IRS Proposed Regulations Should Encourage Family Businesses to Complete their Succession Plans in 2016

September 20, 2016

by Andrew P. Grau, Esq.

The time to act is now for implementing family business succession plans that involve transfers of business ownership interests that are valued using discounts.

Valuation discounts have helped family businesses “hit home runs” with regard to the tax aspects of their succession plans.  Such discounts are generally based on the lack of control and lack of marketability that applies to the ownership interests that are being valued.

The use of such discounts will be severely restricted by proposed IRS regulations which were recently published and which will likely go into effect after the end of this calendar year.  Once these regulations are finalized, family businesses will then have to settle for triples or doubles instead of home runs with regard to the tax aspects of their succession plans.

Succession plans often involve gifting ownership interests, or selling them in exchange for a note that freezes the value within the transferor’s estate thereby shifting future appreciation to the next generation.  In either case, the value of the transferred interests must be supported by a professional appraisal to withstand scrutiny from the IRS.  To the extent there is a gift involved, the amount of the gift must be reported to the IRS, and this amount will reduce the donor’s lifetime gifting credit, which in turn reduces the amount that the donor can shield from the Federal Estate Tax upon his or her death.

Gifts and valuation freezes involving appreciating assets, such as the stock of a successful family business, are powerful tools used to structure highly effective succession plans.  The potential estate tax savings from such plans can be enormous for businesses that project substantial future growth.  The savings get even better when the business appraisal incorporates valuation discounts.  The appraiser can factor in the lack of control associated with non-voting or minority stock.  The appraiser can also take into account lack of marketability when there is a buy/sell agreement that restricts subsequent transfers of the ownership interests.

Valuation discounts enable the appraiser to depress the overall value of what is being transferred.  This is fair, because on the open market a buyer will pay less per share for a minority ownership stake than for a controlling majority stake.  The IRS has long frowned on using these discounts where family-controlled businesses are involved, and now will begin significantly restricting the use of such discounts under the new regulations.

To discuss this issue or any questions you may have about succession planning, please contact one of the attorneys in our Business Advisory Group.

Questions Every Business Must Ask

Q. Has your business recently reviewed its legal structure to determine whether it is set up in the most advantageous manner for legal and tax purposes, considering recent developments and changes in the law?

Q. Do the owners of your business have a current, updated buy-sell agreement which controls how ownership interests in the business are to be transferred in the event of an owner’s death, disability or termination of employment?

Q. Have the owners of your business developed a succession plan to define how ownership and authority will transition upon the death or retirement of the present owners?

Latest News & Events

Selling Your Business: Resolve Major Issues Early In The Process

by Andrew P. Grau, Esquire The letter of intent often kicks the can down the road with respect to key terms that will be negotiated in the formal purchase agreement. Frequently, the parties do not realize there are major points of disagreement until the first agreement draft is circulated. For this reason, the seller should… Read more »

Investments In Qualified Opportunity Zones Can Provide Significant Tax Benefits

by Jonathan Samel, Esquire The Federal Tax Cuts and Jobs Act (the “Act”), which became effective on January 1, 2018, created Qualified Opportunity Zones (QOZs) as a tool for promoting long-term investments in low-income communities. Through this program, investors are provided significant tax benefits for investing in businesses and in real estate located in QOZs. … Read more »

Non-Compete Covenants in Pennsylvania

by Robert Sebia, Esq. Pursuant to Pennsylvania law, restrictive non-compete covenants are enforceable only if they are: (1) ancillary to an employment relationship between an employee and an employer; (2) supported by adequate consideration; (3) the restrictions are reasonably limited in duration and geographic extent; and (4) the restrictions are designed to protect the legitimate… Read more »