Act Now to Avoid Possible Estate Tax Hike

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December 29, 2016


The window could soon be closing for individuals to take advantage of valuation discount planning, a change that likely would result in substantial increases to estate taxes beginning in early 2017.


In August, the U.S. Treasury announced it would seek changes to Section 2704 of the Internal Revenue Code. This change would prevent families with operating businesses and companies that hold passive investment assets from being able to discount the value of their business.


“Because of this narrow window of time, business owners should review their business planning strategy with their tax and legal advisors to determine if discounting would be a benefit to the overall family estate,” says Stephen Sherline, Market Leader for The Private Client Reserve of U.S. Bank in Los Angeles. “If the answer is yes, they should take advantage of the rules before the proposed changes go into effect.”

Otherwise, the hit could be substantial.


“We’ve seen examples where as much as 40 percent of this discount was lost,” Sherline cautions. “Time is a significant factor, so it's important to act quickly.”


Keep in mind, however, that with the upcoming administration change on Jan. 20, some experts think these regulations may not be implemented.

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December 29, 2016

Additional Changes

The proposed regulations would also make significant changes to the valuation for transfer tax purposes of interests in a family-controlled entity when the interests are subject to restrictions on redemption or liquidation.


Sherline explains that most business owners have goals for their company’s future after they retire, such as selling to a private buyer or handing the company over to a child or employee.


“When a business constitutes the majority of a family estate and the owner plans to sell it or hand the reins over to an heir, the result can be large estate tax issues,” Sherline says. “Reducing the value of the business for tax purposes can have an enormous impact on the wealth a family retains when a business is sold or passed on to the next generation. The changes proposed by the U.S. Treasury could affect how business owners reduce business values for estate-planning purposes.”

Challenges of S Corporations


For a variety of reasons, the majority of businesses are formed as S corporations or “pass through” entities due to the benefits of flow-through taxation to the owners.


Although this flow-through taxation can benefit owners, there are restrictions that come from this S corporation status, the biggest of which is that the basic structure does not separate preferred and common interests that allow control and ownership. However, this ability is essential to effective business succession and estate planning. A good solution in this case may be recapitalization.


Recapitalization of the S Corporation Stock


“A recapitalization of the S-corp stock allows existing stockholders to start transferring the business to the next generation without abdicating control, and it gives the new shareholders an incentive to grow the business,” Sherline explains. “Recapitalizing shares is a nontaxable event.”

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During the recapitalization process, typically the control and voting shares of the business are held by the original business owner and family members who are active in the company so they can continue managing the business until it is successfully passed on to another person or entity via transfer or sale. Those shares will continue to stay in the family estate.


“The valuation of the non-voting shares or equity ownership interest of the master 




holding company can be gifted or sold to a grantor irrevocable trust to remove any future growth of the company from being included in the estate,” Sherline says. “Because these are non-voting shares, they can be discounted for lack of control and marketability purposes, reducing the amount of gift taxes owed on their transition into the trust.”


For more insight on how this change in discounting regulations could impact your financial plans, contact your Wealth Management Advisor.

Financial Planning