Proposed Treasury Regulations Will Limit Discounting

Bottom Line: If you like jumping right to the punchline, this post serves as an alert that in order to save gift and/or estate taxes to which you may otherwise become subject, making some gifts over the next four months would be highly recommended. For details, please read on…..

Background: One very effective estate tax (and gift tax) reduction planning strategy will (absent any successful legal challenge or modification) be greatly curtailed after the end of this year. The strategy targeted here is the widespread use by individuals in making gifts of portions of entities (such as partnerships and LLCs) and having the value of such gifts “discounted” so that there is less consumption (or no consumption) of such individual’s lifetime exemption from federal gift and estate taxes. Additionally, this discounting strategy has to date also allowed individuals to reduce estate taxes by retaining only a minority position in such entities.

Lack of Control and Marketability: This ability to apply discounting results from the fact that the holders of such fractional interests in these entities were one step removed from having any direct ownership in the underlying assets inside the entities. Having no direct ownership in those underlying assets resulted in the holder having less control over such assets, less access to such assets, and less opportunity to sell such assets to others.

Impact of New Law: The new regulations, when finalized later this year, will disregard most of the above factors that reduce the value of the interest in the entity. As such, the percentage of the entity owned by the individual will most likely be treated as being (or approaching) the same value that would have applied to the same percentage of the entity’s underlying assets. This will have a negative impact (i.e., higher estate or gift taxes) on high net worth individuals with taxable estates (e.g., under current law, unmarried individuals worth in excess of $5,450,000).

Action Step: The good news is that many individuals still have a window of opportunity for the rest of this year to achieve the tax benefits of more significant discounting. If you wish to reduce your taxable estate through some gifting, action should be taken sooner versus later, especially in light of some lead time being needed to obtain any proper appraisals.