The IRS recently signaled that it may be ready to issue new regulations that will affect valuation discounts on family business entities by early September.

What Are the Benefits of Planning With a Family Business Entity?

For years wealthy families have taken advantage of limited partnerships and limited liability companies (collectively “family business entities”) to hold a family business or investments for the following reasons:

Centralized Wealth Management.
a. Such an entity allows the family to create a cohesive investment policy, teach investing skills, consolidate investments, and pool assets for better diversification and risk allocation.
Consolidation of Tax Reporting.
a. Gathering investments held in various accounts into one business entity allows for the streamlining of tax and business reporting.
Creditor Protection.
a. Assets held within a properly managed family business entity will be protected from the personal creditors of its members and assets of members that are held outside of the business entity will be protected from liabilities incurred by the business.
Divorce Protection.
a. A divorcing spouse of a member of a properly managed family business entity will only be able to attach their spouse’s membership interest, not the underlying assets held in entity, which will have little or no value to the divorcing spouse.
Ease of Transfer After Death.
a. Transferring assets held within such an entity after death is accomplished by assigning membership interests to heirs, while transferring individually held assets requires retitling each and every asset.
Valuation Discounts for Gift Tax and Estate Tax Purposes.
a. Gifting assets held within such an entity during life or bequeathing interests at death allows for discounts on the value of the underlying assets due to lack of marketability and control.

It is only this last benefit – valuation discounts for gift and estate tax purposes – which the new IRS regulations will attempt to curtail. If you would like to teach your children and grandchildren about investing, protect their inheritance from creditors, predators and divorcing spouses, all the while maintaining control of your investments, you should consider consolidating your investments into a single family business entity to accomplish these and the other goals listed above.

How Do Valuation Discounts on Family Business Entities Work?

Under current rules a family business entity allows for the shifting of wealth from older generations to younger generations at a discount for gift tax and estate tax purposes due to the following:

Lack of Marketability.
a. Younger generations will not receive any ownership rights in the underlying assets owned by the entity, but merely a fractional interest in the entity itself. This results in a discount on the value of the interest since the owner will not be able to easily convert the interest into cash.
Lack of Control.
a. Younger generations will not receive any management or voting rights in the business entity. An ownership interest in a business that has no control over how the business is run is less valuable than an interest with management rights.

What Will Be the Effect of the Impending New Regulations on Valuation Discounts for Family Business Entities?

Under §2704(b)(4) of the Internal Revenue Code, the IRS is given broad authority to impose regulations that would disregard certain restrictions in determining the value of an interest in a business entity transferred to a family member. Throughout the years the drafting and implementation of these regulations has been put on hold for various reasons, but IRS officials have now indicated that the regulation project is progressing, with new regulations being issued as early as September 2015.

Speculation is that these regulations will create a new category of restrictions that will be disregarded when valuing an interest in a family business entity, in turn reducing or even eliminating the use of valuation discounts for these entities. Further speculation is that the new rules could be made effective when they are released.

With New Regulations Looming, What Should You Do Now?

While an operating family business with actual sales will most likely still provide planning opportunities using valuation discounts after the new regulations go into effect, family business entities that are created mainly to take advantage of valuation discounts will become all but obsolete. Therefore, if you are interested in setting up a family business entity for the purpose of taking advantage of valuation discounts, you must proceed without delay to insure your planning can be implemented before the new regulations go into effect.

Our firm is available to assist you with the immediate implementation of your wealth transfer plan using valuation discounts. If you want to ensure that your family is cared for, please click here to schedule your complimentary Estate Planning Strategy Call with San Francisco’s premier estate planning attorney, Matthew J. Tuller.