Proposed Valuation Discount Regulations Would Impact Few, But Impact Them Greatly
Update: On October 4, 2017, Treasury announced that it would be withdrawing these proposed regulations.
First some context. The American Taxpayer Relief Act of 2012 has ensured that only a select few pay any estate taxes in America. To be liable for estate tax in 2016, for example, you must die with more than $5.45 million in assets. The news gets better for married taxpayers. With the implementation of permanent “portability,” spouses can essentially share their combined exclusions, meaning that they should be able to avoid any transfer taxes for up to $10.9 million in combined assets. That certainly excludes most of us from having to worry about reducing estate taxes.
In fact in 2014, only 11,931 estate tax returns were filed. This was a 74% decline from 2005. Although Iowans filed only 180 estate tax returns, that number was in the top five in the nation for Estate Tax Returns Filed as a Percentage of Adult Residents. That is no doubt due to Iowa’s valuable farmland. And when estate tax is due, it is really due. A whopping 40% tax is imposed on every dollar subject to the tax. Of those 180 2014 estate tax returns filed in Iowa, 51 estates owed more than $104 million in combined estate tax. So while estate tax planning is no longer a concern for the vast majority of Iowans, it is very important for some, especially those who have accrued many acres of farmland and wish to pass it to the next generation.
One way some owners of farmland have avoided estate taxes is through careful entity planning. Family limited partnerships and limited liability companies have become popular entities into which to transfer such assets. Mom and dad, for example, can transfer their farmland into an FLP, each retaining 1% general partnership interests and 48% limited partnership interests. Then, over time, they can gift the limited partnership interests to their children, retaining control of the FLP, but reducing the assets in their estate. The idea is that the shares that are transferred have a lower value because the children receiving them do not have control over the partnership. Additionally, these shares are not marketable. Combined lack of marketability and control discounts can be substantial (around 30 percent in many cases). Lower value means less transfer tax. That’s been the theory anyway.
For a number of years, the IRS has been targeting these transfers, considering them “loopholes” to avoid estate tax. In 1990, Congress did pass provisions to restrict some of these family transactions. The law required that certain restrictions on the stock (so as to justify a discount) be disregarded in the context of a family transfer. IRS has never believed, however, that Congress went far enough, particularly when the courts have often sided with the taxpayer. When proposed legislation to close these purported loopholes never advanced, IRS decided to take it upon itself to implement greater restrictions via regulation. Last week, IRS and the Treasury Department released proposed regulations (REG-163113-02) seeking to further restrict valuation discounts in this context.
The proposed regulations are subject to a 90-day comment period. No regulations will be enforceable until they are finalized. To read more detail about the substance of the proposed regulations, click here.
While these regulations would not negatively impact large numbers of people, those they do impact will seemingly be impacted greatly. Anyone potentially subject to these new regulations should consult with their counsel very soon to determine how these proposed regulations, if finalized, would impact their estate planning options.
The Center for Agricultural Law and Taxation does not provide legal advice. Any information provided on this website is not intended to be a substitute for legal services from a competent professional. The Center's work is supported by fee-based seminars and generous private gifts. Any opinions, findings, conclusions or recommendations expressed in the material contained on this website do not necessarily reflect the views of Iowa State University.