Colorado Probate Blog - Wade Ash Woods Hill & Farley, P.C.

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Minority Interest Discounts in Family Controlled Entities

On August 2, 2016, the Treasury Department proposed a series of regulations to Section 2704 of the Internal Revenue Code. If these proposed regulations are made final, this could greatly limit the ability of family controlled partnerships, limited liability companies, and corporations to transfer interests in a manner that takes advantage of minority discounts.

The fair market value of a property for transfer tax purposes is the hypothetical price on which the property would change hands between a willing buyer and a willing seller. Minority discounts exist to reflect the reality that a minority interest lacks control over the entity. In addition, family entities very often restrict the ability of family members to transfer their membership interest to members outside of their immediate family. As a result, discounts up to 40% have been recognized by the IRS and courts when valuing transfers of these interests.

The eradication of minority discounts would most likely only be a negative result to those individuals with taxable estates which, for a person dying in 2016 is $5,450,000, and $10,900,000 for a married couple. If an individual does not have a taxable estate and receives a minority interest as a result of a parent’s death, they would prefer to receive the asset at a high value because this would give them a high income tax basis in the asset. If, however, an individual has a taxable estate, they would want to receive the minority interest discount in order to reduce the size of the estate tax.

The provisions of the proposed regulations will not apply until they become final, which at the earliest would be sometime in 2017, and more realistically 2018 or beyond. Very likely, the proposed regulations will be modified before they are made final, and will not completely extinguish the ability of individuals to use minority interest discounts. More realistically, the Treasury Department will limit valuation discounts in some way.

At the end of the day, what this all means is that if you have been planning for years to sell or gift minority interests in a family controlled entity to other family members, this proposed legislation may affect you. In addition, if you have a taxable estate then you may wish to think about gifting minority interests sooner rather than later in order to take advantage of the discounts that may be reduced in the future.

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