Proposed 2704 Regulations, as they are now drafted, would make vast and substantial changes to the valuation of interests in many family-controlled entities, such as a Family Limited Partnership (FLP) or Limited Liability Company (LLC), for purposes of estate, gift, and generation-skipping transfer taxes.
Currently, due to the restrictions placed on a limited partner of a FLP or non-managing member of an LLC, interests that are gifted are valued less than the fair market value of the gifted share, as the donor owns a non-controlling interest and his or her interest is not readily marketable. Thus, discounts for lack of control and lack of marketability apply, reducing the value for estate tax purposes.
Additionally, a potential buyer will pay less for an interest that is subject to restrictive agreements, such as restrictions on transferability or formulas setting a withdrawal or repurchase price. Such restrictions are frequently used in buy-sell or stock restriction agreements between business owners. Similarly, a willing buyer will pay less for an interest that is subject to certain rights held by other interest owners, such as puts, calls, and liquidation rights.
The Regulations will change the discount-ability of non-controlling interests. Specifically, they disregard certain restrictions on liquidation in determining the fair market value of a transferred interest. This means that transferring an interest in a FLP or LLC may be found to have been a transfer of higher value, rather than a transfer of discounted value. The higher the value of the gift transferred, the higher the gift tax. Additionally, the Regulations treat the lapse of voting or liquidation rights as an additional transfer, thus, another taxable event.
As noted, the Regulations are in proposed form and certain aspects may become final as soon as December 1, 2016. If you are interested in forming a family limited partnership or limited liability company for the significant non-tax business advantages these types of entities provide, you should consider doing so before these Regulations become effective to also obtain the tax benefits noted above.