Stricter Rules for Valuation Discounting and Estate Planning

An estate and succession planning tool for passing down appreciable assets to family members utilizing discounts is soon to end. Current rules have flexibility and does allow for some advantageous estate tax planning for taxpayers. What are those strategies and how do they work?

Assume real estate-planningestate was purchased twenty years ago for $750,000 with $250,000 being allocated to land. After consideration for depreciation, the adjusted tax basis of the property is $494,000 today. Also assume that the proper
ty has a fair market value of $2,500,000 when the property is contributed into a Family Limited Partnership (FLP) for gifting. When the gift is made, the actual gift will be units of the FLP, not the deed of the property itself.

Generally, the courts allow for a discount to reflect the lack of control held by a minority interest owner and the lack of marketability of such interest held by a FLP. As such, a minority interest and lack of marketability discount is appropriate for the gift of the FLP interest. There is no set formula for determining the exact percentage of the minority interest and lack of marketability discounts, but often, discounts fall between 20% and 40%. The average 30% discount would allow the $2,500,000 gift to reduce the life-time exemption by $1,750,000 saving $750,000 for additional gifting.

This technique was extremely powerful when the lifetime exemption was only $1,000,000, rising to $3,500,000 through 2009. But in 2010 when the lifetime exemption increased to $5,000,000 and the rules of portability came into play, complex estate planning became less necessary for many small business owners. For these taxpayers, it may be advantages to leave the assets with the original holder and allow for a stepped up in basis at the time of death. But for single and joint estates larger than $5,450,000 and $10,900,000, respectively, this technique is still a very important estate tax saving tool.

The ability to use this type of discounting as a viable estate planning tool is about to change with new proposed regulations. The purpose of the new proposed regulations is to substantially reduce an individual’s ability to apply valuation discounts when gifting interest in closely held family businesses and other appreciable property. The proposed regulation is not expected to take effect until sometime in early to mid-2017.

The old rules are very complex, the new rules are even more complex. There is still time to take advantage of the current law before the proposed regulations become Final Regulations. We encourage you to speak to your estate and tax advisors about these changes as soon as possible because planning is complex and implementation does take time. Please feel free to call the GKG tax team if you would like any additional information on this subject.

Wayne L. Martin CPA, CGMA