A few years ago, concerns arose that absent legislative action to modify the magnitude of the available lifetime gift tax exemption amount, a significant estate tax exposure could arise for many owners of private companies. A rush to carry out ownership transfers to avoid such consequences ensued.
For some time now, the IRS has been indicating that it would issue new regulations aimed at curbing perceived abuses in connection with transfers of business ownership interest to family members involving material discounts taken for lack of control and marketability. On August 2, 2016, the IRS issued proposed regulations under Internal Revenue Code Section 2704 that would significantly limit such discounts in many family-controlled business entities for estate, gift, and generation skipping transfer tax purposes and materially increase the tax implications involved in transferring ownership of a family controlled business.
The entities potentially impacted by the proposed regulations include corporations, partnerships, and limited liability companies, among others. Estate planners and their clients are once again faced with a threat that many anticipate will lead to an acceleration of transfers aimed at avoiding the effective date of the implementation of these new rules.
The proposed regulations will be subject to a comment period of 90 days which, in turn, will be followed by a public hearing before final regulations will be issued. A significant amount of negative feedback is anticipated to be provided during the comment period. Some have suggested that the IRS is overstepping its authority in an area best left to legislative remedy, a process which has not taken place despite considerable initiatives by the IRS over many years to seek legislative answers to the perceived abuses it seeks to curb.
Final regulations often differ in material respects from initial proposals and considerable time can elapse between the issuance of proposed and final regulations. One twist is that the current Presidential election takes place at the end of the ninety day comment period. One candidate is calling for the elimination of transfer taxes and the other is proposing changes that would increase the application of these taxes as well as the rate of tax.
The election’s results may impact the content and/or timing of issuance of the final regulations, which is likely to be no earlier than 2017. Many advisors, however, are recommending that transfers aimed at avoiding the effective date of final regulations occur prior to December 1, 2016, the date of a scheduled public hearing dealing with the content of these regulations.
The subject matter of the proposed regulations is perhaps best described as highly technical in nature. Much of tax planning is this area has historically relied on complex interaction among Federal and state laws and details involving how business organizations are structured and governed. While it may not be essential for business owners to familiarize themselves with all of the nuances of the issues covered in the proposed regulations, it would be a good idea to sit down with one’s advisors to review your existing and contemplated estate planning, with an eye toward the potential implications of these proposed regulations.
Opportunities may exist to take advantage of the current law before final regulations take effect. Common business sense should ultimately rule out over tax considerations; however, there are many situations where an acceleration of ownership transfers may be well advised.
Michael R. Viens can be reached at Email or 215.441.4600.