Family Wealth Transfer Planning: The Window is Closing on Valuation Discounts




Investors have for years utilized family-controlled entities as part of their estate and wealth transfer planning to shift assets to succeeding generations while minimizing transfer taxes, facilitating succession and governance planning, and enhancing long-term family asset management.

However, it appears that the opportunity to achieve a discount on the value of interests transferred for estate and gift tax purposes is coming to an end.
The Internal Revenue Service and the Treasury Department have this month proposed regulations that, if finalized in their current form, would significantly limit (or, for all intents and purposes, likely eliminate) valuation discounts on transfers of interests in family-controlled entities. With a public hearing scheduled for December 1, 2016, time appears to be running out for those who are considering transfers of interests in family-controlled entities for this purpose. As a result, individuals, couples, and families will pay considerably more in estate and gift taxes.
Until then investors with a taxable estate can still realize significant savings, for example, by transferring assets, such as an investment real estate property or private equity, to a family limited liability company, or LLC, and retaining a member-manager role. Over time, they can transfer minority interests in the LLC to family members or to trusts for the benefit of family members. Those gifts of LLC interests, where the recipient is not a manager of the LLC, can potentially be valued for gift tax purposes at less than the underlying asset value due to the restrictions in the agreement, typically for reasons such as lack of marketability and minority interest. This can result in the grantor passing more potential value for estate and gift tax purposes to the beneficiaries.
Why is this important? Currently, an individual’s federal lifetime gift tax exemption is limited to $5,450,000, above which a federal gift tax rate of 40% is charged (with a few exceptions). In this example, the grantor could possibly transfer approximately $9 million of underlying asset value if a 40% discount is applied to the LLC interests transferred. This example of a valuation discount would save approximately $1.4 million in federal gift taxes and allow the increased assets to compound for the next generation.
Internal Revenue Code Section 2704 was originally designed to eliminate the perceived abuses related to the use of valuation discounts in valuing interests in family-controlled entities. However, through proper planning and entity structuring, investors and their advisors were able to rely on several exceptions to obtain discounts on the valuation of those transferred interests and achieve significant savings on estate, gift or generation-skipping taxes in the process, as the example above illustrates. Now, the proposed regulations seek to severely limit and/or eliminate the use of these exceptions while broadening other restrictions.
The proposed regulations, which were issued by the IRS and the U.S. Treasury Department on August 2, 2016 but have been expected by practitioners in some form for a long time, are focused on limiting the current exceptions from transfer taxes on lapses of a voting or liquidation restriction under IRC.Sec. 2704. These exceptions would also be impacted by a new rule that would cause estate includability if a transfer occurs within three years of the transferor’s date of death. Furthermore, they will severely curtail valuation discounts on transfers of interests in family-controlled corporations and partnerships, and expand the class of entities covered under this section to include limited liability companies and other foreign or domestic business entities. Additional disregarded restrictions, further clarifications of entity control, and a broader definition of family control are among the proposed changes.
While these proposed regulations, if finalized in their current form, constitute a major shift in traditional estate planning for families, loss of valuation discounts alone is not the only reason to move quickly to develop a plan of action. In recent years, the so-called Greenbook, a “General Explanations of the Administration’s Revenue Proposals” released by the Treasury, has included yet-to-be-adopted proposals severely limiting the benefits of using an installment sale to defective grantor trusts, further limitations on grantor retained annuity trusts, or GRATs, and other significant changes that could now be back on the table. Furthermore, the Democratic tax plan includes lowering the federal estate tax exemption to $3.5 million and the federal gift tax exemption to $1 million (both down from $5.45 million), and other significant adjustments.
At Evercore, we believe that time is of the essence in assessing estate and wealth transfer plans, especially in light of these likely massive shifts in the estate planning environment. Even without valuation discounts, the timely use of estate freeze strategies such as GRATs and installment note sales to grantor trusts with high potential growth assets in a low interest rate environment can still result in passing significant wealth free of transfer taxes over the long term. Reconsidering gifts to Spousal Access Trusts, for example, where a spouse can be a beneficiary in the event of an emergency or unforeseen need, may help individuals accelerate their wealth transfer planning if the thought of giving away assets too soon is an obstacle. And installing a competent, experienced corporate co-trustee, along with a family member, can soothe outstanding concerns over long-term governance and oversight, which can sometimes delay estate plans from being implemented in a timely manner. Investors contemplating these types of plans should certainly consider accelerating their decisions.
While there may be changes to the regulations before they are finalized, we strongly encourage individuals to consult soon with their wealth advisors, attorneys and accountants to develop a plan to address this changing tax and estate landscape. From strategy development to implementation, these plans can take time to effectuate, and there may be only a few months left to do so.
Chris Zander is the Chief Wealth & Fiduciary Advisor at Evercore Wealth Management. He can be contacted at