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Potential federal rules could have major estate tax implications

Last month the Treasury Department proposed rules that could dramatically impact estate tax planning. Specifically, the Treasury Department is planning to limit, or even eliminate, the use of "valuation discounts" for closely-held companies, LLCs and other assets. The Treasury Department issued these proposals in August. On December 1, 2016, there will be a public hearing to discuss the merits of this proposal. It is possible the Treasury Department will formalize changes to these rules before the end of 2016.

What are valuation discounts?

Valuation discounts allow individuals or businesses to divide interests in an asset, thereby reducing its value. For instance, if a business owner divides a family-owned business into three equal parts and gives a part to each child, the value of each piece is less, often much less, than the value of the whole business, since a portion of the business is likely to hold little value. By using valuation discounts, assets that could have faced the estate tax as a whole would not be subject to the estate tax in parts.

Valuation discounts can apply to nonbusiness assets as well. Commonly, the owner of the assets will distribute assets to a holding company or a charity. Owners of the assets could then hold onto their part of the asset until the statute of limitations for an audit has passed, and then sell the assets at full market value.

How would the IRS limit valuation discounts?

The Treasury Department's proposed rules would allow the IRS to collect estate and gift taxes when taxpayers divide assets to create valuation discounts. Further, if the owner of the assets dies within three years of the valuation discount, the IRS would be able to collect. The Treasury Department is quoted as saying the limitation of valuation discounts would "close a loophole that certain taxpayers have long used to understate the fair market value of their assets for estate and gift purposes."

Many estate tax professionals disagree, stating that there are often very legitimate reasons for business owners to transfer part of a business to heirs. Without valuation discounts, however, these heirs would be taxed on value they do not enjoy. However this situation plays out, it will be very interesting to see what happens.

Creating a strong estate plan can minimize one's exposure to estate taxes, gift taxes and the like. It is critical to work closely with a knowledgeable estate planning attorney. For decades, people across Bergen County and beyond have put their faith in the lawyers of Michael A. Manna & Associates.

Sources: IRS Targets Popular Estate Planning Technique, The National Law Review, August 29, 2016, by Robert A. Mathers, The Controversial Way Wealthy Americans Are Lowering Their Taxes, The Wall Street Journal, August 19, 2016, by Laura Saunders

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