Why The US Treasury Proposed Tax Regulation Must Be Defeated?
On August 2, 2016 the Treasury Department through the Internal Revenue Service (IRS) proposed a very important change in the regulation currently titled "Internal Revenue Code Section 2704 (IRC Section 2704)" that has been around for more than 100 years. That regulation deals with Estate, Gift, and Generation-skipping Transfer Taxes. The proposed regulation is titled: "Estate, Gift, and Generation-skipping Transfer Taxes: Restrictions on Liquidation of an Interest, (REG. 163113-02)." This is very impactful change that could possibly result in artificially inflating the value of small businesses and even force them out of business with devastating consequences for the country.
What is at issue?
The IRS is proposing to change the existing regulation by adding more restrictions that will significantly affect the valuation of entities that are transfer vehicles like family limited partnerships, S corporations, limited liability companies, etc. The issue at stake here is that essentially the IRS wants to do away with discounts that are applied to minority shareholders in en entity or corporation in a liquidation situation. Those discounts are called “discount for lack of control (DLOC) or “minority discount” and “Discount for lack of liquidity or marketability (DLOM).”
Why does it matter to small and closely held businesses?
To explain this let's start by defining what a discount is? A discount is a deduction made from the price or value of an entity. If your business is valued at a higher amount, you will have to pay more taxes compared to if your business was valued at a lower amount. In tax valuations, for example estate or gift tax, the standard of value is Fair Market Value. It is defined by the IRS in Revenue Ruling 59-60 as:
“The amount at which a property would change hands in an arms length transaction between a hypothetical willing buyer and a hypothetical willing seller, when neither is acting under compulsion and both have reasonable knowledge of the relevant facts.”
This standard of value (FMV) requires that we take into consideration the fact that a minority shareholder does not have a readily available market that will buy his shares within 3 business days. Therefore, to account for the risk of losing value during his search of a buyer, a discount should be applied. Actually two discounts will apply: one for not having control of the company to make critical business decisions (lack of control) and a second for the fact that his shares are not immediately (within 3 days) marketable (lack of marketability). Those discounts are multiplicative not additive. They will consequently, lower the value of that entity (shares or business), which means he will have to pay fewer taxes to the IRS. This is what the IRS wants to change and this is why every business owner must be outraged.
How to prevent it from happening?
There is a hearing on December 1st 2016, at the Treasury Department (IRS) Auditorium located at 1111 Constitutional Avenue NW Washington DC 20224. Many stakeholders like NACVA, AICPA, ASA, business owners, law firms, CPA firms, business valuation firms like us, The Washington Valuation Group (WVG), will be at that hearing. The objective is to fight this proposed change by testifying and showing why this proposed change to a regulation that is over a century old and grounded on scientific facts, is bad for everyone including the IRS. The ultimate goal is to get the IRS to drop the proposed regulation.
Here is NACVA's response to the proposed regulation. Click Here.
Here is the proposed regulation from the web site Regulations.gov.
Join us tomorrow at the IRS auditorium to help defeat this proposed regulation.
Achille Ekeu, MBA, CVA
The Washington Valuation Group
Achille Ekeu is a Certified Valuation Analyst (CVA) member of the National Association of Certified Valuators and Analysts (NACVA) in the DC-MD Chapter. He provides valuation services for Estate and Gift Tax, Purchase, Sale of business, Debt Financing, Buy-Sell Agreements, and Litigation Support in Divorce/shareholders disputes cases. He can be contacted by phone at 240-274-9570 or by email at firstname.lastname@example.org.