Earlier this month, the IRS proposed regulations that could seriously curtail the use of valuation discounts associated with transfers of intra-family interests held in privately owned businesses. The net effect of the proposed regulations is that family members of family owned businesses would be treated more like a single owner by disregarding certain fractional ownership interest characteristics. This comes from the IRS’s long-standing aversion to valuation discounts in family business succession and estate planning strategies.
Determination of the fair market value of an equity interest requires an analysis of the inherent investment characteristics. The two investment characteristics most often considered are those related to control, or lack thereof, and those related to the lack of marketability. Attributes of an ownership interest that increase the risk of holding an investment will inherently reduce the value of that interest, which is the basis for valuation discounts.
For example, a fractional interest in an entity with limited rights to affect change in that entity inherently has less value than it would if such rights were not limited. Also a fractional interest in a closely held enterprise inherently has no ready market of buyers. The value of such interest is further limited when a shareholder’s agreement restricts an interest holder’s rights on how it can sell its interest.
However, the proposed regulation would place significant restrictions on what can be considered when determining adjustments for lack of control and marketability used to arrive at a valuation of a fractional interest in a family owned business. Although not inclusive of all the changes, the proposed regulations address what constitutes control of family limited entities, transfers with certain time frames and refines select definitions, including a three year lookback on such transactions.
Do the proposed regulations go too far? Do they violate the fair market value standard of a hypothetical willing buyer/seller? There are many questions that need to be answered as this proposed regulation gets debated. But time is short as there is a hearing on the proposed regulations on December 1, 2016. The new regulations will not become law until 30 days after they become final.
If you have clients that may be adversely affected if these proposed changes become law, we would be pleased to provide valuation services to meet your client’s needs.