Dramatic Proposed Changes to Impact Estate and Gift Tax Planning

By Naomi Ganoe, CPA, MT, CFP
Tuesday, September 20, 2016

Individual taxpayers should examine their estate now before changes are made that affect gift and estate taxes.

While most taxpayers are spending the summer focused on economic developments associated with the market, foreign affairs, or election year developments closer to home, high net-worth taxpayers have other negative developments to be concerned about. The estate and gift tax rules, which became permanent after 2012, may experience dramatic changes based on new proposals by one Presidential candidate and the current administration. Current Federal law provides for an estate and gift tax exemption of $5,450,000 ($10.9 million for a married couple). This exemption is indexed for inflation and increases each year. One Presidential candidate proposes to reduce the estate tax exemption to $3.5 million ($7 million for a married couple), reduce the gift tax exemption to $1 million ($2 million for a married couple) and repeal the inflation indexing. This will significantly increase estate and gift tax for taxpayers whose net worth is equal to or greater than the existing exemptions.

The use of valuation discounts to reduce the estate and gift tax valuation of family-owned businesses is an important estate planning tool. Discounts are commonly claimed for lack of control (minority interest discount) and lack of marketability. Applying such discounts in the context of family controlled entities has long been a point of contention for the IRS. Unsuccessful in attempts to restrict the use of valuation discounts through legislative changes, the Treasury Department has proposed regulations under Section 2704 to accomplish this goal and eliminate discounts on family controlled entities.

Valuation discounts, commonly used for family limited partnerships (FLPs) and limited liability companies (LLCs), allowed for more wealth to be transferred free from estate, gift and generation skipping transfer (GST) taxes. If a 25 percent discount is appropriate, then a $1 million partnership interest can be transferred as a $750,000 gift. This would save $250,000 of the gift or estate exemption.

The Obama Administration proposed, without success, changing the law over several annual budget proposals in order to restrict or eliminate valuation discounts on transfers of interests in family controlled entities. Now the IRS is exploring other means to reach the same end — specifically new tax regulations. Whether these new restrictions will withstand a court challenge remains to be seen.

The IRS has been frustrated that Congress has not acted to change the law restricting valuation discounts, and these proposed regulations are expected by many to be made effective by January 2017 or earlier. This means that it is likely that any transfers of interests in family entities that took place before the regulations are effective would be “grandfathered,” i.e., the IRS would respect the ability to use the discounts.

If you are in the process of planning your estate and are considering forming a FLP or a LLC, you should be aware of this development. The family valuation discounts to which we have become accustomed over the past 20 years may not continue to be available. If you have an existing family entity, you may want to revisit your estate plan to see if you would like to make additional transfers before the rules change. Many taxpayers have remaining lifetime transfer tax exemption (gift, estate and GST) to utilize in a current transfer. Please contact your CPA or your estate tax attorney for additional information.

Naomi Ganoe is a Director of CBIZ MHM, LLC & Mayer Hoffman McCann PC, an independent CPA firm in Akron, Ohio.