An important gift tax planning tool that families have used for decades may soon be coming to an end. The Treasury Department has announced plans to issue proposed regulations, possibly around Labor Day, that would significantly curtail the use of “valuation discounts” for gifts of interests in family entities such as limited partnerships (“LPs”) and limited liability companies (“LLCs”). If you are considering taking advantage of valuation discounts by making these type of gifts to family members or others, you should take action before the law changes.
Valuation discounts allow a taxpayer to transfer a minority interest in an LP or LLC to a family member at a value that is “discounted,” or reduced, for gift tax purposes. Importantly, the family member receives an interest in the entity instead of directly in the underlying assets. The value of the gift can then be discounted for gift tax purposes, because (i) the donee will lack any control over the entity or its assets (a so-called “lack of control” discount), and (ii) the donee would be hard pressed to quickly find a third party willing to buy his or her interest in the entity for cash (a so-called “lack of marketability” discount).
Depending primarily on the type of assets held by the entity, the combined valuation discount will typically range from 20% to 50%, or more. For example, a gift of an LP interest worth $5m may actually represent underlying assets of $7.5m if the combined discounts for lack of marketability and lack of control amount to 33%. The discount of $2.5m could save up to $1m in estate taxes at the current estate tax rate of 40%.
While the proposed regulations may be issued very soon, they are only proposed regulations. The effective date of any final regulations that may be issued is currently unknown. The final regulations could be effective upon the date they are issued, or they could be deemed effective back to the date the proposed regulations were first issued. In any event, we expect a great deal of analysis and criticism of the proposed regulations, which could result in final regulations that are substantially watered down. Nevertheless, anybody who intends to take advantage of gift discounts should not bank on this outcome, and should consider making their gifts sooner rather than later.