previously been put in a qualified retirement account.

© 2014 Parsonage Vandenack Williams LLC

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Trusts Can Be Excepted From Passive Activity Losses Related to Real Estate

The IRS has historically argued that trusts are categorically excluded from obtaining an exception to the passive activity rules for rental real estate activities. A recent Tax Court ruling has contradicted this position and indicated that a complex trust engaged in rental real estate activities can qualify for an exception to the passive activity rules.  In determining that the exception was available, the court looked to the activities of the individual trustees and determined that the material participation trust was satisfied. This is an important ruling in the trust income tax regime and creates the opportunity to limit trust exposure to the tax on investment income.

© 2014 Parsonage Vandenack Williams LLC

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Supreme Court Upholds Individual Mandate

The Supreme Court has upheld the constitutionality of PPACA in a 5-4 ruling issued today.  The Supreme Court determined the individual insurance mandate was not unconstitutional under the Tax Clause of the Constitution.

A key provision of PPACA was deemed unconstitutional.  Under the Act as originally drafted, the Secretary of Health and Human Services would have had the power to withdraw all Medicaid payments from any state that failed to comply with the expanded Medicaid requirements under the Act.  The Supreme Court held that this provision is unconstitutional.  As a result, the Secretary of Health and Human Services may only withhold funds disbursed under PPACA if a state chooses to participate in the program and fails to comply with its provisions.

The Supreme Court’s ruling underscores the importance of planning for the implementation of PPACA.  Several key provisions of the Act take effect in 2013.  These provisions include Medicare tax increases for individuals earning more than $200,000 per year and married persons filing jointly  earning more than $250,000 per year.  The Act also imposes a $2,500 cap on employee health flexible spending account contributions.  Beginning in 2013, employers will no longer be eligible to take a deduction for providing retiree prescription drug coverage.

Additionally, the comparative effectiveness research fee for employers sponsoring group health plans will increase in 2013.  Employers were previously required to pay a $1 fee for each participant in a sponsored group health plan.  That fee will now double in 2013, and will afterward be indexed to national health expenditures.  Employers will also be subject to additional notification requirements regarding exchange programs.  For example, employers in participating states will be required to provide employees with information about options they may have if the employer’s coverage is not affordable. In light of the major effects that PPACA will have on group health plans and other related policies, it is crucial for employers to review these plans and policies to make sure that they comply with PPACA provisions coming into force in 2013.

Stay tuned for future blogs and articles about the PPACA once the entire opinion can be digested…

© 2012 Parsonage Vandenack Williams LLC

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