Our last blog post discussed the potential repercussions from the new proposed IRS 2704 regulations, which could remove the proverbial icing off the cake for transfers in family-controlled entities.
To put this in perspective, Mark Mazur, Treasury assistant secretary for tax policy, said in a statement that the proposed regs would eliminate a preference “that certain taxpayers have long used to understate the fair market value of their assets for estate and gift tax purposes, and it is common for wealthy taxpayers and their advisers to use certain aggressive tax planning tactics to artificially lower the taxable value of their transferred assets.” Mazur added that the “Treasury’s action will significantly reduce the ability of these taxpayers and their estates to use such techniques solely for the purpose of lowering their estate and gift tax.”
Even though the proposed regulations will drastically change (or eliminate) the minority valuation discounts associated with estate planning in the family-owned business context, there are steps clients can take in the next 90 days in regard to their own assets. Now is the time to accelerate any gifting that has been under consideration. We are emphasizing the following four techniques because of the positive results in transferring appreciating assets from a client’s estate, none of which require the use of any gift or GST exemptions.
- Grantor Retained Annuity Trusts (GRATs).
- The transfer of an appreciating asset into this type of trust will be beneficial because the fixed annuity paid each year will leave beneficiaries with little or no estate tax applied to the assets of this trust at the end of the annuity term. Coupling the current valuation discounts of FLP interests inside of a GRATs has the potential of dramatically increasing or “supercharging” the tax savings and performance of the GRAT.
- Intentionally Defective Grantor Trusts (IDGTs).
- Transferring assets to this type of trust will be beneficial because the grantor of the estate will be able to make tax-free gifts to the estate and successfully transfer their money for the benefit of their beneficiaries. Families can supercharge the IDGT by using a traditional installment sale transaction to the IDGT which further reduces estate tax. Because this trust is considered a “grantor trust”, the grantor is able to make tax free gifts to the trust in the amount of income taxes owed, thereby further reducing the client’s estate for estate tax purposes. Another technique may be for clients to now sell interests in family-controlled entities to existing grantor trusts particularly if they are able to sell an asset to the trust at a discount and later “swap” that same asset out for assets of equivalent value; ultimately achieving the effect of allowing more assets into the trust on a transfer tax free basis.
- Fractional Interests.
- These are interests individuals own as “tenancy-in-common” – often real estate. It is possible these interests, used for real estate and personal property, will remain in affect with the new regulations. Section 2704 only applies to interests in family-controlled entities. Discounts for fractional ownership, real or personal, have been recognized in the past an ostensibly should be allowed. Assuming that fractional interest discounts will not be eliminated, transferring assets of real or tangible personal property may be beneficial because they will allow for the transfer of property with little transfer taxes.
- Now is the time to accelerate any gifting that has been under consideration. Clients could benefit from gifting if they tailor their estate plans so charitable entities or non-family members who will be receiving gifts, hold small percentages of the company for the three year kickback period prior to the transfer of funds. Then, their gifts to these organizations will not be disregarded by the new regulations in regards to transfer tax.
When reviewing estate plans, clients should also review their insurance policies with regard to their payment of estate taxes. These new regulations are removing common discounts clients depend on, therefore, when it comes time to pay the estate taxes, clients could be forced to sell a portions of the company in order to pay if they do not plan for payment of taxes in advance.
A review of a client’s estate planning documents (wills and trusts) particularly the tax apportionment provisions or governing state law will be prudent because the estate tax might be different now than what was originally anticipated and the burden of payment might be more attributable to these family-controlled entities.
Finally, a review of Shareholder Agreements, Partnership Agreements, LLC or FLP agreements that affects the rights of shareholders, partners and owners of entity interests as some of the restrictions are derived from these governing documents and are affected by these new proposed regulations.
The window is closing. It is important that clients act within the next 90 days, even though the regulations will not be effective until 2017. A hearing is scheduled for December 1, 2016. With these proposed regulations, not only will the lack of discounts affect transfers after the effective date, but the IRS will apply the regulations to transfers made three years prior to a client’s death, if he or she dies after the regulations become final. Estate trust assets should be protected from the lack of discounts.