Tax Law Changes Make Estate Planning Tougher

By Kimberly R. Hoipkemier, Esq.

If the IRS has its way, one of our prime estate planning techniques will soon be obsolete.

Earlier this month, the Treasury Department released proposed regulations under Section 2704 of the Internal Revenue Code that will severely undermine valuation discounts, which are commonly used by us and other estate planners to reduce the value of assets that are gifted or sold pursuant to a client’s estate planning.

Many of our clients have taken advantage of this discount planning when entering into popular and effective freezing techniques involving gifts and sales to irrevocable grantor trusts. These savings are often accomplished by transferring assets for business and other non-tax reasons to a partnership, limited liability company or closely held business organized with Class A voting and Class B non-voting membership interests at a 1 to 99 ratio.  Then, Class B membership interest are gifted and/or sold to the irrevocable trust which is generally for the benefit of children and future generations.

As mentioned above, when valuing the Class B non-voting interests being transferred, we have been able to comfortably assess a lack of control and lack of marketability discount on the Class B interests of 25-45 percent.  This means that Class B interests with a proportionate liquidation value of $1 million can be gifted to the trust using only $650,000 of the client’s lifetime transfer tax exemption.  Should the value of the Class B interests exceed the available transfer tax exemption, we enhance the freezing technique by selling the Class B interests to the Trust for the discounted value, leaving only a promissory note (with very low interest rates) in the taxable estate, ‘frozen’ at the discounted value of the interests.  All appreciation on the underlying assets in the entity grows estate-tax free. While these “freezing” techniques will likely remain attractive after the 2704 regulations because of the ability to remove future appreciation from the grantor’s taxable estate, the recent proposed Regulations for Section 2704(b) will dramatically inhibit the ability to achieve tax savings through valuation discounting.

The good news is these Regulations are not yet in force.  We anticipate they will not be effective until early 2017, so there is still (some!) time to plan and utilize valuation discounting techniques to reduce estate tax exposure.

We strongly recommend contacting our office as soon as possible if you are considering this type of discount planning, as the valuation process may take some time to complete.

For more information regarding this or any other estate planning concern, please contact us at 404-255-7400 or at info@hoffmanestatelaw.com.

EXAMPLE 1:  No Estate Tax Planning

Clients Bob and Mary have a combined net worth of $20,000,000 comprised of securities, real estate, and a closely held family business.  With no planning, Bob and Mary’s children will owe approximately $3,656,000 in estate taxes.  Estate taxes are due nine months from death and payable in cash.

EXAMPLE 2:  Estate Tax Planning in 2016 with Discounting Technique Currently Available

Clients Bob and Mary have a combined net worth of $20,000,000 comprised of securities, real estate, and a closely held family business.  Bob and Mary contribute all of their investment real estate worth $8 million to Family Land, LLC with Class A Voting and Class B Non-Voting interests.  Bob and Mary retain 1% Class A Voting Interest and transfer all 99% Class B Non-Voting Interest to the Family Trust for the benefit of their children and grandchildren.

Family Land, LLC is appraised at $8 million.  After 35% discount for lack of control and lack of marketability, the 99% Class B shares are valued at $5,148,000, allowing Bob and Mary to transfer all of the Class B interests and use just under one of their estate tax exemptions to remove an $8 million asset from their taxable estate.

Family Trust holds $8 million worth of real estate, and all appreciation thereon, separate from the estates of Bob and Mary, for the benefit of children and future generations, free from creditors and estate taxes

*Of course, after the death of one spouse, the assets continue to appreciate, and estate taxes (historically over 50%) are paid at the death of the second spouse.

EXAMPLE 3:  Mary Outlives Bob and Assets Appreciate with No Estate Tax Planning

Clients Bob and Mary have a combined net worth of $20,000,000 comprised of securities, real estate, and a closely held family business.  At Bob’s death, the real estate is worth $8 million, and his entire estate tax exemption is used to shield estate taxes.  Mary outlives Bob by 10 years, and the real estate is now worth $16 million.  With no estate tax planning, the estate taxes now payable by their children are $6,856,000.

EXAMPLE 4:  Mary Outlives Bob and Assets Appreciate with 2016 Tax Planning Techniques

Clients Bob and Mary have a combined net worth of $20,000,000 comprised of securities, real estate, and a closely held family business.  Bob and Mary contribute all of their investment real estate worth $8 million to Family Land, LLC with Class A Voting and Class B Non-Voting interests.  Bob and Mary retain 1% Class A Voting Interest and transfer all 99% Class B Non-Voting Interest to the Family Trust for the benefit of their children and grandchildren.

Family Land, LLC is appraised at $8 million.  After 35% discount for lack of control and lack of marketability, the 99% Class B shares are valued at $5,148,000, allowing Bob and Mary to transfer all of the Class B interests and use just under one of their estate tax exemptions to remove an $8 million asset from their taxable estate.

Mary outlives Bob by 10 years, and at her death the real estate in Family Land, LLC is worth $16,000,000.  Family Trust holds $16 million worth of real estate separate from the estates of Bob and Mary, for the benefit of children and future generations, free from creditors and estate taxes.

*Of course, after the death of one spouse, the assets continue to appreciate, and estate taxes (historically over 50%) are paid at the death of the second spouse.

For more information regarding this article or any other estate planning inquiry, please contact us at 404-255-7400 or info@hoffmanestatelaw.com.