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Time To Put Succession Plans Into Motion – Potential Reduction Or Elimination Of Valuation Discounts

Time to Put Succession Plans into Motion – Potential Reduction or Elimination of Valuation Discounts

3 min read

By the end of 2016, it’s likely that the Internal Revenue Service (IRS) will amend a taxpayer’s ability to take valuation discounts on Limited Liability Company (LLC), Limited Partnerships (LP), and S-Corps. These discounts have commonly been used as a way to reflect the lack of control and liquidity of LLC/LP interest. Most commonly these are used with illiquid assets such as closely held businesses, real estate, and private equity, but valuation discounts can also be used with marketable securities and cash. The major draw to using valuation discounts is the impact on succession plans — the leverage one receives as they transfer wealth to a younger generation.

If the proposed legislation passes — which we believe some form of the proposal probably will — it’s important for family-owned companies to seriously consider their succession plan before the end of this year. The earliest the new tax laws can be approved is December 1, in which case, the laws take effect on December 31, 2016.

Understanding valuation discounts

A bit of background on valuation discounts may help explain why quick action is so important.

Closely-held businesses have long offered a nice opportunity for business owners to do efficient wealth transfer planning. Here’s an example: Let’s say your family business is owned by an LLC and is worth $30 million. As part of your succession plan, you’d like your daughter to eventually take over the business, and as such, you’d like to begin to transfer the LLC interest to her. For the first tranche you want to transfer 10% of non-voting interest to her.

In this example the value of the transfer should theoretically be worth $3 million, right? Not exactly.

Limited control means lower value

Your daughter’s 10% share of the company doesn’t give her control of the future of the company. In addition, there’s a lack of liquidity of these shares since there is no market for the shares. Because of these limitations, the IRS currently permits you to “discount” the value of her shares when you gift them to her.

In essence, the idea is that her chunk of the company should be valued at less than its full $3 million. That’s a good thing for you! You want the value of your gifted shares to your daughter to be as low as possible so you use up less of your lifetime gift and estate tax exemption. The combined marketability and liquidity could mean substantial discounts resulting in a valuation of the gift to be approximately $2 million instead of $3 million.

Discounts Face Scrutiny – Act Now!

There’s no question that valuation discounts face scrutiny and the IRS is looking to make a change. The question is, who will be impacted? The line in the sand to determine who is impacted depends may come down to a couple of factors, but the most significant seems to be, what are the assets within the LLC? Is one looking to take a valuation discount on illiquid assets, or is the valuation discount on liquid securities (cash and marketable securities)?

One school of thought is transfers of closely held business interest or illiquid securities will be able to continue to use valuation discounts. However, if the LLC interest holds a combination of marketable securities and/or cash then the discounts will not be permitted. The second popular opinion is that the use of all valuation discounts will be excluded. Regardless, RegentAtlantic recommends talking with your Wealth Advisor, business succession consultant, accountant, and/or attorney to determine whether action should be taken before the end of the year.

Important Disclosure Information

Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request. This article is not a substitute for personalized advice from RegentAtlantic.  This article is current only as of the date on which it was sent.  The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic.  Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

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