Valuation discounting: For a limited time only

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Estate planning attorneys have been using discounting techniques as an important part of wealth transfer planning for many years. This past year there were several indications that regulations would be issued soon by the Treasury Department that will significantly curtail this practice.

Generally speaking, discounting involves the use of planning techniques that facilitate an estate and/or wealth transfer plan that makes assets less valuable for gift and estate tax purposes. Discounting in its simplest form is often times achieved by transferring the assets to an entity (such as a limited partnership) that imposes restrictions on the ability of the owners to convert the assets into cash. Gifts of an interest in the limited partnership would be valued at less than the underlying assets in the partnership because there would be significant restrictions. For example, typically, there is no way to convert the partnership interest to cash and no way to control the investment decisions or the decision to sell the assets. The actual value of the gift would be determined by an appraiser, but even a modest discount from the fair market value of the underlying assets could save a considerable amount of gift and/or estate taxes.

The IRS has, over the years, fought this type of planning, especially where the assets consisted of marketable securities. There have been many cases in Tax Court where the IRS has challenged this type of discounting strategy, and it has had some success. Most of the taxpayer losses have been in situations where the partnership or LLC was not set up properly, or the gifting was not executed properly.

There has been a fair amount of press this summer on the IRS plan to curtail this estate planning technique in a more formal and permanent way. Treasury already has been given broad authority to issue regulations limiting situations where discounts can be taken. Existing regulations provide that an “Applicable Restriction” is ignored when determining the value of an asset. An “Applicable Restriction” is one that limits the ability of a corporation or partnership to liquidate, if the restriction lapses or could be changed in the future by family members. A limit provided under state or federal law is NOT considered an applicable restriction, so these types of restrictions are permitted and can provide the basis for a discount on the value of an interest.

All indications were that these regulations would be released by the end of summer, but we have heard little on the subject in the last few months. While most practitioners feel that an outright prohibition on marketability discounts would be beyond the power of the Treasury, there may be some room for Treasury to scale back the use of this technique. The scope of the changes is unclear, as is the timing of the effective date of the regulations. Although these regulations would likely be issued as proposed regulations, these types of regulations are oftentimes made effective as of the date of initial publication, meaning there would be little or no advance notice that the changes were coming.

This and other tax issues will be the topic of discussion at our upcoming Business Hour event – Top tax issues and planning ideas for 2015. Join us for a discussion on the latest tax updates, strategies, and insights by registering to attend our Business Hour or to watch the live webcast so you can start planning for 2015 taxes now.

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