The Latest on Valuation DiscountsDecember 11, 2015
Mark S. Campbell, CPA, ABV, CFF
When it comes to estate planning with respect to closely-held family businesses, one important component in the valuation is adjustments for lack of control and lack of marketability(commonly referred to as valuation discounts). Under existing law each ownership interest is treated as a separate interest, regardless of the balance of the ownership interests, which may be held by other family members. As such, a minority ownership interest in a family limited partnership or a limited liability company may be discounted to reflect its lack of control and lack of marketability.
These discounts are common in use, which has resulted in significant scrutiny from the Internal Revenue Service (“IRS”). Moreover, recent press has highlighted efforts to curtail or eliminate such “discounts.”
A1993 Revenue Ruling eliminated consideration of aggregate of family control of an entity in valuing family owned minority interests. As a result of this ruling, there has been an increased use of family limited partnerships and limited liability companies to hold family assets, including businesses, in order to make use of discounts on transferred interests.
Internal Revenue Code Section 2704 codified the 1993 revenue ruling. In addition, under Section 2704, certain restrictions are disregarded for the transfer of an interest in an entity to a family member and if the family controls the entity immediately before the transfer, in determining the value of the interest that was transferred. The IRS has tried to rely on section 2704 to challenged valuation discounts, but has had limited success.
Proposed Amendments to Section 2704
From 2010 the Obama Administration has proposed amendments to Section 2704 to 1) limit discounts to entities that conduct an active trade or business and 2) reduce or eliminate the ability to apply discounts for lack of control or lack of marketability for certain family owned entities.
Beginning earlier in 2015, the IRS and Treasury Department officials indicated that new regulations may be issued to limit or do away with some discounts for valuations of family-owned businesses. The conventional wisdom was that these new regulations would be issued sometime toward the end of the summer. However, last month a senior IRS official disclosed at a CPA tax division meeting that, while guidance on restrictions under 2704 would be issued soon, the IRS was not looking to a 2013 Obama Administration proposal that called for additional restrictions on valuations of family-controlled entities. Instead, the guidance will be focused on the statute as currently written. Based on this announcement, it appears that restrictions on family-controlled entities may not be as significant as originally feared.
Mark S. Campbell, CPA, ABV, CFF, is a partner with BlumShapiro, the largest regional business advisory firm based in New England, with offices in Connecticut, Massachusetts and Rhode Island. The firm, with over 400 professionals and staff, offers a diversity of services, which includes auditing, accounting, tax and business advisory services. In addition, BlumShapiro provides a variety of specialized consulting services, such as succession and estate planning, business technology services, employee benefit plan audits, litigation support and valuation. The firm serves a wide range of privately held companies, government and non-profit organizations and provides non-audit services for publicly traded companies.