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Estate and Elder Law

John Dedon On Estate Planning: Are Asset Discounts on Family Transfers a Thing of the Past?

Perhaps the primary estate planning strategy utilized in reducing gift and estate tax for several decades has been taking advantage of discounts for family transfers of closely held businesses and real estate interests. These same discounts also apply to marketable securities if packaged properly in an LLC or a Family Partnership.

The value of the transferred interests are often in the form of non-voting stock or a non-controlling limited partnership interest or assignee interest. E.g., Dad places marketable securities, with a value of $1 million into a Limited Partnership. Next, Dad transfers a 99% Limited Partnership interest to his children or a Trust for his children. Because the Limited Partnership interest has no control and is not freely marketable, the value of the 99% Limited Partnership interest for gift tax purposes is $643,500, not $990,000, because of a combined 35% market and minority discount.

Depending on the assets transferred and the facts, the discounts can range from 20% to as much as 45% or 50%, provided they are supported by an appropriate appraisal. The IRS’ position is that these discounts are not appropriate within a family setting. According to the IRS, these family transfers are done only for tax planning and the family remains in direct or indirect control of the transferred asset. (In contrast to an arm’s length purchase of a minority interest by a non-related third party.)

However, the Service has met with limited success in combatting these discounts. The success they have had is often due to the taxpayer’s poor planning or the taxpayer’s failure to observe the formalities of the transfer and of the post-transfer ownership requirements. When done appropriately, the discounts are allowed although there is often a compromise if a taxpayer is audited. E.g., Taxpayer claims a 44% discount, the IRS initially offers a 15% discount, the parties settle for a discount of 35%.

Now, the IRS may be receiving more ammunition to combat discounting of family transfers. Proposed regulations are due out by the end of 2015, which would impose restrictions on intra-family transfers designed to obtain valuation discounts. When the regulations under Internal Revenue Code Section 2704 come out, and what precisely they say, is uncertain. What is certain, however, is that the IRS will not stop challenging the discounts. From the taxpayer’s perspective, any potential planning would be better implemented now versus later when the IRS may have additional authority on its side. 

Read more discussion of estate planning topics affecting Virginia residents and U.S. citizens at Dedon on Estate Planning.

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