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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Proposed Basis Consistency Regulations

The Internal Revenue Service released proposed and temporary regulations to further consistency in the reporting of the tax basis of certain property received by a beneficiary of an estate or trust. These regulations provide guidance regarding the basis consistency requirements under IRC 1014(f) and reporting requirements under IRC 6035.

For estates with tax due after July 31, 2015, the executor or trustee is required to file Form 8971 indicating information about the beneficiaries, the property to be acquired by the beneficiaries, and the estate tax value of the property. The initial basis of the beneficiary may not exceed the basis reported to the IRS on such form. The executor is also required to furnish a statement (Schedule A of Form 8971) to each beneficiary who will acquire property from the estate including the value of the property. Estates filing tax returns to elect portability for a surviving spouse are not required to file the basis consistency reports. The regulations also establish penalties for inaccurate basis reporting and failures to furnish correct statements.

 Generally, Form 8971 must be filed with the IRS no later than 30 days after the estate tax return is due or filed and is required to be filed separately from the estate tax return. Effective March 23, 2016, the IRS announced that additional time will be granted to estates currently required to file Form 8971 and delayed the time to file and furnish the statement to beneficiaries until June 30, 2016.

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Using Intra-Family Loans to Transfer Wealth

Intra-family Loans can be a great opportunity for families to give their children or relatives additional funds, or if a relative is looking to make a significant purchase, a relative can borrow from a member of the family at a much better rate than going to a financial institution. Most individuals are familiar with the idea of making gifts to their children or relatives of an amount below the annual gift exclusion of $14,000, but those seeking to make transfers to their family that exceed the annual exclusion should be considering intra-family loans because of current low interest rates.

If making such a loan, the loan should be properly documented and interest must be charged and paid. If these requirements are not met, the Internal Revenue Service (“IRS”) may recharacterize the loan as a gift. If treated as a gift, the loan will reduce the lender’s gift and estate tax exemption or may cause the gift to be taxed at the current gift tax rate of 40%. It is recommended that the loan be documented with a promissory note and a fixed payment schedule. An interest rate equal to or above the Applicable Federal Rate (AFR) must be charge on the loan. The AFR will depend on the length of the loan. For loans with an annual compounding interest, the January interest rates are as follows: short-term (< 3 years): .56%; mid-term (3-9 years): 1.68%; and long-term (> 9 years): 2.61%. The recommended length and structure for repayment of the loan will likely depend on the AFR at the time of the loan, the financial needs of the lender, and the funds available to the borrower.

As an example of the effectiveness of such a loan, Parent makes a loan to Child for $500,000 and Child invest such funds with an annual return of 5%. If the loan is for a term of 9 years with a balloon payment at the end of such time, the applicable January mid-term rate would be 1.68%. At the end of the 9 year period, Child would have $775,664. The payment due on the loan would be $580,885. Child nets $194,779. Parent would be required to report the amount of interest, $80,885, as interest income.

While current rates remain low, it is likely that the rates will increase over the course of 2016. If you want additional information or would like to take advantage of the current interest rates, contact the attorneys at Vandenack Williams LLC.

© 2015 Vandenack Williams LLC
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