On August 2, 2016, the Treasury Department issued proposed regulations that would significantly reduce the tax planning benefits involving family limited partnerships and similar structures which are effective tools for certain wealthy families. Under a typical scenario, one or both parents might transfer various assets worth several million dollars into a limited partnership or limited liability company structured to have both controlling/voting shares and non-controlling/non-voting shares. The parent(s) might then transfer, either by gift or sale, substantial portions of the company, via the non-voting shares, to lower generation family members. Under the terms of the company’s governing documents, there are significant restrictions imposed on freedoms and controls of the non-controlling/non-voting shareholders; and those limitations warrant a significant discount in determining, for transfer tax purposes, the value of what has been given or sold to the lower generation (or to trusts for their benefit).
Historically, those limitations might justify a valuation discount on the order of 35% or more of the value of the underlying interests transferred to the younger family members; and the taxable value for computing the gift tax, estate tax, or generation-skipping tax consequences of those transfers reflects those powerful valuation discounts.
The new Treasury regulations, that could become effective as early as December of 2016, would effectively eliminate tax valuation discounts available to those and similar types of transactions among family members unless completed prior to the effective date of the new regulations.
The proposed Treasury regulations apply to family limited partnerships and similar family-owned entities without regard to whether the underlying assets relate to active business interests or more passive holdings such as marketable securities and real property. In addition, although much of the focus of the new regulations is targeted toward lifetime gifting and sale transfers, the elimination of these valuation discounts will also impact a decedent’s retained interest in such entities in terms of their value to be included in his or her taxable estate. Even clients who have already made lifetime transfers under the benefit of the old rules and available discounts will still need to be mindful of the consequences these new regulations can have on family company interests which they still own.
Individuals who likely face significant estate tax exposure and who are willing to irrevocably transfer a meaningful portion of their wealth into trusts for the benefit of their descendants (and in some cases for the benefit of one’s own spouse) may wish to consider acting very quickly so that, in addition to the other tax and non-tax benefits these structures afford, they can still also get the benefit of the available tax valuation discounts before those are eliminated.