New Regulations May Limit How the Wealthy Can Lower Their Estate and Gift Taxes

The federal estate and gift taxes affect only a small percentage of citizens, but, for those that are affected, the 40% tax rate on both estate and gift transfers over a certain is significant to say the least. For decades, wealthy individuals holding significant business interests have been able to take advantage of an estate planning strategy to lower the value of their estate and gift transfers below the federal exemptions, but this strategy may soon disappear as new Treasury and IRS regulations limiting the strategy may soon take effect.

The Heretofore Allowable Discount Strategy

The current lifetime estate and gift tax exemption is $5.45 million per individual and $10.9 million for a married couple. Under the regulations that have existed to date, wealthy couples have been allowed to take assets that are worth more than $10.9 million and place them into a holding company or entity created for the purposes of the gift transfer and then give beneficiaries varying levels of ownership in that holding company or entity. Because the individual beneficiaries are now essentially minority shareholders in a commonly-held company shared with others, they do not have the right to control how the assets are maintained, nor is there a market in which they can transfer their ownership in the company. As a result, the wealthy couple who placed the assets in the company can get an appraisal of the individual holdings in the company which reflects a 30 to 50 percent discount of the actual value of the assets due to the ostensible illiquidity of the individual holdings.

To give an example, a wealthy couple might have $15 million in assets that they want to give to their five children, either during the lifetimes or following their deaths. They can create a holding company and transfer the $15 million in assets into the company, and grant their five children 20% ownership stakes in the company, either through a will or through a present gift. Because each child is a minority shareholder in the company without the power to currently manage the company’s assets or sell their ownership stake, the couple can then get an appraisal reflecting a $5 million discount based on this illiquidity and lack of control, devaluing the company to $10 million and placing it firmly within the lifetime estate and gift tax exemption.

How the New Regulations Will Affect This Strategy

Under the proposed regulations set forth by the IRS and Treasury Department, the IRS would be permitted to ignore the discounts provided by taxpayers in appraisals of such assets and disallow other types of discount valuations provided by taxpayers who die within three years of making gifts to families and others. Thus, in the above example, the couple would face estate and/or gift taxes for the full $4.1 million value of the $15 million that exceeds the $10.9 million exemption. At a 40% tax rate, this would mean an added tax of $1.64 million on the couple’s holdings.

It is also important to remember that the estate tax rate that is applied to a party’s estate is the one in effect at the time of death, not at the time the estate planning was done. Presidential candidate Hillary Clinton has indicated she will work to raise the current estate tax rate.

Work with a Pasadena Estate Planning Attorney to Prepare for Estate and Gift Transfers

As of October 2016, the proposed regulations have not become final, so taxpayers still have time to take advantage of the current rules. Estate planning attorney Christopher B. Johnson, located in Pasadena, California, has years of experience in all aspects of estate planning, will work with you to maximize the assets available to your beneficiaries while minimizing your tax burden. To request an immediate consultation, contact him today at (877) 755-9178.