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Estate Tax Archives - Ketel Thorstenson, LLP


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June 1, 20180

Historically, individuals with ownership in family businesses may have been encouraged to transfer the business to LLCs or partnerships to take advantage of discounting for estate tax and other reasons.  While the discounts created lower values, there was also less benefit from step-up in basis.  (Step-up in basis essentially means the heir of the entity ownership is allowed to adjust the basis in entity value from the date the decedent acquired the interest to the value at the date of the decedent’s death.)  Individuals were accepting of the discounting and minimal step-up in basis to avoid paying little or no federal estate tax.  Those were the days of low federal estate tax exemptions.

However, times have changed…
With the federal estate tax exemption increase to $11.2 million for individuals 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 family business LLCs and partnerships given the potentially deep discounts inherent in owning a minority interest in such entity.   The discounts derive a lower value which does not allow the heir to have as great of a step-up in the basis of entity value.  Consequently the discounts for estate and gift tax purposes may no longer be desirable.

The table below illustrates the impact of moving away from LLCs and limited partnerships holding family businesses:

 

 

 

 

 

 

 

 

In this instance, the heir gets to “step-up” to a new basis from $75 (the value when the decedent acquired the interest) to $160 or $200 (the value at the decedent’s death for interest held in an LLC/Partnership or held outside an LLC/Partnership, respectively).

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 to discuss your specific situation.


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March 21, 20180

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.


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October 11, 20170

If you recall, just more than one year ago the Treasury Department resurrected Proposed Section 2704 Regulation which disallowed discounting on closely-held businesses owned by families for estate and gift tax purposes.  This Proposed Regulation would have been devastating to all family-owned business but especially to farm and ranch operations given the high value of agricultural ground with relatively low cash flows.

The following scenario is painted to illustrate the lack of fairness to disallow such discounts.  Brother Earl lives in South Dakota where he operates the family ranch, Eden’s Acres.  Earl owns 60%, a controlling interest, in Eden’s Acres.  Earl’s sister, Ethel, lives out of state and is removed from ranching operations.  She owns a 40%, minority interest in the entity.  As the controlling owner, Earl determines what level of distributions will be paid to shareholders.  Earl decides to retain all available cash flow each year for future purchase of additional land rather than distribute to shareholders.  As a result, Ethel is an owner of dirt in South Dakota but has no economic benefit from such ownership.  Under the assumption that the Regulations would have made law, at Ethel’s time of death her estate will include the value of 40% of the value of the real estate (appraised at $8 million), or $3.2 million.  If Ethel has much wealth outside of Eden’s Acres, she could very easily have a taxable estate.  It seems absurd that her ownership of a minority interest in a family-owned entity that she received no economic benefit of would result in a value of $3.2 million, eating up nearly 60% of her estate exemption of $5.49 million!

The October 3, 2017 Treasury report helps to add a happy ending for poor Ethel.  Such report entirely withdrew the Proposed Regulation citing, “the Proposed Regulation’s approach to the problem of artificial valuation discounts is unworkable.”  It further noted that the Treasury Department and IRS could not determine an entity interest should be valued as if restrictions did not exist.

Do you or your clients have Business Valuation questions or needs?  Please contact me!


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October 6, 20160

Ericka-Heiser-headshotThe Treasury Department is proposing radical changes to the regulations of Section 2704 which was made law in 1990. Without explicitly stating so, the Proposed Regulations will virtually eliminate valuation discounts (minority and marketability) in the context of family-controlled entities for estate and gift tax purposes. These complex regulations have been described as an assault on family business, and a “back door” for the Administration to increase the Estate Tax without Congressional review. The Department is holding a hearing on the Regulations in December and some form of the proposed Regulations are expected to be finalized in early 2017.  Several in Congress are scrambling to stop these Regulations, and many legal pundits believe they may be unconstitutional.  However, if you are contemplating intra-family entity transfers, it may be better to transact under the current rules.   Talk to your tax and legal professional in the very near future.

We would be delighted to help you or your clients. Please contact the KTLLP Valuation Team for your business consulting and valuation questions.

 


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