What the proposed valuation regulation means for family-owned businesses
IRS Proposed Regulations clearly signal the Treasury Department’s intent to severely curtail the use of valuation discounts in family-owned entity transfers. Currently valuation discounts for items such as lack of marketability and/or lack of control are often used when valuing transfers amongst family members. A lower business valuation provides an attractive way to transfer assets to the next generation at a reduced tax cost.
Restrictions
The new regulations have four new types of restrictions called “disregarded restrictions” that will not be allowed to be taken into account when valuing certain interests that are transferred. These restrictions include the ability to liquidate the transferred interest; limit the liquidation proceeds to an amount less than a minimum value; defer the payment of the liquidation proceeds to six months or more; and permit the liquidation proceeds payment in any other manner than in cash or other property (other than certain notes). Also, taxpayers are prohibited from transferring a nominal interest to non-family members, such as employees or charities, in order to prevent a restriction from becoming a disregarded restriction.
Also, the regulation states that non-voting shares transferred to family members will be eligible for a valuation discount. However, if the owner who transfers the non-voting shares dies within three years of the transfer, the difference in value between non-voting shares and voting shares will become part of the owner’s estate.
Control and Lapsed Rights
The new regulations also expand the definition of “control” of an entity to holding at least 50 percent of capital or profits or ownership of any equity interest with the ability to cause liquidation. This expanded definition of control reduces the likelihood of being able to take a valuation discount. And the family member’s percentage of interests is calculated based on the entire family’s interest held including interest held indirectly by other entities. The new regulation also requires that if there is a lapse of a voting or liquidation right in an entity and the owner’s family holds control before and after the lapse, then its value is treated as a gift for taxation purposes.
Timing
The proposed regulations are proposed, but not yet law. The regulations were released at the beginning of August and a 90-day public comment period will ensue followed by a hearing set for December 1, 2016. The final regulations, which may be different than originally proposed, will be finalized once the Treasury Department publishes them. Although it’s not completely clear exactly what the final regulations will be, it is an indication that a change is coming.
What you should do now
Call us and we can help you prepare for the changes to come. Even if these changes are delayed or altered during the comment period and hearing, it is clear that changes are coming. Your CPA is your best adviser to help you navigate the changes for the best result for you. Contact Ciuni & Panichi, Inc. – Jim Komos, Tax Partner, at 216-831-7171 or jkomos@cp-advisors.com.
