By Liz Moyer
The Internal Revenue Service is taking aim at the way wealthy
families value certain assets they are passing along to heirs, a
move that could crimp estate planning.
Family limited partnerships and limited liability companies long
have been used to help pass family-owned businesses to younger
generations in a way that may reduce gift or estate taxes. They
also have been used in recent years to pass down portfolios of
publicly traded securities at a discount, something the IRS is
looking to end, some estate lawyers say.
In a typical arrangement, a family limited partnership is set up
by a husband and wife to own a business or securities that they
expect will increase in value over time. The couple acts as general
partners and makes gifts of limited-partner interests to their
children. Those gifts remove the assets from the couple's estate
for estate-tax purposes even though the couple retains control of
the assets.
A key appeal of this strategy is that the combined value of the
limited-partner interests is discounted, after evaluation by an
appraiser, from the value of the underlying assets--which can mean
a lower tax bill.
The value is lower because the limited partners don't control
the assets and the individual limited-partnership interests are
less marketable than the underlying assets.
Todd Povlich, a partner at Lawrenceville, N.J.-based Management
Planning who specializes in valuing closely held businesses and
partnerships, says a typical discount range for securities held in
them is currently 30% to 38%, based on publicly available market
data and his firm's own analysis. Curtailing the discount could
especially affect families with "balance sheets dominated by highly
liquid assets," he says.
Under IRS rules, the partnership has to serve a legitimate
business interest, but that definition is wide enough to include
family involvement in investment decisions related to a securities
portfolio, lawyers say.
There is language in the tax code that supports discounts for
lack of control and marketability, lawyers say. The law doesn't
specify the magnitude of acceptable discounts, and disagreements
between the IRS and taxpayers frequently get resolved in cases
before the U.S. Tax Court.
The tax code also says the Treasury Department can add
restrictions on asset discounts. Based on recent comments by IRS
officials at industry gatherings, lawyers expect the department
will propose to significantly limit or prevent these discounts,
especially for entities holding primarily marketable
securities.
It long has been an issue on the IRS's agenda, tax lawyers say.
Cathy Hughes, a tax lawyer in the Treasury Department's Office of
Tax Policy, told attendees at an American Bar Association meeting
in May that proposed regulations could be out before the ABA's next
taxation section meeting in mid-September, according to several
accounts of those present to hear her comments. An IRS spokesman
declined to comment beyond Ms. Hughes's remarks.
Meanwhile, "there's a great deal of consternation about these
[expected] regulations," says Richard Dees, a partner in the
private-client group at McDermott Will & Emery. "There could be
a great freeze in the ability to do transactions of all types."
In one case heard in Tax Court last year, the estate of someone
who had a partial interest in a $52 million portfolio of government
bonds and blue-chip stocks battled with the IRS over the discount.
The estate's original appraisal put the discount at 70% of the
underlying $10.4 million market value. After dueling appraisals,
the court decided on a $6.5 million valuation, which was a discount
of 38%.
A new limit on discounts would thwart an estate-planning
strategy that is often used by wealthy individuals or couples who
already have used up their exemptions for giving financial gifts
during their lifetimes. In 2015, the exemptions are $5.4 million
for individuals and $10.8 million for a couple.
People who have assets above and beyond those thresholds and
want to make additional gifts while alive "are out of dry powder,"
says Jonathan Forster, a tax lawyer at Greenburg Traurig in Tysons
Corner, Va. So they have a particular incentive to use discounts to
reduce the size of their taxable gifts.
Judith Saxe, a senior wealth strategist at Atlantic Trust, the
Atlanta-based U.S. wealth-management arm of Canadian Imperial Bank
of Commerce, says the IRS's action potentially could curtail
discounts on other assets, including privately held businesses.
"There's a worry that the definition will be broader than
intended," she says.
Write to Liz Moyer at liz.moyer@wsj.com
