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Are Family Business Valuation Discounts in Jeopardy? 
For many years, transferring ownership of a family-owned business from one generation to the next has been aided by allowable discounts in the value of the ownership interest being transferred. For example, if a parent were to gift to their child an ownership interest in the family business with a fair market value of $1,000,000, discounts could effectively reduce that value to $700,000 (or less). At the current gift tax rate of 40%, this discount would allow the child to avoid paying approximately $120,000 in taxes.
 
But all good things may end, and it looks like the Internal Revenue Service (IRS) and U.S. Treasury Department have been authorized by Congress to take aim at these helpful valuation discounts. On August 4, 2016, the IRS and Treasury issued proposed regulations to close a "tax loophole that certain taxpayers have long used to understate the fair market value of their assets for estate and gift tax purposes," according to Mark Mazur, Assistant Secretary for Tax Policy at the Treasury Department.
 
In other words, the discounts in family business valuation are in jeopardy of being eliminated, or at least sharply reduced, thus reducing their effectiveness as a planning tool.
 
It is important to note that only transfers by an individual or their estate above the current $5.45 million lifetime gift tax exemption are subject to tax. For married couples, there is no tax on the first $10.9 million transferred. The IRS estimates that fewer than 10,000 of the biggest estates are subject to any transfer tax at all each year. Still, among taxpayers who exceed the lifetime exemptions, many are family business owners wishing to transfer the company to the next generation.
 
A word about the process: proposed regulations are not tax law, but an indication of the position favored by the IRS. There is a 90-day comment period, followed by a public hearing on December 1, 2016. At some point after considering the comments received, the IRS will finalize the regulations, which then have the force of tax law.
 
What does this mean to the owners of a family business? If there is any chance that you will be transferring part or all of the interest in the business through gifting, it is important that you evaluate how the elimination or reduction of the discounts will affect your plans, especially the timing. If the rules on discounting are likely to be changed in early 2017, you may wish to accelerate any transfers that were under consideration. Which means taking action now in order to accommodate the time necessary to obtain appraisals or a business valuation.
 
This likely change in the status of discounts may also impel current family business owners to review their own financial situation and post-retirement income sources.
 
This is a complex issue that requires careful deliberation and guidance. We will continue to monitor the proposed regulations and report back on their progress.
 
If you have a question on discounts or other tax issues, please contact Gray, Gray & Gray's Tax Department at (781) 407-0300.






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