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Family Businesses Face Continued Uncertainty in the New Year

December 22, 2016

The IRS proposed changes aiming to curb valuation discounts on transfers of family business interests—but some are concerned with the proposal...find out why.

Last August, the IRS proposed new tax regulations aimed at curbing valuation discounts on transfers of family business interests, including family limited partnerships (FLPs), under IRC Section 2704. During its three-month comment period, the proposal received over 9,800 written letters — primarily from critics calling for significant revisions or withdrawal of the proposal altogether.

On December 1, a record number of people attended the IRS hearing on the proposed changes. All but one witness testified against finalizing the current version of the proposal. The IRS will consider this testimony, but it’s not required to implement any of the feedback received from comment letters or during its hearing when deciding the fate of the proposal.

Here are some concerns related to the proposed changes to Sec. 2704, as well as some additional comments on the future of estate planning.

Concerns Mount

In general, numerous valuation experts, business advisors and taxpayer advocacy groups argue that the Sec. 2704 proposal is ambiguous and overly broad, extending to operating businesses not just asset holding companies. Many expressed concerns that the proposal creates a “deemed put right” that would eliminate the use of all discounts for lack of control or marketability when valuing transfers of business interests among family members.

During the hearing, Catherine Hughes, estate and gift tax attorney-advisor for the IRS, assured that the regulations, if finalized, would not include a deemed put right or eliminate valuation discounts. Moreover, Hughes said that the regulations, if finalized, won’t include a retroactive three-year “look back period,” a provision that many critics argue goes beyond preventing “death bed” transfers.

Despite these assurances, many who testified at the December hearing remain concerned that a judge might later interpret the rules differently, if they’re finalized as is. So, business owners and their advisors have urged the IRS to specifically add these assurances in any finalized Sec. 2704 regulations. Though the IRS seems eager to forge ahead with its proposal, it’s likely to take significant time and effort to review all of the comment letters and re-propose the changes.

Plans to Repeal the Estate Tax

In the meantime, Congressional Republicans are drafting a tax reform package that’s expected to include a repeal of the estate tax. President-elect Trump has expressed support for repealing the estate tax and, instead, requiring estates to pay capital gains tax on appreciated assets over $5 million per individual or $10 million for married couples. If this happens, the IRS may lose interest in finalizing the proposed changes under Sec. 2704.

Wait-and-See Approach

It’s hard to predict how, when or even if the IRS will finalize the proposed regulations. The issue is further complicated by the transition from the Obama administration to the new Trump administration in January 2017, including the possibility of the repeal of the estate tax.

We’ll continue to post updates regarding the progress of this proposal and any activity by the new administration regarding estate and gift tax issues. Please contact our Private Client Services Group to discuss these developments and their impact on transfers of ownership interests in your family business.

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