Chapter 16 - § 16.2 • VALUATION DISCOUNTS

• Jurisdiction: Colorado

§ 16.2 • VALUATION DISCOUNTS

Many estate and gift tax planning techniques have produced significant savings because of valuation discounts. On August 4, 2016, the IRS proposed amendments to the regulations under I.R.C. § 2704(b)(1) (Proposed Valuation Regulations), 81 Fed. Reg. 51,413 (Aug. 4, 2016), limiting the discounting of family entities in gifting. The Proposed Valuation Regulations were withdrawn by President Donald Trump's Executive Order 13789, issued April 21, 2017.

Valuation discounts arise because direct ownership of an entire asset (such as a parcel of real estate or an interest in a successful business) is more valuable than an undivided interest in an entity that owns the same asset. Historically, court decisions in estate and gift tax cases have recognized substantial discounts to the valuation for estate and gift tax purposes of interests in limited partnerships, LLCs, and corporations for minority interests, lack of control, lack of power to liquidate, and potential taxes.⁹

• A lack of liquidity discount is based on the fact that ownership interests in a privately held company cannot easily be sold and the owner is not able to liquidate the entity by his or her own volition; and
• A minority interest or lack of control discount reflects that a minority interest holder cannot impose business or other decisions on the other members or partners.

Attorneys have often recommended that their clients employ LLCs and limited partnerships to achieve valuation discounts. Although valuation discounts also may be allowed for stock in corporations, LLCs or limited partnerships have typically been used because of the interplay between the law providing that a decedent's assets receive a new tax basis and the differing provisions of subchapter K (relating to partnerships) and subchapter S (relating to S corporations) of the I.R.C., as discussed in § 16.3, "Adjustments to Basis."

An example may be helpful here. Parents of three children own an interest in a piece of commercial real estate, which they lease.¹⁰ Assume that the fair market value of their interest is $10,000,000 at date of death of the surviving parent. If the parents were to die leaving the property to their children (and assume that their estate is well above the basic exclusion from the estate, gift, and generation-skipping tax), the federal estate tax on this asset would be $4,000,000 (40 percent).

• Were the parents to contribute the property to an LLC during their lifetimes, they could gift ownership to their children and grandchildren. A 1-percent interest (with a pro-rated value of $100,000) might be valued at $70,000 because it is a non-publicly traded minority interest that has no power to compel liquidation.¹¹ Using discounts, the parents could continue to gift ownership interests to their children (or grandchildren) over a period of time so that, at death, each parent and each child owns 20 percent, the valuation before discounts of the two parents' interest at date of death (assuming they die together and the $10,000,000 value) would be $4,000,000, and applying a 30-percent lack of liquidity and minority interest discount, taxable value would be $2,800,000, resulting in a tax of $1,120,000 as compared to $1,600,000 without discounts.¹² The aggregate estate tax savings is even greater if one considers that, if the LLC had not been formed and no gifts had been made, the estate tax on the $10,000,000 of value transferred to the LLC would be $4,000,000. Moreover, because of the gifting program, appreciation in the value of the transferred asset would also escape estate taxation to the extent attributable to the gifted interests. Even if valuation discounts are eliminated by the finalization of the Proposed Valuation Regulations, gifts will still remove future appreciation in the value of the gifted asset from the donor's estate.
• Admittedly, the parents could transfer undivided interests in the property to their children so that each of the five of them would be 20-percent co-tenants, and the undivided interests will be valued at a discount.¹³ However, creating a number of tenants-in-common will cause the land to be more difficult to manage, financings will be more complicated, the minority interests will be available to the creditors of the individual owners, and there will be the possibility of partition

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