Family Limited Partnerships after IRS Code 2704

This notification was written by Matt Ryan, Director – Advanced Sales Attorney

Proposed Treasury Regulations Could Spell End to Valuation Discount Strategy

On August 2, 2016 the Treasury Department and the IRS published regulations under Internal Revenue Code Section 2704 that would eliminate valuation discounts on intra family gifts of Family Limited Partnerships (FLP).  In December 1, 2016 a public hearing will take place after the 90 day public comment period.  Shortly thereafter the Treasury and IRS will issue a final notice and that will become effective 30 days from that issuance.  This may mean that starting in 2017 estate planning practitioners may have one less arrow in their quiver.

Family Limited Partnerships have been an effective wealth transfer strategy for the past two decades.  If done properly, this strategy may generate a 10-45% valuation discount that has been validated by tax courts.  Estate planning practitioners use this strategy to help transfer small family businesses and ranch/farming operations to the next generation.

Under current rules and regulations “lack of control” and “marketability “ discounts reflect limitations on a minority owner’s ability to participate in the management of the entity, to withdraw from the entity or compel a distribution or redemption with respect to the minority owner’s interest.  This result enables high net worth individuals to receive a discount on the value of the FLP interests transferred to the next generation.  Under the proposed Treasury Regulations the IRS would be cracking down on both “lack of marketability” and “lack of control” valuation discounts for family owned business transfers.

NEW PROPOSED REGULATIONS

Under the new proposed regulations, if an individual transfers an interest in an FLP to a family member and his or her liquidation or voting rights in the FLP lapse as a result of the transfer, the value of the lapsed liquidation or voting right will be a taxable gift or included in the transferor’s estate if the transfer occurred within three years of transferor’s death.

For example, let’s assume father owns 51% of FLP interest and transferred 2% within a couple of days of his death.  Under the old rules the father would receive a valuation discount on the 2% FLP gift to the children.  The transferor’s estate would also receive a minority valuation discount for the remaining 49%.  However, the new proposed regulations would eliminate the minority valuation discount on the 49% due to the fact the transfer happened within three years of death and it may also eliminate the minority valuation discount on the 2% as well.  The end result would be the new rules will prevent discounts for some deathbed transfers.

The new proposed regulations would also define an additional category of ”disregarded restrictions” that are ignored when determining the valuation of the business, if the family still has control in the aggregate to eliminate the restriction after the transfer or gift.  These disregarded restrictions would include any that:

• Limits the ability of the holder of the interest to liquidate the interest
• Defers the payment of the liquidation proceeds for more than six months
• Permits the payment of the liquidation proceeds in any manner other than cash or other property
• Limits the liquidation proceeds to an amount that is less than a minimum value (minimum value is FMV minus outstanding obligation of the entity).

This means that transfers subject to the new disregarded restriction rules would not qualify for a valuation discount for “lack of control “ or “lack of marketability” when the family will retain control of the business after the transfer occurs (whether a gift during life or a bequest at death).

To review the Internal Revenue Code Section 2704, click here.

The companies of National Life Group^® and their representatives do not offer tax or legal advice.  Please encourage your clients to seek tax or legal advice from their appropriate professional advisor.

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