Some Examples of New Proposed IRS Rules on Valuations
Last week we did a post on proposed new IRS Regulations on reducing the amount of allowed minority discounts (and possibly marketability discounts) for transfers of family business interests. With this post, I thought we would show a few examples on how this might affect future family transfers if the Proposed Regulations are finalized.
First, if a transfer occurs within three years of death of the taxpayer (deathbed transfers), the new Regulations indicate any minority discount taken will be brought back into the estate as a “phantom” asset. As an example, assume Farmer Jones transfers to his son and daughter 20% each of his farm LLC. The total value of the LLC before discounts is $10 million. The valuation ends up taking a 25% discount for minority interest which reduces the value of each gift from $2 million to $1.5 million. Farmer Jones passes away within three years of the gift and the estate tax return must include this $500,000 minority discount for each gift ($1 million total) on the estate tax return and if Farmer Jones estate owes estate tax, this will result in an extra $400,000 of estate tax.
Second, if minority discounts are eliminated under the Proposed Regulations, then the example shown above may apply to the gift made during Farmer Jones life. This would result in Farmer Jones using an extra $1 million of his lifetime exemption amount. For 2016, the exemption is $5.45 million. Under old rules, the gifts would reduce his exemption to $2.45 million. Under the new rules, it would reduce it to $1.45 million.
Now, there are many cases where this might be a good rule. If your estate is under the lifetime exemption amount, then any closely held business interests owned by farmers at death would get a greater step-up in value. Let’s assume Farmer Jones is married and his half of the LLC is transferred to his son and daughter at death. Under the old rules, the value of the LLC likely would have been $3.75 million ($10 million times 50% times 75%) and that is cost basis that son and daughter would receive in the LLC. Under the new proposed rules, the cost basis would be $5 million. This results in an increase of $1.25 million in cost basis to son and daughter and a reduction in capital gains of this amount or extra depreciation based on the extra $1.25 million. (We know in many cases, under old rules, many heirs would use the $5 million number for their cost basis, but that would not be technically correct).
The bottom line is that these Proposed Regulations are not good news for farmers with taxable estates. If you are in that situation, you should consider making substantial gifts before December. However, if your combined estate (assuming you are married) is less than $11 million, then the new proposed rules actually might be a good thing. We will keep you posted.
Paul Neiffer, CPA
CliftonLarsonAllen, LLP
Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a principal with CliftonLarsonAllen in Walla Walla, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. Paul and his wife purchase an 180 acre ranch in 2016 and enjoy keeping it full of animals.
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