Problems with the Proposed Regulations
The proposed regulations were meant to curb the heavily scrutinized practice of funding assets into an entity and claiming a valuation discount for the interest held in that entity by members of the same family. Allowing aggressive discounting of passive entities creates an opportunity for wealthy individuals to pass on relatively liquid assets (e.g. stock portfolios) at steeply discounted values to avoid estate and gift tax. Obviously, such treatment should be limited to prevent loss of tax revenue where the structure of the entity has no legitimate purpose other than tax avoidance. This goal is accomplished but not reasonably tailored to prevent harsh treatment against legitimate businesses. Treasury drafted the proposed regulations extremely broadly covering both operating and passive businesses. Furthermore, the proposed 2704 Regulations cover more diverse ownership groups than what most would consider a “family business”. However, the current proposed regulations do not except legitimate businesses that have true economic purpose other than tax avoidance. Additionally, the proposed regulations redefine the concept of “Fair Market Value” that has been a fundamental concept of tax law for decades. Because of the broad nature of the regulations, they are akin to amputating a foot because of a wart on a toe. These issues caused significant pushback from commentators and will warrant revision, or wholesale abandonment, of the proposed regulations.
The current transition of presidential administrations places this battle in an interesting political context. Like all other departments, the Treasury will cede control to a new administration next year. Let’s explore the possible fate of the proposed regulations.
The treasury can move forward and implement a final rule with little or no modification. At that point, the rule can be challenged by litigation, overturned by Congress, or revised by later action of the treasury department. Actions against the rule can be pursued pre-emptively in Congress, and there are currently efforts underway to “vote down” the regulations legislatively. If the regulation is passed, both houses of Congress can pass a resolution of disapproval which, upon signature by the president, voids the rule. This congressional process is rarely used and would be unnecessary if a pre-emptive measure were successful. The new president would have the final say on a congressional vote to void the regulations due to the timeframe given for congressional review. A litigation challenge would be undertaken after the rule, which would subject the rule to judicial scrutiny, but could only be brought after the rule becomes final. Finally, the Treasury (under the new administration) has the ability to implement regulations of its own, which would likely walk back any rule that is implemented.
Impact on Family Businesses
Given the above opportunities for challenge, the proposed rule is likely short-lived in its current form. At a minimum, the drafting concerns voiced at the hearing need to be addressed. This presents a planning opportunity. In the near term, the hearing gave some clarification on the currently proposed regulations. In the long term, it looks like there may be a more favorable environment for transitioning ownership in family businesses. Discussing how the proposed rules and the potential changes of the next administration are critical to determining intermediate and long-range succession plans for family businesses. Contact our office to make an appointment with one of our estate planning attorneys to discuss how the current environment impacts your business.
Ask Kit Kat – Pet Sitters
Hook Law Center: Kit Kat, what can you tell us about dogs and how they respond to speech and tone of voice?
Kit Kat: Well, it looks like dogs are amazingly perceptive when it comes to interpreting speech and tone of voice. Researchers at Eotvos Lorand University in Budapest, Hungary have done some pioneering work on this subject. Like people, dogs use the left hemisphere of their brain to interpret meaning, They use the right hemisphere to interpret sound and its emotional content. The study was led by Dr. Attila Andics, and the techniques used were by themselves quite pioneering. The dogs in the study had to be trained to lie perfectly still while a picture of their brain was taken by a MRI machine. This is very remarkable, because other primates like apes cannot be similarly trained. The MRI requires complete stillness, and they cannot manage that.
This is what the researchers discovered. Dogs reacted most strongly when words of praise like ‘good boy’ or ‘well done’ were used. These positive words elicited a lot of activity in their brain’s reward center. When the researchers used less defined language like conjunctions and some adverbs (‘however’ or ‘nevertheless,’ for example), the dogs’ reward center in their brains registered much less brain activity. With the words of praise, it was almost like they were given a delicious treat to eat; it was that reinforcing. So what does this mean? It means humans are not the only creatures who have the ability to understand and react to language. What’s more, other scientists like Dr. Brian Hare of Duke University believe the canine’s ability to do this developed long before humans started to use language. Did this ability aide dogs in the domestication process, as dogs moved from the wild to living with humans? More research will be needed to answer that question.
I suspect many dog owners intuitively have known how smart their dogs are. Now we have confirmation. They really are man’s best friend. (James Gorman, “With Dogs, It’s what You Say—and How You Say It,” The New York Times, Science section, August 29, 2016) (http://nyti.ms/2c40znU)
Distribution of This Newsletter
Hook Law Center encourages you to share this newsletter with anyone who is interested in issues pertaining to the elderly, the disabled and their advocates. The information in this newsletter may be copied and distributed, without charge and without permission, but with appropriate citation to Hook Law Center, P.C. If you are interested in a free subscription to the Hook Law Center News, then please telephone us at 757-399-7506, e-mail us at mail@hooklawcenter.com or fax us at 757-397-1267.The post Problematic Proposed Regulations May Harm Family Businesses If Left Unaddressed first appeared on SEONewsWire.net.]]>
For many years, families whose fortunes exceeded the applicable estate tax exemption amount (currently $5.45 million) have tried to reduce the value of their estates for estate and gift tax purposes by utilizing planning techniques that take advantage of discounts available in the valuation of assets held by entities such as LLCs, partnerships or corporations. For instance, clients have been advised to create family limited partnerships or family limited liability companies and to transfer a portion of their assets to these entities. Then, clients are encouraged to make gifts of sufficient interests in the business such that they are left with a minority interest in the company and their children each also own minority interests. The gifts of the minority interests to the children are subject to valuation discounts such as minority discounts and lack of marketability discounts that reduce the “cost” of the gift for gift tax purposes. And then, when the client passes away, similar discounts are available to lower the estate tax value of the interest retained by the client. In this way, it is possible to reduce the value of the property passing subject to estate and gift taxes by 30-40% or more. For clients with active businesses, the same discounting techniques are available and often advisable.
The new proposed regulations may change the ability of family business owners, even of active businesses, to take discounts once the regulations become effective. Although there is some disagreement among commentators about the scope of the Section 2704 Proposed Regulations, there is some consensus that there is a significant risk that the discounts will simply disappear for family-controlled entities or, at the very least, become far less attractive as a planning tool.
The proposed regulations add a new three-year rule which would treat certain transfers which occur within three years of the death of the original transferor, like the plan described above, as a deemed transfer of the lapsed voting or liquidation power at the transferor’s death. This results in the value being included in the gross estate of the transferor. As a result, it seems that the discounts that otherwise would have been available on the transfer of minority interests are recaptured, and no discount is available for the minority interest that is retained. Additionally, the proposed regulations would deny the ability for discounts based on the status of a transferee as a mere “assignee” instead of being a full member of the business.
In addition to these roadblocks, the Service has proposed that certain restrictions be “disregarded” for valuation purposes. These would include the ability of a non-family member, such as a charity, to prevent the removal of the restrictions that would otherwise allow for discounts unless the non-family member meets certain criteria, including significant ownership interests for significant periods of time and the right to be bought out of the business for cash or property. The criteria are such that it is unlikely to be workable in practice. In addition, the proposed regulations state that restrictions that are not mandated by federal or state law are to be disregarded. This is particularly problematic, because most state statutes are not mandatory by nature. Rather, they provide default rules in many cases but allow the business entity to make choices for itself about liquidation rights, voting rights and many of the other important rights that affect the valuation of an ownership interest in a business entity.
The details of the proposed regulations are too extensive and complicated to cover completely in this newsletter. The proposed regulations will not be effective until 30 days after the regulations are finalized. There is a hearing scheduled in Washington, D.C. on December 1, 2016 to discuss the proposed regulations, and we expect that the regulations will not be finalized until sometime in 2017. We, therefore, have some time to take advantage of planning opportunities for discounts that may not be available next year. Of course, we do not know the scope of the three-year rule and exactly how it will be changed when the regulations are finalized. There is some risk that transfers made before the regulations are finalized may become subject to the regulations that will include the discounts taken into the estate of the transferor if the transferor dies within three years of the transfer.
The attorneys at the Hook Law Center are ready to meet with you to discuss your options, to review your operating agreements and to assist you in planning to meet the challenges posed by the proposed regulations. Furthermore, if transfers have already taken place, it may be important to discuss a plan for the payment of estate taxes on any amount added back to the gross estate. For all our clients engaged in active family businesses, business succession planning is always challenging; however, the proposed regulations do provide some safe harbor relief that must be investigated on an individual basis to determine what may work for your situation.
Ask Kit Kat – Reindeer Struck by Lightning
Hook Law Center: Kit Kat, what can you tell us about the reindeer in Norway that were killed on August 26, 2016 by a terrible lightning strike?
Kit Kat: Well, this is a very sad tale, indeed! 323 reindeer were struck by lightning in a hunting area of the Hardangervidda mountain plateau of central southern Norway on Friday, August 26. At those altitudes, the mountains are treeless, and the reindeer took the brunt of the lightning strikes. From a picture in the article which appeared in The Washington Post, it looked like something out of a science-fiction or horror movie. Deer were stopped in their tracks, and fell dead right where they stood. In some cases, this meant falling right on top of one another. Reindeer when grazing, cluster in herds, and this was quite a large herd. This is especially true during bad weather. A gamekeeper discovered them. He notified NTB, a Norwegian news outlet. In turn, experts were called in to take samples of the carcasses which were later sent to a state veterinary institute to officially determine the cause of death.
Unfortunately, animals being struck by lightning is not unheard of. Before this latest incident, the largest group of animals known to be killed by lightning was a group of 68 Jersey cows in Australia in 2005. And just this past March (2016), 21 cows in South Dakota were killed when they became electrocuted from their metal feeder, which was struck by lightning. Yet, some animals get lucky! A male bison in Iowa, who lives at Neal Smith Wildlife Refuge, was struck by lightning in the shoulder in 2013. He lives to this day, though he has a large, hairless patch where he was hit. His caretakers have fittingly named him “Sparky!” (Karin Brulliard, “A lighning strike killed 323 reindeer, and this is the ghastly aftermath,” The Washington Post, Animalia section, August 29, 2016)
Distribution of This Newsletter
Hook Law Center encourages you to share this newsletter with anyone who is interested in issues pertaining to the elderly, the disabled and their advocates. The information in this newsletter may be copied and distributed, without charge and without permission, but with appropriate citation to Hook Law Center, P.C. If you are interested in a free subscription to the Hook Law Center News, then please telephone us at 757-399-7506, e-mail us at mail@hooklawcenter.com or fax us at 757-397-1267.The post New Changes Coming for Family-Owned Businesses first appeared on SEONewsWire.net.]]>