For affluent taxpayers, reducing estate and gift taxes on asset transfers to family members at time of death is a major concern. The U.S. government is now proposing new regulations that will make transferring assets without paying hefty estate taxes much more difficult, adding more worry and anxiety to the process.
Currently, the effective federal estate and gift tax rate is 40 percent for individuals with assets in excess of $5.45 million (and in excess of $10.9 million for married couples). Assets valued below that threshold can pass free of federal estate tax. Thus, any successful efforts to reduce transfer taxes is enormously valuable to the beneficiaries of the taxpayer — typically children and other descendants.
A common technique used to reduce transfer taxes has been the practice of discounting interests in business entities owned by the taxpayer. For instance, if the taxpayer owns a closely held business and transfers a minority interest to children or other descendants during his or her lifetime, under current regulations, the taxpayer/beneficiary is able to argue successfully that the value of the minority interest for transfer tax purposes should be discounted to reflect lack of marketability and/or lack of control in the hands of the recipients. The practice can result in discounts ranging from 20-25 percent for entities holding publicly traded securities to 35-40 percent or more for closely held businesses owned and controlled by the taxpayer.
The death of New York Yankees owner George Steinbrenner in 2010, for example, occurred in a year when there was no federal estate tax. Should such an estate tax have been in effect, Forbes magazine assessed that, due to his estimated net worth at $1.1 billion, the Steinbrenner family would have paid approximately $600 million in estate taxes.
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For years, the Internal Revenue Service has actively opposed the discounting of business interests, especially when placed in structures for the ultimate benefit of the taxpayer’s family members. When done correctly, taxpayers and their advisers have been able to ward off attempts by the IRS to unravel these entities and eliminate discounts for valuation purposes. The structuring of these entities can take the form of limited partnerships, limited liability companies or other similar entities.
The proper creation, funding and management of such entities has proven to be beneficial for taxpayers whose estates are facing potentially devastating estate taxes at time of death. The payment of estate taxes, due nine months after the date of death, can cripple the ability of a closely held business to continue to operate and can lead to the untimely liquidation of the business, often at forced sale prices. For instance, in 1990, when Miami Dolphins founder Joe Robbie died, his family was forced to sell the franchise because of a reported $47 million estate tax bill.
Still, the IRS is taking a new approach to directly eliminate discounting when such entities are used to transfer ultimate control to family members. On Aug. 2, the IRS issued new regulations that will ultimately remove discounts for lack of marketability and/or lack of control in many situations. The IRS will hold hearings on the proposed regulations, which are quite complex and will produce considerable debate and response from the financial planning community, on Dec. 1. The effective date of the regulations will be 30 days after the regulations are published as “final regulations,” which is likely to be sometime in 2017.
South Florida is home to many prominent family-owned businesses that are vital to our economy, and many will be significantly affected by these new IRS regulations. Business owners and taxpayers should begin assessing the impact to their existing plans and shoring-up entities that will permit significant discounts in valuation before the new regulations take effect in 2017. The negative dollar impact on their estates is potentially enormous and the possibility of loss of ownership and control of a family business for the next generation is a very real possibility, now more than ever.
Donald A. Kress is a senior vice president at Coral Gables Trust Company. He is a member the board of directors and vice president of the Estate Planning Council of Greater Miami, and is a member of the University of Miami Estate and Gift Planning Advisory Board. Contact him at 786-497-1212 or firstname.lastname@example.org.