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Industry Leaders Deliver Strong Response Against Proposed New IRS Regulations to Eliminate Valuation Discounts

On December 1, 2016 the IRS held a hearing to discuss the proposed IRC 2704 Regulations. Testimony included 37 total speakers ranging from CPA’s, tax attorneys, business valuators, and small business owners. Michelle Gallagher of AICPA Family Limited Partnership Issues Task Force spoke in regards to the proposed regulations. The IRS received over 10,000 comment letters on these regulations.

Ms. Gallagher also recently presented on this issue at the 2016 AICPA’s 2016 Forensic & Valuation Services Conference that was held in the beginning of November. Members of Forensic Valuation Litigation, LLC, including Partners Catherine T. Marchelletta and Fabian O’Connor, were in attendance.

Per Ms. Gallagher’s testimony, the AICPA strongly opposes these new regulations arguing that they unfairly target family businesses, create significant problems for valuators and would eliminate valuation discounts for lack of marketability and minority interests unless the interest is actively traded. They also argue that the regulations as written are overly broad and target closely-held entities that were not created for tax reasons. Furthermore the regulations would require that business valuators ignore economic reality, market conditions, governing documents, and local law when valuing the interest and effectively changes the long standing definition of fair market value.

Cathy Hughes, a tax lawyer in the Treasury Department’s Office of Tax Policy, made two comments responding to the day’s testimony. In reference to criticism relating to a provision that would require valuators to assume that an interest in a family business can be liquidated within a six month period (the so-called “put right”), she said the IRS did not intend for the creation of such a right as a result of the proposed regulations. She also confirmed that the three year rule (which establishes a three year lookback period on certain transactions) would not be applied retroactively. This means that the provisions are not likely to apply to transactions completed prior to the effective date of the new regulations.

Ms. Hughes also noted that due to the large number of comment letters, it does not appear likely that the new regulations will be finalized before the end of 2016. However there was no indication that the Treasury Department intends to withdrawal these proposed regulations and there is a strong possibility that they will be completed by January 20, 2017, before the new Presidential Administration takes office.

An important and valuable aspect of planning techniques to minimize gift, estate and generation-skipping transfer taxes is the use of valuation discounts. The regulations restricting or eliminating valuation discounts and imposing a three-year look-back for lapses in liquidation rights will apply prospectively, and could become law within the year. Thus, time is of the essence for individuals and family offices to evaluate their holdings in closely-held family corporations, LLCs and partnerships.

For additional information on the proposed regulations, see Ms. Marchelletta’s article from August 2016, New IRS Regulations Targets Valuation Discounts on Family-Owned Businesses.

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