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Proposed IRS regulations on family valuation discounts could devastate small businesses

11-30-2016

IRSThe IRS has never been shy about finding new ways to separate taxpayers from their hard-earned money.

While this certainly isn’t news to small business owners – many of whom pay tax rates that are much higher than the average taxpayer – the agency’s latest shameless cash grab could have a devastating impact on many of the nation’s family-owned companies and farms.

The IRS is advancing controversial new rule changes without the benefit of legislation in a regulatory over-reach that is expected to take effect soon after a Dec.1 hearing is held in Washington, D.C.

The IRS has attempted to change the way business interests are valued in a family business since the 1980s at least, to no avail.  But they are trying once more.

Valuation discounts in jeopardy

Earlier this year, the IRS proposed sweeping regulatory changes pertaining to business valuation for transfer tax purposes, such as inheritance taxes or gift taxes. This new policy would force stakeholders to shoulder a significantly higher tax bill whenever shares in a business change hands, by artificially increasing the value of family businesses and farms.  This change would be achieved by eliminating or reducing discounts for lack of marketability and minority interests. This conceptually results in a higher business value than if the interest were to be sold to a non-related third-party.

The IRS has long attempted to restrict or eliminate these two valuation discounts when transferring interests in a family-controlled entity.  The proposed regulations would limit the way a family member’s ownership interests are attributed in a business, due to a lack of control caused by having only a minority interest, and secondarily, for lack of marketability.

Both reflect the fact that a family member can rarely sell his or her shares quickly or easily, because they lack legal control of the company as one of several owners.

This looming tax threat is especially dangerous to smaller companies and family farms in which the largest part of the estate is tied up in property and equipment. A surviving heir could be forced to sell the business just to pay an estate tax bill when the primary owner passes away, potentially erasing generations of hard work.

Although these proposed changes appear to have been fast-tracked by the IRS, the results of the 2016 elections may cause the agency to pump the brakes on any new, anti-business regulations. However, the Trump Administration’s silence on the issue leaves open the possibility that the IRS could quietly push through these changes in the near future.

It is critical for small business owners to understand the impact of these regulations and take the necessary precautions now to avoid potentially devastating financial consequences.

How business owners can protect themselves

The new IRS regulations would treat family-owned businesses differently from other companies – a step that not only runs contrary to mountains of established case law, but contradicts the agency’s own standards for business valuation. However, most small business owners lack the resources to challenge these regulations in court.

It may make financial sense for some small business owners to move forward with a transfer in a percentage of ownership immediately. A timely transfer not only could reduce gift taxes up front, but also limit the IRS’s ability to collect additional taxes from heirs in the event of a business owner’s death. Discussing these concerns with a qualified expert in estate planning is critical.

The election of Republicans to the White House and both houses of Congress make it somewhat less likely that the IRS will move forward with these regulatory changes in the immediate future. However, it does not eliminate that possibility entirely. There is also little that prevents the agency from pursuing these changes at a later date.

Small business owners should ensure they are prepared for these potential changes and any other curveballs the IRS might throw at them by discussing these issues with someone who understands the complexities and nuances of the Internal Revenue Code.

Keith R. Gordon, CPA, CFF, CVA is a Senior Manager with Boyer & Ritter and has nearly 25 years of experience in business valuations, litigation support, accounting, income tax and management consulting. He can be reached at (717) 761-7210 or kgordon@cpabr.com

 

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