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IRS Estate-Tax Proposal Could Hit Wealthy Business Owners Where It Hurts

Sept. 9, 2016
Advisors, Estate Planning, Financial Planning, Investing
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Wealthy business owners transferring ownership stakes to their children will soon see a bigger tax hit, if new IRS estate-tax rules take effect.

We asked financial advisors what impact these changes might have, and who will be affected.

First, a little background: Last month the U.S. Department of the Treasury proposed curtailing so-called valuation discounts on transfers of business interests among family members in closely held firms. These discounts were often used to keep transfers under a $10.9 million lifetime estate-tax exemption for married couples, thus lowering the tax on transferred wealth from one family member to another, for example a parent to a child.

Valuation discounts have long reflected the notion that the value of a minority interest in a family-owned company is somewhat less than its face value, because minority shareholders often have limited influence over a company’s operations and limited ability to sell or liquidate their stakes, for example. The government proposal would largely do away with that discount on transferred business stakes.

A public hearing on the issue is scheduled for Dec. 1, and new regulations could be in place in early 2017.

Forrest Baumhover and Larry Weiss, members of NerdWallet’s Ask an Advisor network, gave their reactions to the proposal and offered some estate-planning tips for consumers.

Who would be affected if this proposal were enacted?

Forrest Baumhover: This proposal is specifically targeting high-net-worth families with family businesses.

What is an example of how this works and how it might change?

Larry Weiss: Let’s say a married couple owns a business that is valued at $30 million. If they wanted to transfer a collective 40% stake in the company to their child, that would represent a $12 million stake, well above the $10.9 million exemption for married couples. However, the valuation discount could bring the value of the transfer under $10.9 million, meaning the couple wouldn’t have to pay the estate tax, which currently has a top rate of 40%. If the new regulations pass, the value could not be discounted this way and the full estate tax would have to be paid.

What guidance would you give clients who were affected?

Larry Weiss: This new proposal is an opportunity to meet with your clients and to discuss with them their estate planning goals. If your goal is to continue a family business, I would look at gifting in the current year rather than waiting for a future time when these planning discounts might not be available.

Forrest Baumhover: I would advise my clients to stay tuned, keep their legal documents up to date, but not to panic. Also keep in mind that the estate tax could undergo changes beyond this proposal. Democratic presidential candidate Hillary Clinton has proposed lowering the estate tax exemption and raising the maximum estate and gift tax from 40% to 45%, while Republican candidate Donald Trump has proposed eliminating the tax altogether.

For people who are not wealthy business owners, what is the most important thing to keep in mind about estate planning?

Forrest Baumhover: The most important thing for any consumer is to make sure your estate planning documents accurately reflect your intentions. Too many people pass away with dated documents that clearly do not reflect their interests. For example, divorce and remarriage can cause one’s estate to go to an unintended beneficiary if the estate planning documents aren’t up to date.

Larry Weiss: For many individuals, estate planning is about control. Are you ready to share or give up control of a family business? If you plan today, you will be able to greatly reduce potential estate taxes in the future, which would benefit your heirs substantially. The key factor is, “Are you willing to share or delegate the decision-making process to other family members?”

For many parents or business founders, the ability to step away from the decision-making process can be a far greater hurdle than the threat of estate taxes. Good planning can help reduce the tax burden, but for many the decision is emotional rather than logical.

Forrest Baumhover is a financial advisor with Westchase Financial Planning in Tampa, Florida.

Larry Weiss is a fee-based financial planner affiliated with NEXT Financial Group Inc. Member FINRA/SIPC.