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Act Now! The IRS signals its intent to Limit Valuation Discounts on Family Business Entities in the near future.

The IRS recently signaled that it may be ready to issue new regulations that will affect valuation discounts on family business entities by early September.

What Are the Benefits of Planning With a Family Business Entity?

For years wealthy families have taken advantage of limited partnerships and limited liability companies (collectively “family business entities”) to hold a family business or investments for the following reasons:

  • Centralized Wealth Management. Such an entity allows the family to create a cohesive investment policy, teach investing skills, consolidate investments, and pool assets for better diversification and risk allocation.
  • Consolidation of Tax Reporting. Gathering investments held in various accounts into one business entity allows for the streamlining of tax and business reporting.
  • Creditor Protection. Assets held within a properly managed family business entity will be protected from the personal creditors of its members and assets of members that are held outside of the business entity will be protected from liabilities incurred by the business.
  • Divorce Protection. A divorcing spouse of a member of a properly managed family business entity will only be able to attach their spouse’s membership interest, not the underlying assets held in entity, which will have little or no value to the divorcing spouse.
  • Ease of Transfer After Death. Transferring assets held within such an entity after death is accomplished by assigning membership interests to heirs, while transferring individually held assets requires retitling each and every asset.
  • Valuation Discounts for Gift Tax and Estate Tax Purposes. Gifting assets held within such an entity during life or bequeathing interests at death allows for discounts on the value of the underlying assets due to lack of marketability and control.

It is only this last benefit – valuation discounts for gift and estate tax purposes – which the new IRS regulations will attempt to curtail.  If you would like to teach your children and grandchildren about investing, protect their inheritance from creditors, predators and divorcing spouses, all the while maintaining control of your investments, you should consider consolidating your investments into a single family business entity to accomplish these and the other goals listed above.

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How Do Valuation Discounts on Family Business Entities Work?

Under current rules a family business entity allows for the shifting of wealth from older generations to younger generations at a discount for gift tax and estate tax purposes due to the following:

  • Lack of Marketability. Younger generations will not receive any ownership rights in the underlying assets owned by the entity, but merely a fractional interest in the entity itself.  This results in a discount on the value of the interest since the owner will not be able to easily convert the interest into cash.
  • Lack of Control. Younger generations will not receive any management or voting rights in the business entity.  An ownership interest in a business that has no control over how the business is run is less valuable than an interest with management rights.

What Will Be the Effect of the Impending New Regulations on Valuation Discounts for Family Business Entities?

Under §2704(b)(4) of the Internal Revenue Code, the IRS is given broad authority to impose regulations that would disregard certain restrictions in determining the value of an interest in a business entity transferred to a family member.  Throughout the years the drafting and implementation of these regulations has been put on hold for various reasons, but IRS officials have now indicated that the regulation project is progressing, with new regulations being issued as early as September 2015.

Speculation is that these regulations will create a new category of restrictions that will be disregarded when valuing an interest in a family business entity, in turn reducing or even eliminating the use of valuation discounts for these entities.  Further speculation is that the new rules could be made effective when they are released.

With New Regulations Looming, What Should You Do Now?

While an operating family business with actual sales will most likely still provide planning opportunities using valuation discounts after the new regulations go into effect, family business entities that are created mainly to take advantage of valuation discounts will become all but obsolete.  Therefore, if you are interested in setting up a family business entity for the purpose of taking advantage of valuation discounts, you must proceed without delay to insure your planning can be implemented before the new regulations go into effect.

Sorrell Law Firm, PLC is available to assist you with the immediate implementation of your wealth transfer plan using valuation discounts.  Please call our office at 480-776-6055 to arrange for your consultation.

How Will the 2015 Supreme Court Decisions Affect You and Your Family?

While approximately 10,000 cases are appealed to the U.S. Supreme Court each year, only 75 to 80 make it to oral argument.  Of those cases, only a handful grab the media’s attention.  Below is a summary of three landmark decisions handed down in 2015 that could affect how you are taxed, pay for healthcare, and plan your estate.


Comptroller v. Wynne – A State Can’t Double Tax Income Earned Outside of the State

Legal Issue:  Does Maryland’s state income tax scheme violate the U.S. Constitution by “double taxing” a resident’s income earned from economic activity in another state that also taxes the same income?

Decision, 5 – 4:  In a taxpayer-friendly ruling, the Supreme Court ruled that, yes, Maryland’s “double taxation” scheme violates the dormant Commerce Clause.

The Wynne case involved a Maryland couple who owned stock in a Maryland S corporation that did business in 39 states.  Since income generated by an S corporation is passed through to its shareholders, the Wynnes paid income taxes in Maryland as well as their pro-rata share of taxes on the income the corporation earned in the other states.

In Maryland, residents are subject to a state income tax as well as a “local tax” based on the city or county in which they live.  Prior to the Wynne case, the state allowed residents to take a credit against the Maryland state tax to offset a similar tax paid to another state, but it did not allow a credit to be taken against the local tax.  Thus, income of a Maryland resident earned outside of the state was “double-taxed” by being subject to (1) out-of-state taxes, and (2) the local city or county tax.  The Court struck down this “double taxation” scheme, holding that because the dormant Commerce Clause gives Congress power over interstate commerce, Maryland could not hinder interstate commerce by offering a credit against state income taxes but not against local income taxes.

Planning Tip:  The Wynne decision will potentially affect hundreds of cities, counties and states other than Maryland, including Indiana, New York, and Pennsylvania.  If you pay income taxes in your home state and other states, you should seek qualified tax advice regarding filing protective claims (such as amended returns or requests for refunds) for tax years in which the statute of limitations has not run.

King v. Burrell – Obamacare Subsidies Are Available to All

Legal Issue:  Can the IRS provide tax-credit subsidies to healthcare coverage purchased through the federal healthcare exchange under the Patient Protection and Affordable Care Act (the “ACA,” commonly referred to as “Obamacare”)?

Decision, 6 – 3:  Yes, Obamacare subsidies are available to individuals who obtain their healthcare coverage through a federal exchange.

Buried in the 2,700-page ACA is a provision which states that tax-credit subsidies are available to individuals who sign up for healthcare coverage “through an exchange established by the state.”  After the ACA was passed, 34 states did not establish exchanges, leaving their residents to use the federal exchange to obtain their coverage.  The King case challenged the validity of federal subsidies given to these residents since the ACA appeared to limit subsidies only to individuals who relied on a state-established exchange.  Writing for the majority, Chief Justice John Roberts stated, “We doubt that is what Congress meant to do.”  Thus, the validity of subsidies claimed by residents of the 34 states that use the federal healthcare exchange was upheld.

Planning Tip:  Despite the King decision, the Obamacare debate will continue to be hashed out in the political arena as the 2016 presidential election fast approaches.

Obergefell v. Hodges – Same Sex Marriage is Legal Everywhere in the United States

Legal Issue:  Does the Fourteenth Amendment of the U.S. Constitution require a state to license same sex marriages and recognize same sex marriages that are legally licensed and performed in another state?

Decision, 5 – 4:  Yes, same sex marriages are legal and must be recognized everywhere in the United States.

The Obergefell case consolidated four cases that challenged state-banned same sex marriages in Kentucky, Michigan, Ohio and Tennessee.  Relying on the Due Process and Equal Protection Clauses of the Fourteenth Amendment, the Court held that marriage is a fundamental liberty and denying the right of same sex couples to wed would deny them equal protection under the law.

Planning Tip:  Same sex couples who are considering marriage need to decide if commitments regarding how to handle money, debt, and related matters should be formalized in a prenuptial agreement.  Same sex couples who are already married need to determine if their prenuptial agreement should be fine-tuned and if their estate planning documents need to be amended in view of the King decision.

The Bottom Line on the Wynne, King and Obergefell Decisions

There are constant changes in the law from judicial, legislative, or regulatory action. These selections from the recent Supreme Court session are just a small example of the numerous changes that occur every year. How the Wynne, King and Obergefell decisions will affect your planning options has yet to be fully determined.

Sorrell Law Firm, PLC is available to answer your questions about these landmark cases and how they may affect you and your family.