Client Advisory Bulletin



The Department of Treasury's recently issued Proposed Regulations under Section 2704 once they become final would adversely impact the estate planning for some business owners by eliminating certain valuation discounts as well as reducing the ability to leverage the maximum amount of assets out of harm's way due to divorce, lawsuits or other claims.

Proposed Regulations Recently Issued: The Department of Treasury ("IRS") recently issued Proposed Regulations that could have a dramatic impact on your estate planning by eliminating valuation discounts. For high net worth individuals looking to minimize their future estate tax, this is critical. It can also be important for others as well. If you are concerned about protecting a family business from the risks of future divorce, or protecting your assets from lawsuits or other claims, discounts can enable you to leverage the maximum amount of assets out of harm's way, without triggering a gift tax to do so.

Act Now: Time is of the essence. Once the Proposed Regulations are effective, which could be as early as year-end, the ability to claim discounts might be substantially reduced or eliminated, thus curtailing your tax and asset protection planning flexibility.

What are Discounts Anyway? Here's a simple illustration of discounts. Tom has a $30M estate which includes a $15M family business. He gifts 40% of the business to a trust to grow the asset out of his estate. The gross value of the 40% business interest is $6M. Since a minority 40% trust/shareholder cannot force a sale or redemption of its interest, the non-controlling interest in the business transferred to the trust is worth less than the pro-rata value of the underlying business . Thus, the value should be reduced to reflect the difficulty of marketing the non-controlling interest. As a result, the value of the 40% business interest transferred to the trust might be appraised, net of discounts, at $3.6M. The discount has reduced the estate by $2.4M from this one simple transaction.

Election Impact: If the Democrats win the White House and the Democratic estate tax proposals discussed below are enacted, the results will be devastating to wealth transfer planning. Pundits have prognosticated that a Democratic White House could affect down-ballot races and flip the Senate to the Democrats. The Democratic tax plan includes the reduction of the estate tax exemption to $3.5M, elimination of inflation adjustments to the exemption, a $1M gift exemption and a 45% rate. The Democratic plan will most likely include the array of proposals included in President Obama's Greenbook which seek to restrict or eliminate GRATs, installment sale transactions to grantor trusts, and more. Wealthy taxpayers who don't seize what might be the last opportunity to capture discount planning, might lose much more than just the discounts. They might lose many of the most valuable planning options.

Not a 2012 Boy Who Cried Wolf: Many of you might remember the mad rush to plan in late 2012 on the fear that the gift, estate and generation skipping transfer (GST) tax exemption might be reduced from $5M to $1M in 2013. After many incurred significant costs and hassles in implementing planning quickly, that change never occurred. For those who might be affected by discounts, the situation in 2016 seems vastly different. The Proposed Regulations could be changed and theoretically even derailed before they become effective. The more likely scenario is that they will be finalized after public hearings and the ability to claim valuation discounts will be severely curtailed. If you do undertake planning, be cognizant of an important lesson from much of the planning that was done in 2012. Consider using planning techniques that assure you (or if you are married, your spouse) access to funds transferred in the discount planning. The main regrets in 2012 planning were for many of those who transferred assets out of their own reach.

Client Advisory Bulletin

What You Should Do: Contact your planning team. A collaborative effort is generally essential to have your planning done well. Your estate planning attorney can review strategic wealth transfer options that will maximize your benefit from discounts while still meeting other planning objectives. Projections completed by your wealth manager or other financial advisor could be essential to confirming how much planning should be done and how. Your CPA will have vital input on wealth transfer options, federal and state income tax implications, and more. Your insurance consultant can show you how to use life insurance to backstop some of the planning strategies, in coordination with the financial forecasting done by your wealth manager, or financial advisor to maximize both the tax benefits and your financial security.

Options to Consider: If estate tax minimization is a primary objective, then the following options should be considered: (i) if there is already an existing entity such as a corporation, limited partnership or limited liability company, then gifts of the equity interests to various types of your irrevocable trusts, including spousal access trusts of which one of the spouse's is the primary beneficiary, should be considered, (ii) installment sales of the equity interests to an irrevocable trust that is a grantor trust for federal income tax purposes, or (iii) if there is not already an existing entity, then a family limited partnership or a family limited liability company could be formed so that the type of discount planning described in clauses (i) and (ii) immediately preceding could be implemented.

If asset protection is a primary objective and there is not already an existing entity, then a family limited partnership or a family limited liability could be formed so that discount planning could be used to maximize the amount of property that would be given away to a trust that was designed for asset protection, which would include a spousal access trust.

It is likely our fourth quarter will be very busy helping clients who want to take advantage of the discount planning opportunities that are currently available so do not delay if you want to implement discount planning before the Proposed Regulations become effective.