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In the crosshairs: Popular estate planning practice in jeopardy

December 8, 2016


A practice commonly used by many dealerships to reduce estate taxes could be on the chopping block. In August, the Treasury Department proposed new regulations that would place limits on the use of this practice by all family-owned businesses, including dealerships.

Valuation discounts

The practice involves discounting the value of ownership shares in a family-owned dealership when transferring them to heirs. These discounts are permitted due to a lack of control and marketability, which makes them harder to sell and thus worth less money.

By reducing the value of a dealership in this way, owners may be able to keep the value of their estate under the $10.9 million lifetime exclusion amount for married couples (or $5.45 million for individuals) for 2016. Estate and gift taxes are assessed at a top rate of 40% on all transferred assets above these amounts.

The proposed new regulations would make it harder for family-owned dealerships to obtain these discounts for lack of marketability and control. As a result, estates that are close to the exclusion amount could be pushed over the limit, thus subjecting heirs to estate and gift taxes.

Many family-owned dealerships have used this practice to reduce estate taxes since the IRS first began allowing it more than two decades ago.

What the regulations would do

Business valuators consider a variety of different factors when quantifying discounts for lack of control and marketability. These include:

  • The nature of the business’s underlying assets,
  • Historical and expected income distributions,
  • Rights and restrictions granted in a partnership agreement, and
  • State laws and legal precedent.

The proposed new regulations would limit the use of valuation discounts by dealerships by disregarding some applicable restrictions on transferred interests when valuing the interests for gift or estate tax purposes. An applicable restriction is one that effectively limits the ability of the owner to liquidate his or her interest in the dealership, but which will lapse or can be removed, after a transfer, by the transferor and the family.

Current regulations limit the definition of an applicable restriction by requiring that it be more restrictive than the limitations that would apply under local law in the absence of the restriction. The proposed new regulations would change the definition of applicable restriction by eliminating the comparison to state laws’ liquidation limits.

In addition, the proposed regulations identify some additional restrictions that may reduce the transfer tax value of an interest in a family-owned dealership despite not reducing the interest’s value to the family member receiving it. These restrictions should be disregarded for transfer tax valuation purposes, the IRS believes. A restriction on an interest owner’s right to sell that interest would be disregarded if the restriction would lapse after the transfer, or if the transferor and the family could remove or override the restriction.

The IRS also believes that some family-owned businesses have avoided the applicable restriction scenario described here by transferring a nominal interest in the business to a nonfamily member. The proposed regulations would ensure that the family alone wouldn’t have the power to remove a restriction. Instead, the existence of such an interest would be recognized only if the interest were economically substantial and longstanding. The IRS has introduced a bright line set of criteria for determining whether such an interest is substantial and longstanding.

For example, a nonfamily member’s interest wouldn’t meet this criteria and would thus be disregarded if it had been held for less than three years before the transfer, represented less than 10% of the value of all ownership interests, or constituted less than 20% of the value of all ownership interests when combined with the interests of other nonfamily members. In addition, the nonfamily member would have to have a put right to require the business to redeem his or her interest within six months for a newly defined “minimum value” — and that value wouldn’t recognize discounts.

Window closing fast

Proposed regulations are subject to a 90-day public comment period. A public hearing on the regulations was scheduled for December 1, 2016. Some of the regulations will be effective upon final issuance, and other parts won’t take effect until at least 30 days after they’re finalized.

Therefore, a small window might still exist during which time you can complete transfers of discounted ownership shares in your dealership to your heirs. But you should act quickly at this time — because this window will close fast. Consult with an estate planning professional or attorney on how these proposed regulations may impact your particular estate plan.

© 2016

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.


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