By Drew Grey, CPA, Partner
On May 7, Melissa Liquerman, IRS branch chief in the Office of the Chief Counsel, told an ABA gathering that final regulations relating to these rules could be released within the next six to eight weeks. That means that by July 7 we may see regulations which address valuation adjustments for family-owned businesses and other entities, such as family limited partnerships and family LLCs.
Some have speculated that the regulations might exempt operating businesses. The gift of a 20% interest in the family “S” corporation that operates business might not be affected. However, the gift of 20% interest in a family limited partnership or LLC that holds real estate would lose the discount.
The situation we are now in is reminiscent of the situation at the end of 2012, when the fear was that the estate tax exclusion would be reduced from $5 million to $1 million. At the time, lawyers and taxpayers rushed to do planning to use up each taxpayer’s $5 million lifetime transfer tax exclusion. Of course, the reduction never occurred, and their $5 million exclusion became “permanent” and has been increased by change in the cost of living. This time appears to be different because the change will not be made by Congress, which is changeable, but by the IRS, which is implacable. The end of valuation discounts in at least some situations seems certain to occur, as the IRS has been discussing this – and warning us about this – now for years.
WHAT SHOULD WEALTHY TAXPAYERS DO? For liquid assets, investment real estate and other non-operating assets, establish the family limited partnership now. Then consider the best way to transfer significant interests in those entities to an irrevocable trust for the children. The best way might be the way that uses the least amount of lifetime exclusion, or the way that keeps all of the income from going to the parents, or that transfers the most amount of the wealth, or the way that accomplishes all of the above.
Of course there is no certainty as to the effective date of regulations which have not yet been issued. They might be prospectively effective, which will give additional time to engage in planning. However, transactions completed before the effective date will almost certainly be “grandfathered” as the U.S. and California constitutions both have contract clauses. Article I Section 10, clause 1 of the U.S. Constitution states “No State shall … pass any … Law impairing the Obligation of Contracts.” See also Article 1, Section 9 of the California Constitution.
Even if the regulations eliminate discounts, that will not be the end of estate tax planning. We will still be able to argue about the value of the assets, e.g., the investment real estate and the closely held businesses. We will still have structures, such as GRATs (grantor retained annuity trusts), SCINs (self-cancelling installment notes), Private Annuities and QPRTs (qualified personal residence trusts), that have discounts inherent in them. However, it will put more pressure on experienced professionals to be thoughtful with planning.
The above is not tax advice for any client or matter; it is provided as a topic of general interest to our readers and should not be used for tax planning purposes. Each client’s situation contains unique facts.
If you are interested in exploring how these rules could benefit you, please contact Drew Grey at (818) 995-0090 or at firstname.lastname@example.org to receive advice on your specific matter.