Authored by: Paul J. Sowell

Just when those impacted by the moving target that was the gift and estate tax exemption collectively sighed in relief at the passage of the fiscal cliff deal, it appears the celebration may have been premature.  President Obama recently released his proposed budget for 2014 where he seeks to revisit the exemption amounts. Under the President’s proposed budget, the gift and estate exemption would be reduced to the 2009 level of $3.5 million and the estate tax rate would be set at 45% starting in 2018.  In addition to fiddling with the gift and estate exemption amounts and estate tax rate, the President continues to advocate for the “tightening of the screws” of some popular wealth transfer planning tools, such as the popular trust arrangement known as a GRAT, which allows families to potentially move large amounts of assets off their balance sheet at discounted values. The administration’s proposals would also severely limit the use of GRATs by requiring a minimum 10-year term (Grantor must survive to the end of the term), rather than the current 2-year requirement.  If implemented, this would certainly (negatively) impact many clients by restricting their estate planning opportunities. Many clients,  who because of their advanced age, might simply find it unreasonable to expect to survive such an extended age hurdle.

Curiously, a mainstay of his prior budget proposals, the elimination of valuation discounts for family owned entities, is not mentioned in the proposed budget. This may portend something even more ominous for the future of family entity discounting and the impact may be significant.

Valuation discounting of privately held business interests is in many instances a predicate to the most sophisticated wealth transfer planning strategies. At the core of the use of discounts is the ability of families to pass wealth at values which are less than the assets gross value. Primarily (but not exclusively) this is accomplished by applying discounting principles known as lack of marketability and minority interest. Lack of marketability means that finding a willing buyer for a privately held company may be more difficult because the shares of such company are not traded on a public exchange, like shares of Apple stock. Minority interest means that the owner lacks control of the asset and can’t get income from it unless the business makes a distribution. Based on these principles, families looking to transfer family owned business have been able to get the face value of the business reduced by appraisers who apply these concepts. Many estate tax advocates, including the current administration, feel that this is just another loophole for the rich which needs to be closed. So how might they close it? It appears a new treasury regulation may be on tap.

What exactly is a treasury regulation? Treasury regulations pick up where the Internal Revenue Code (IRC) leaves off by providing the official interpretation of the IRC by the U.S. Department of Treasury.  The IRS has for several years maintained that it has the authority to restrict or eliminate valuation discounts by regulation. Prior Department of Treasury commentary states that sections of the IRC were intended to limit planning techniques designed to reduce transfer tax values, but that does not reduce the economic benefit to the transferee. Can the absence of any mention of family discounting in the 2014 budget indicate a shift in strategy by the administration and the imminent issuance of a regulation as the IRS has been alluding to for years now? It is very possible. It looks like that collective sigh at the beginning of the year may become a hiccup.

What does all this mean to affluent clients, their families and their family business interests?  Generally speaking it requires them to pay careful attention to weighing the benefits of engaging in wealth transfer planning at a time when the current administration seems inclined to raise taxes and restrict wealth transfer opportunities that have been taken for granted for a long time by many of our clients.