Category Archives: Estate Tax

2704 Regulations Explained: Proposed Rules Are Set to Further Expand Value Differences between Family-Controlled Entities and Other Companies

The IRS is focused on reducing valuation discounts associated with transfers of interests in family-controlled businesses, but this focus will result in family members being deemed to receive a different value than non-family members.  This also means that an appraiser will be required to establish two different values based on ignoring certain restrictions for family members, while taking those same restrictions into consideration for non-family members.

Consider, for example, a trust that provides that 50 percent of a decedent’s family-controlled business interest will go to charity and the remaining 50 percent will go to family members.  The IRS will be expecting that the interest being conveyed to the family members to result in a higher value when compared to the same percentage interest being conveyed to charity.  This ultimately means that the interest conveyed to family will result in higher estate taxes and the interest conveyed to charity will result in a smaller charitable deduction for estate tax purposes.  The end result is the IRS receives more estate tax from the estate even though the same restrictions apply to all members (both the family members and charity).

This post is part of a series of blog posts addressing the proposed 2704 regulations and the parties that should be reviewing their plans as a result.

View previous posts:

Thomas J. McLaughlin
tmclaughlin@williamsparker.com
941-536-2042

What Do Estate Tax Laws in Other Countries Tell Us About the Presidential Candidates’ Proposals?

Under current law, the federal government imposes a 40% estate tax to the extent an individual’s estate exceeds a $5.45 million exemption. Republican presidential nominee Donald Trump advocates eliminating the tax. Democratic presidential nominee Hillary Clinton previously previously proposed reducing the exemption to $3.5 million and increasing the tax rate to 45%. Last week, she further proposed increasing the tax rate to 50% to the extent an estate exceeds $10 million, 55% to the extent an estate exceeds $50 million, and 65% to the extent an estate exceeds $500 million.

According to a 2015 Tax Foundation study, the current top 40% federal estate tax rate was the fourth highest amongst the 34 countries in the Organization for Economic Cooperation and Development (OECD) at that time. Japan had the highest top rate, 55%. Spain had the next highest rate behind the U.S., 34%. Chile rounded out the top 10, at 25%. 15 countries imposed no estate tax.

Adopting the Clinton proposal would make the U.S. top estate tax rate 10% higher than any other OECD country’s top rate. Even if we ignore the 65% rate applicable only to estates over $500 million, a 55% top rate would tie the U.S. with Japan for the highest rate. Even a 50% top rate would tie the U.S. with South Korea for the second-highest rate.

What does this tell us? The candidates’ proposals are at the opposite extremes of worldwide estate tax policies. While neither proposal seems likely to pass into law, the divergence underscores the tax policy polarization between the candidates.  Rather than “fitting in,” each pushes our nation’s tax policy to an extreme.

There is also a question whether adoption of either policy would serve the proposing candidate well as President.  How would Mr. Trump’s disgruntled blue collar supporters react to estate tax repeal?  One also can wonder whether Ms. Clinton’s proposal would motivate more of the wealthiest Americans to surrender their citizenship and move capital out of the U.S., not a result she relishes.

Here is a link to the Tax Foundation estate tax study: http://taxfoundation.org/article/estate-and-inheritance-taxes-around-world

Here are links to recent media coverage regarding the candidates’ estate tax proposals: http://www.wsj.com/articles/hillary-clinton-proposes-65-tax-on-largest-estates-1474559914

http://www.latimes.com/nation/politics/trailguide/la-na-trailguide-updates-1474577545-htmlstory.html

http://www.forbes.com/sites/robertwood/2016/09/23/hillary-clintons-65-estate-tax-or-donald-trumps-repeal/#450664385bf7

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

2704 Regulations Explained: Proposed Rules Negating Gift and Estate Tax Valuation Discounts May Ensnare Your Vacation Home Too

As mentioned in several recent posts, the proposed regulations under Code Section 2704 are aimed at reducing valuation discounts associated with transfers of interests in family-controlled businesses.  So that the proposed regulations capture certain entities that may be disregarded for federal income tax purposes, such as single-member limited liability companies, the definition of a family controlled entity under the regulations casts a wide net.  In fact, this net is so expansive that it has the ability to reach certain business arrangements that are significantly different from the typical family business.

Consider, for example, three siblings who own a vacation home as tenants-in-common.  Assume that the siblings have executed a co-tenancy agreement that restricts each tenant’s ability to partition and sell their interest (as many of these agreements do).  If this arrangement constitutes a controlled entity under the proposed regulations, then the regulations would apply to this co-tenancy arrangement in generally the same manner that they would apply to an active trade or business.  Should the proposed regulations apply, if a co-tenant transfers his or her interest in the vacation home (either during life or at death), the value of this interest for transfer tax purposes may be computed without regard to the restriction on partition in the co-tenancy agreement and, in turn, any valuation discounts that this restriction may warrant.  In this event, the application of the proposed regulations may result in a higher gift or estate tax value associated with this transfer.

This post is part of a series of blog posts addressing the proposed 2704 regulations and the parties that should be reviewing their plans as a result.

View previous posts:

Douglas J. Elmore
delmore@williamsparker.com
(941) 329-6637

2704 Regulations Explained: Winners and Losers of Proposed §2704 Regulations, Is the IRS a Loser?

The recently issued proposed regulations under Code Section 2704 are specifically targeted at substantially reducing valuation discounts associated with family-controlled businesses.  The clear losers are the families that have taxable estates. These families will likely pay additional estate and gift tax once the §2704 regulations are finalized. In order to reduce the impact that will occur when the regulations are finalized, families that have taxable estates should review their existing plans to determine whether planning now could save them substantially later.

The IRS is likely to win in the long run, but the increased estate and gift tax revenue will be offset to an extent by a reduction in income tax.  In addition, courts have been reluctant to go along with the IRS’s past attempts to substantially change the value of a family-controlled business. Accordingly, if the IRS finalizes the regulations without substantial changes, we can expect multiple challenges to be forthcoming from taxpayers, which could further reduce what the IRS likely perceives as a significant revenue booster.

The clear winners are the family business owners that do not have taxable estates ($5.45MM on an individual basis and $10.9MM for a married couple) because the proposed regulations should allow their family to receive a larger step up in the income tax basis of the business, and in some cases the business’ assets, when they pass away.

This post is part of a series of blog posts addressing the proposed 2704 regulations and the parties that should be reviewing their plans as a result.

View previous posts:

Thomas J. McLaughlin
tmclaughlin@williamsparker.com
941-536-2042

2704 Regulations Explained: Why is the IRS Targeting Valuation Discounts on Family Controlled Entities?

The simple answer is that the IRS believes that valuation discounts taken on family controlled entities are falsely high, which results in lower transfer tax revenue to the Treasury.  With the foregoing in mind, it is important to understand how the IRS, courts, and taxpayers value a business interest under current law for estate and gift tax purposes.  The general rule for a valuation is to determine the price at which property would change hands between a willing buyer and a willing seller, both of whom have reasonable knowledge of the facts and neither of whom is compelled to complete the transaction.

The courts and the IRS have recognized that discounts should be allowed where the property transferred is a minority interest in an entity that cannot force or compel the entity to act (“lack of control”) and where there is a limited market for the property (“lack of marketability”).  Taxpayers and their planners began to take advantage of this knowledge by adjusting their entity’s governing documents to increase the discounts available when transferring interests to family members.  In 1990, Congress enacted Code Sections 2701 through 2704, known as Chapter 14, to quell what was seen by some as aggressive, and in some cases abusive, uses of these discounts to reduce transfer tax values especially when many of the restrictions imposed had limited or no significant substantive effect because the family had the ability to fully control the entity and eliminate the restrictions at its will.  Since Chapter 14 became effective, the IRS has slowly seen Chapter 14’s impact dwindle due to court decisions and changes in state law.  As a result, the Treasury began seeking legislative changes to Chapter 14; however, these changes were not getting traction in Congress after several years.  The proposed regulations are Treasury’s response to the inaction of Congress and an attempt to substantially reduce discounts that the Treasury believes to be an estate and gift tax planning fiction.

Over the next several weeks we will be providing a series of blog posts addressing the proposed regulations and a synopsis of the parties that should be reviewing their plans as a result of the regulations.

Thomas J. McLaughlin
tmclaughlin@williamsparker.com
941-536-2042

IRS Targets Valuation Discounts on Family Controlled Entities

The Treasury has followed through on its promise to issue proposed regulations that are intended to significantly reduce the lack of control and lack of marketability discounts applied by appraisers when valuing family-controlled entities.  The proposed regulations follow closely with guidance provided in the Treasury Department’s “Greenbook” as discussed in our prior post (click here to view prior post). The good news is that the proposed regulations have provided everyone with a window of opportunity to complete their planning before the regulations become final. We will provide a more detailed analysis of the proposed regulations soon.

Thomas J. McLaughlin
tmclaughlin@williamsparker.com
941-536-2042

IRS Rattles Its Saber to Restrict Family Partnership Planning. What Should You Do?

If you are, or someone that you know is, considering transferring an ownership interest in a family controlled entity the best time may be now.  Speculation abounds over the impact that potential new regulations may have on the valuation of a closely held business interest.  For several years, the Treasury Department’s “Greenbook” contained a Revenue Proposal entitled, “Modify Rules on Valuation Discounts.”  Based on recent comments made by IRS and Treasury officials, it is possible that new proposed regulations will be issued by the middle of next month.  In some cases the Treasury has made proposed regulations effective as soon as they are issued, which could occur in this case as long as the regulations are not otherwise modified when they are finalized.  When issued, many practitioners believe that the proposed regulations will reduce the amount of the lack of control and lack of marketability discounts that appraisers apply when valuing family-controlled entities.

With the lack of clear guidance available, it is impossible to know how significant an impact the potential new regulations may have.  The best guidance likely comes from last time the proposal was contained in the Greenbook, which read as follows:

This proposal would create an additional category of restrictions (“disregarded restrictions”) that would be ignored in valuing an interest in a family-controlled entity transferred to a member of the family if, after the transfer, the restriction will lapse or may be removed by the transferor and/or the transferor’s family. Specifically, the transferred interest would be valued by substituting for the disregarded restrictions certain assumptions to be specified in regulations. Disregarded restrictions would include limitations on a holder’s right to liquidate that holder’s interest that are more restrictive than a standard to be identified in regulations. A disregarded restriction also would include any limitation on a transferee’s ability to be admitted as a full partner or to hold an equity interest in the entity. For purposes of determining whether a restriction may be removed by member(s) of the family after the transfer, certain interests (to be identified in regulations) held by charities or others who are not family members of the transferor would be deemed to be held by the family. Regulatory authority would be granted, including the ability to create safe harbors to permit taxpayers to draft the governing documents of a family-controlled entity so as to avoid the application of section 2704 if certain standards are met. This proposal would make conforming clarifications with regard to the interaction of this proposal with the transfer tax marital and charitable deductions.

When additional guidance is provided, or the proposed regulations are released, we will provide an update discussing the potential impacts of the regulations.

Thomas J. McLaughlin
tmclaughlin@williamsparker.com
941-536-2042

Can Your Estate Plan Become More Effective if You Use an Holistic Approach Unique to Your Own Family’s Goals?

Estate Planning is hard for many reasons—from discomfort with death to difficult family dynamics. It is made harder by complicated tax laws and documents. Too often, in estate planning, the focus is solely on tax planning without considering the impact of the planning upon the family or incentivizing the type of behavior that is desired to act as an extension of the client’s system of values.

We try to make estate planning easier and more effective through a holistic approach, which entails sophisticated tax planning tailored to a client’s objectives for his or her family. To learn more, review these materials from our recent presentation at The World MoneyShow Orlando© conference:

View Presentation Here

Ric Gregoria
rgregoria@williamsparker.com
941-536-2031

Rose-Anne B. Frano
rfrano@williamsparker.com
941-536-2033

$14,000 Gift Checks Deposited After December 31 Will Give You a Holiday Hangover; Charitable Gifts, Not So Much

To conclude the Williams Parker Business & Tax Blog’s inaugural year, a few year-end tax tips:

If you receive a holiday gift check intended to qualify for the donor’s 2014 Federal Gift Tax annual exclusion of up to $14,000 per year, per recipient, improve your chances of repeat future gifts by depositing the check on or before December 31, 2014.  If you deposit the check during 2015, the check will not qualify for the donor’s 2014 annual exclusion.  That will make your generous donor unhappy because only annual exclusion gifts are “free” for transfer tax purposes.  If the gift does not qualify for the annual exclusion, the donor may owe gift tax or have to reduce his or her lifetime exemption, increasing Federal Gift Tax or Federal Estate Tax in the future.  More likely, the donor will give you less next year so your total gifts in 2015 fit within the donor’s 2015 annual exclusion.

Charitable gifts are more flexible.  Recipient charitable organizations are not required to deposit donation checks on or before December 31, 2014, to qualify for a 2014 income tax deduction.  The donor only has to document that the check was mailed or otherwise sent outside the donor’s control on or before December 31, 2014.

We hope you enjoy the holidays and have a happy new year.

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

Has Your Family Partnership Become a Family Liability?

Non-controlling family partnership interests with limited marketability have long been discounted for federal gift and estate tax valuation purposes, reducing their deemed fair market value and the gift and estate tax attributable to such interests. The income tax tradeoff for a partnership interest held until death is that the income tax basis in the partnership interest is lower to the inheritor, because that tax basis is automatically adjusted to fair market value. A lower tax basis potentially creates more taxable gain when the asset is later sold.

The tradeoff was traditionally tolerated because the federal gift and estate tax rate was higher than both ordinary income and capital gain tax rates. Since the federal estate and gift tax exemption increased to over $5 million per individual and over $10 million per married couple a few years ago, however, many families’ estate tax exposure has disappeared. For families with no ongoing estate tax exposure, valuation discounts that once made their family partnerships “tax assets” may now make the partnerships “tax liabilities.” Even though they may no longer have estate tax to avoid, the families are still left with a lower mark-to-market tax basis and potentially more future taxable gain after a family member dies.

Also, with recent changes in the law, the highest marginal federal income tax rate and the federal estate tax rate are now very close. For assets that produce ordinary income when sold for a gain, this reduces or reverses the estate-income-tax-rate arbitrage even for families with continuing estate tax exposure.

Should families unwind their family partnerships?

For families affected by these factors, it is worth asking the question anew. The question should be evaluated in the context of the many advantages and disadvantages–including non-tax factors–that characterize family partnerships.

In contrast, families with ongoing estate tax exposure whose family partnerships hold assets that will likely produce capital gain when sold are less likely to be affected by these factors. Their family partnerships likely remain effective estate planning tools.

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037