New Treasury Department Regulations May Limit Transfer Tax Savings

The Treasury Department proposed new regulations that may impose limitations on transfer tax savings for corporate, partnership and limited liability company agreement provisions between family members.

The proposed regulations by the Treasury Department may place limitations on the availability of discounts for lack of control and lack of marketability on ownership of transfer tax savings to family members of closely-held businesses. According to a report from Holland & Knight, these provisions have the potential to adversely impact the valuations of these transfers.

The concern over the potential restrictions came after recent comments by Cathy Hughes, estate and gift tax attorney advisor in the Office of Tax Policy at the U.S. Treasury Department, hinted that certain provisions in transfers of business interests would be subject to for tax purposes. According to Hughes, “applicable restrictions” in governing documents for family-controlled entities would be disregarded for transfer tax purposes in the valuation of transfers for family-owned business interests among family members. Therefore, transfer taxes would take precedent over certain agreed-upon provisions, meaning that most transfers of business interests in family-owned entities would be subject to tax.

Current Treasury Department regulations for transfer tax savings

This change could be significant because under current transfer tax savings regulations, certain interests in privately-owned companies are valued using discounts.  The current standard is the price that a willing buyer and seller would pay, with neither one being compelled to buy or sell and each having an equal knowledge of the facts.  A buyer would not pay a price equal to the pro rata value of the assets in the business because the buyer could not control management decisions, withdraw funds or readily liquidate his or her interest.  These factors for the lack of control and marketability result in lower valuations for transfers of certain shares in a closely held corporation or membership  interests in a limited liability company.

Valuation discounts are important for family-owned businesses because they accurately reflect the value of the specific ownership interest, which cannot easily be sold or disposed. These discounts illustrate what a buyer in an arm’s length transaction would pay for an ownership interest. Discounts reduce the value of the interest and thereby reduces the transfer tax imposed on a gift of the interest.

A discount for lack-of-control may be applied to non-voting shares or interest to voting shares or an that does not have control. Further, a discount for the lack of marketability also helps non-publicly traded businesses because ownership  interests are not traded on a securities exchange and are, therefore, not liquid. Finally, closely-held enterprises often prohibit transfer without consent of the other owners and this further reduces the value of the ownership interest.

Takeaway

While it is not certain whether the proposed regulations from the Treasury Department will cover all family-owned businesses, Holland & Knight propose that it may be prudent for CEOs considering a gift or sale of their family-owned business interests to expedite the completion of the transaction. Although Hughes did not indicate an effective date for the new regulations, the Treasury Department hinted that the regulations could be made final as soon as September 2015.