Historically, relatively wealthy individuals were encouraged to transfer family business or investment assets to LLC’s or limited partnerships to create illiquidity that caused valuation discounts that were favorable for estate tax savings and other business reasons. However, for the heirs, the valuation discounts resulted in reduced stepped-up basis from inherited assets. What is stepped up basis? This means the heir of an asset, such as a family business interest, is allowed to adjust the income tax basis of the asset to its fair market value at the date of the decedent’s death. If the asset is sold shortly after it is inherited, then there is no capital gain. In the days of low federal estate tax exemptions, taxpayers desired low values to minimize estate tax.
However, times have changed…
With the federal estate tax exemption now increased to $11.2 million for an individual and $22.4 million for married couples effective January 1, 2018, very few individuals will face estate tax problems. Therefore, it may be time to consider liquidating or reorganizing family business LLCs and limited partnerships given the potentially deep discounts inherent in owning a minority interest in such entity. The discounts may inadvertently cause the heir to incur a large capital gain after the sale of the asset. Consequently the discounts for estate and gift tax purposes may no longer be desirable.
The table below illustrates the impact of moving away from LLC’s and limited partnerships holding family businesses when an heir sells an asset shortly after receiving it through a will.
As a limited partner, from the original $75 basis, at death the heir gets to “step-up” to a new fair market value of only $160. While if the entity had been reorganized as a general partnership, the new basis would have potentially been $200.
The difference between $2 and $10 in this example doesn’t seem like much. However, it might seem like a big deal if we add three or four zeros behind each figure!
This subject matter can be difficult to comprehend. Call the KTLLP Business Valuation Team today to discuss your specific situation.