Will the IRS Make Valuation Discounts Disappear?

Valuation discounting utilizing family-owned entities has been a popular estate and gift tax planning technique for several decades. New proposed Regulations to Internal Revenue Code section 2704, which tax professionals have been anticipating for years, were published in August, 2016. The proposed Regulations could significantly impact the continued ability to generate valuation discounts when transfers of family-owned entities are involved.

Family business owners and their advisers have to be proactive in advance of the anticipated effective date of the new rules and update existing family business succession plans or implement new ones.  Otherwise, it may be too late.

The IRS is soliciting comments in advance of a hearing scheduled for December 1, 2016. The rules will not take effect until 30 days after the date the proposed Regulations are published as final regulations, which is anticipated to occur sometime in 2017. The proposed Regulations generally apply to transfers occurring after the date the regulations are published as final regulations.  A copy of the proposed Regulations can be found at https://www.regulations.gov/document?D=IRS_FRDOC_0001-1487


In 1990, the IRS enacted a series of Internal Revenue Code provisions adopting special valuation rules aimed at limiting the ability of a taxpayer to transfer appreciating property to family members while retaining some interest in or control over the property, or in a manner that resulted in an overvaluation for gift tax purposes. IRC sections 2701-2704 cover these transactions, called “estate freezes,” and these provisions impose a number of rules regarding the valuation of property for transfer tax purposes. IRC section 2704, entitled “Treatment of Certain Lapsing Rights and Restrictions,” generally provides that when a closely-held interest is transferred within the family, a restriction limiting voting or the ability of the entity to liquidate which can be removed by the family is disregarded when valuing the transferred interest for gift or estate tax purposes.

IRC section 2704 placed limits on the use of valuation discounts, but it did not eliminate them. In fact, under current gift and estate tax law, the IRS and courts have regularly approved discounts ranging from 30% to 40% when valuing the transfer of an interest in a closely-held entity when the transferee of the gifted interest does not have the right to liquidate the entity or withdraw as an owner.  If finalized, the proposed Regulations could eliminate or significantly reduce this valuation discount for gift and estate tax purposes.

The Proposed Regulations

The proposed regulations would limit valuation discounts in several ways. The new rules:

  • Read into governing documents of family-owned entities a “put” right for each owner to sell his or her interest for the fair market value of the owner’s proportionate share of the entity’s net assets.
  • Impute a gift which offsets the effect of discounting for estate tax purposes that might otherwise be available to a controlling owner who transfers interests within 3 years of his or her death.
  • Disregard control exercised by non-family member owners, unless certain exceptions are met – viz. the non-family member has been an owner for more than 3 years, owns a substantial interest in the entity, or has a meaningful “put” right.
  • Expand the types of entities covered by IRC section 2704 beyond corporations and partnerships so as to include limited liability companies and other entities or business arrangements.

Because of the far-reaching scope of the proposed Regulations, challenges are anticipated to the Treasury’s authority to enact such rules. “Safe harbors” may be provided for and some commentators have suggested that the final regulations may, like IRC section 6166, distinguish between operating companies and entities holding only “passive assets” (such as a family limited partnership which owns only marketable securities or similar investments) and deny a valuation discount only in the case of a family entity holding passive assets.

Do the proposed Regulations actually offer a tax savings opportunity for many family-owned businesses?

A report of the Joint Committee on Taxation, entitled “History, Present Law, and Analysis of the Federal Wealth Transfer Tax System,” dated March 16, 2015, suggests that 99.8% of estates will owe no federal estate tax.  For business owners not subject to federal estate tax or where the avoidance of a built-in capital gain is more beneficial than the applicable state estate tax, the inability to discount the value of a family business interest may actually inure to the benefit of these taxpayers and their families.

Here’s why: the undiscounted value of an interest in an entity which is includable in the taxable estate of a decedent will receive a “step-up” in basis under IRC section 1014. When no estate tax is due, the higher undiscounted valuation may actually serve to eliminate or minimize the capital gains tax due when an inherited interest in a family business is ultimately sold by the beneficiary. Also, a higher date of death valuation can allow the beneficiary to depreciate a greater sum under the applicable IRC sections.

Time will tell if the proposed Regulations will be a net revenue loser for the Treasury.

Planning strategies to consider in advance of the effective date 

All family business owners should review their existing agreements and determine whether the proposed Regulations adversely impact or can cause a future dispute over valuation clauses or other provisions in existing shareholder, operating or buy/sell agreements. For those closely-held business owners facing a federal or state estate tax, or where the use of discounting can minimize or eliminate exposure to that tax, planning opportunities utilizing currently recognized discounting techniques should be considered and implemented in advance of the anticipated effect date of the proposed Regulations.

Options include:

  • Consider gifts or sales to grantor trusts, including a Spousal Lifetime Access Trust.  By including a spouse as a beneficiary of a grantor trust, this planning technique provides an opportunity to address a future need for spousal support.  In the not-so-distant past, estate planners addressed a “fiscal cliff” that never materialized.  A substitution power in a grantor trust can also serve as a hedge to address future tax planning opportunities.  For example, a grantor may ultimately decide to swap assets with the grantor trust so as to take advantage of the step-up in basis available under IRC section 1014 in an instance where the capital gains tax exposure exceeds the estate tax savings offered by the grantor trust.
  • Confirm the amount of life insurance or other liquid assets in place to satisfy an expected federal or state estate tax obligation.  Given the potential for the proposed Regulations to impose a tax on “phantom” assets which were gifted during the look-back period, this analysis is critical under the proposed regime and it can forestall an unwanted or forced sale of a family-owned business on the death of an owner.
  • Consider implementing a Grantor Retained Annuity Trust (“GRAT”), which is an irrevocable trust that pays the grantor an annuity payment for a term of years.  The annuity payment is determined with reference to the federal interest rate under IRC Section 7520, which for August 2016 is only 1.4%. When the assets transferred to a GRAT outperform the Section 7520 rate, the remaining value passes to the residuary beneficiaries outside the transfer tax system.  When the value of a family-owned business interest is discounted, a lower annuity payment is required to reduce the value of the gift to the GRAT, typically to zero or near zero.  Depending on the facts, funding a GRAT prior to the effective date of the regulations can leverage more wealth out of a taxable estate.

Estate planning professionals should monitor the proposed Regulations and public comments. At a minimum, the proposed Regulations present planners with an opportunity to meet with existing family business owner clients to review their current documents and discuss their objectives in light of the benefits and detriments of valuation discounting.  Where applicable, family trusts should be created and funded utilizing currently available discounting strategies in advance of the effective date of the new rules.

What Can the Boss Teach New Jersey Residents About Estate Tax Planning?

New Jersey’s legendary troubadour just completed a triumphant return to MetLife Stadium in the swamps of Jersey. We know that Bruce and Miami Steve learned more from a three-minute record than they ever learned in school. But, perhaps you didn’t know that the Boss’s classic lyrics can also remind us to show a little faith as there is still some “magic in the night” for New Jersey residents who want to avoid or reduce the New Jersey Estate Tax.

“Don’t give me my money, honey  . . . I don’t want it back”

The New Jersey Estate Tax is a tax that can be eliminated or reduced by lifetime gifts.  Instead of leaving two grand sitting in your pocket, a New Jersey resident can make gifts without triggering federal gift tax by using available annual exclusions (currently $14,000 per donee) and the lifetime gift tax exemption of $5,450,000.  Because New Jersey does not impose a state gift tax, these federal exemptions offer “tramps like us” an opportunity to stay and avoid getting out while we’re young.

New Jersey’s estate tax law is based on the former credit for state death tax, which was repealed in 2005.  These are better days, it’s true, because under the current rules, lifetime gifts are not “pulled back” when considering the New Jersey taxable estate.  In other words, a New Jersey resident is only taxed on the assets that the decedent still owned at the time of his or her death – not the assets that have been gifted.

Note, before trying to make it good somehow, there are some other taxes to consider before a substantial gift is made.  If appreciated assets are gifted, the donee receives the transferor’s basis.  In an instance where the capital gains tax which would be triggered by a donee’s sale exceeds the anticipated New Jersey Estate Tax, it is more tax-efficient for the individual to retain the asset until death (and pay the New Jersey Estate Tax) because assets subject to the Estate Tax will receive a “step-up” in basis.  The step-up can work to avoid the higher capital gains tax when the beneficiary ultimately sells the asset.  Also, when the donor intends to benefit individuals who are not a spouse, parent or descendant, those lifetime transfers can be subject to a New Jersey Inheritance Tax of up to 16% when the transfers are made “in contemplation of death” to non-exempt beneficiaries.

“This boardwalk life for me is through .  . . you know you ought to quit this scene too”

New Jersey imposes a state estate tax on estates valued in excess of $675,000.  Many clients change their “domicile” to a different jurisdiction to avoid the state estate tax.  Florida is a frequent destination, but more recently, clients will cross the river from the Jersey side to New York to take advantage of the current $4,187,500 state estate tax exemption available to New York residents.

A person can have multiple residences, but for purposes of state estate taxation, an individual has only one “domicile.”   While there is no universally adopted definition of domicile, many states (and the IRS) share a general understanding that domicile means the place where a person has a fixed residence and the present intention of making it his or her permanent home. Once a domicile is established, “she’s the one” until superseded by a new one.

When clients have multiple residences and they want to change their domicile from New Jersey to Waynesboro County, Darlington County or some other jurisdiction, advance planning is recommended. Although there is no one fact that establishes a decedent’s legal domicile, when a change is considered, some of the following actions are recommended:

  • Filing a Declaration of Domicile in the new domicile state
  • Changing of vehicle and voter registrations
  • Filing state income or personal property taxes in the new domicile state
  • Executing new estate planning documents
  • Changing registrations for places of worship or club memberships

“The times are tough now, just getting tougher . . .  cover me”

Many New Jersey estate planning clients choose to maintain their house up in Fairview or take a good look around and refuse to leave their hometown.  The reason is often not tax motivated – clients want to be close to their family, grandchildren, shore homes and friends.  Also, gifting strategies to reduce the estate tax may not be viable or tax efficient.

For those who have learned to sleep at night knowing the price to pay by staying in New Jersey, there has been renewed activity in the purchase of single life and second-to-die life insurance to “cover” the New Jersey Estate Tax that will be incurred.  Many clients are coupling the life insurance with a Long Term Care rider to help preserve family assets in the event of a long-term illness.  Advice from a qualified or visionary planner, perhaps dressed in the latest rage, should be sought regarding the ownership and beneficiary designation of such policies, the tax considerations when an LTC rider is involved and the benefits of an irrevocable trust to own the policy.

The New Jersey Uniform Trust Code Becomes Effective July 17, 2016

On January 19, 2016, New Jersey joined over 30 other states when it enacted its version of the Uniform Trust Code, P.L. 2015, c.276 (“the NJUTC”). The objective of the legislation is to provide predictability, transparency and fairness for parties involved in the establishment and management of trusts, as well as those charged with their administration.

The NJUTC, which is effective July 17, 2016 applies retroactively, with certain exceptions. It’s advisable that parties to existing trusts, as well as legal practitioners and other advisors confirm the impact of the new law and review planning opportunities now available. To highlight some of the important provisions of the new law:

  • Many provisions of the NJUTC can (and, if inconsistent with a Grantor’s wishes, should) be overridden by a trust agreement.  Other provisions of the law, however, cannot. For example, if a beneficiary older than 35 so requests, the trustee must provide the beneficiary with copies of both the trust instrument and information regarding the investment and management of the trust assets;
  • Non-judicial settlements, designed to minimize or eliminate altogether costs and delays inherent in obtaining approval from the court in matters of trust administration are permitted, subject to limited public policy exceptions. Matters that may be resolved by a non-judicial settlement agreement include the interpretation or construction of the terms of the trust, the approval of a trustee’s accounting, direction to a trustee to refrain from performing a particular act or the grant to a trustee of any desirable power, the resignation or appointment of a trustee,  the determination of a trustee’s compensation, the transfer of a trust’s principal place of administration and the liability of a trustee for an action relating to the trust;
  • The NJUTC also allows for the modification of a trust if the trustee and all interested beneficiaries agree. There are several instances when the terms of a trust as envisioned by the trust’s creator no longer meet the intended purpose of the trust. For example, a provision directing a trustee to make distributions at certain pre-set ages may no longer be appropriate if the beneficiary is not sufficiently mature enough to handle the asset distributed, if the beneficiary is experiencing dependency issues or if there are potential creditors that could attach the trust funds distributed.  Similarly, a beneficiary in a strained marital relationship may prefer that mandatory distributions be eliminated;
  • The NJUTC also addresses the relationship between a trustee and an investment advisor, as a result of a new section on powers to direct investment functions. Although the provisions of the NJUTC defining the trustee/investment advisor relationship are clearly defined, such provisions are not within the scope of the mandatory rules and, consequently, can be modified to better conform to a grantor’s objectives. For example, under the default provisions, a fiduciary who has delegated investment functions to an investment advisor has no duty to monitor the conduct of the investment adviser, provide advice to the investment adviser or consult with the investment adviser, communicate with or warn or apprise any beneficiary or third party concerning instances in which the fiduciary would or might have exercised the fiduciary’s own discretion in a manner different from the manner directed by the investment adviser. Grantors should consider whether these provisions are acceptable. It is anticipated that investment advisors will also update their policies as a result of the NJUTC, and those policies should be reviewed by a Grantor who is considering taking advantage of the NJUTC’s new section on powers to direct investment functions.

Legislation Regarding Digital Assets Poses Planning Considerations

As technology and the use of social media become more prevalent, access to digital assets in the event of the account owner’s death has become an increasingly important estate planning consideration. Digital assets include a variety of media including social media pages, emails, and frequent flyer points.

There have been many reported instances when family members have faced tremendous obstacles gaining access to a deceased relative’s digital assets.  A number of states have introduced and/or enacted legislation on the topic. Connecticut laid the groundwork for digital asset planning with the approval of Public Act No. 05-136, “An Act Concerning Access to Decedents’ Electronic Mail Accounts,” which took effect October 1, 2005. Over the past several years, other states have acted to adopt laws that protect digital assets and grant the family of a decedent the right to access and manage those assets.  In 2014, the Uniform Law Commission approved the Uniform Fiduciary Access to Digital Assets Act, which is designed to allow executors, trustees, or the person appointed by the court complete access to a decedent’s digital assets.

In April 2016, the New Jersey legislature proposed bill A3598 which would authorize an executor or administrator to access digital assets of a deceased person. The law was referred to the Assembly Judiciary Committee. A link to the full text of the proposed New Jersey bill is http://www.njleg.state.nj.us/2016/Bills/A4000/3598_I1.HTM.  In May 2016, the New York legislature proposed bill S07604, which is similar to NJ A3598, but primarily focuses on providing a procedure for disclosure of digital assets. The bill was amended on third reading, now titled NY A09910, and is currently awaiting Senate approval. A link to the full text of the proposed bill is http://assembly.state.ny.us/leg/?default_fld=&bn=A09910&term=2015&Summary=Y&Actions=Y&Text=Y&Votes=Y#A09910.

In the absence of a controlling statute, there are a few basic actions that can help secure access to an account owner’s digital assets. At a minimum, it is recommended that a list of all user names and passwords of digital accounts be maintained. This list should be stored in a secure place, and the executor of the account owner’s estate should be notified how to retrieve this information. These digital assets include email addresses and airplane miles/vacation rewards, as well as bank account login codes. This list should be reviewed and updated periodically to reflect password updates.

In an instance where an account owner may feel uncomfortable authorizing access to social media accounts, or other programs that contain personal messages and information, several of the major social media platforms have recently introduced procedures for users to decide how they want their account to be managed after they pass away. For example, Facebook recently allowed its users to select a legacy contact. This contact will be granted limited access to the account. For example, the contact may be authorized to change a profile/cover photo or add relatives who were not previously connected. Limitations have been placed on the contact’s ability to log in to the account or see personal messages or images. Other platforms have similar procedures which can be accessed by the following links:




Don’t be Lulled into Inaction – Plan for the New Jersey Estate Tax

According to a “Quick Facts” report of the United States Census Bureau, the median value of a home in Bergen County, New Jersey for the period ending 2012 was $461,400. This figure is almost 37% higher than the New Jersey state average. Adjusted for inflation, the median value of a Bergen County home will approach $500,000 by 2015. This data confirms that planning for the New Jersey Estate Tax, which is triggered when the value of an estate exceeds $675,000, remains an important consideration for most Bergen County residents. Read more

Benefits of Planning With a Properly Drafted Trust

There are significant “non-tax” estate planning concerns that can be addressed through the implementation of a properly drafted trust. A trust can provide a measure of protection so that the assets you have accumulated over a lifetime are not dissipated by a creditor or divorcing in-law. Read more

A Primer on the New Jersey Estate Tax

There have been a number of New Jersey legislators recently advocating for the repeal of the New Jersey Estate Tax or an increase in the applicable exclusion amount. The text of bill A120 clearly states the basis for the attack – “this archaically low threshold for New Jersey’s estate tax—less than the value of many middle-class homes—encourages small businesses and their owners to shut down and leave the State.” Read more

Rethink the Credit Shelter Trust

For many years, New Jersey resident married couples with estates that exceeded the estate tax exclusion amount routinely implemented Wills that contained a two part trust scheme – a credit shelter trust funded in the amount of the available estate tax exclusion and a marital trust. The merits of continuing to use a credit shelter trust to avoid the New Jersey Estate Tax must be revisited. The reasons for the shift in planning – (i) a trust’s income taxation is similar to individuals, but the tax brackets are very compressed; (ii) assets which fund a credit shelter trust do not receive a basis adjustment at the death of the surviving spouse; and (iii) post-mortem domicile planning or gifting strategies can be implemented to avoid the New Jersey Estate Tax. Read more

Is it Time to Update Your Estate Plan?

There have been significant revisions to the federal estate and gift tax laws over the past five years. In 2010, the federal estate tax was repealed for one year only. When the federal estate tax was reinstated in 2011, an exclusion amount significantly higher than the New Jersey Estate Tax exclusion amount was included. Read more

Avoid the Peril of DIY Estate Planning

The volume of available online information on estate and gift tax issues and advanced estate planning techniques is staggering and there is no shortage of web based services offering the sale of “basic” estate planning documents. Read more