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Valuation Discounts Are Here To Stay

Nov 7, 2017

In August 2016, we wrote about the IRS proposed rules (REG-163113-02) on estate, gift and generation-skipping transfer taxes and restrictions on liquidation of interest. Published in the Federal Register on August 4, 2016, the proposed regulations could have had a significant impact on the valuation of an intra-family ownership interest if implemented. The proposed regulations were published in the Federal Register on August 4, 2016. 

These proposed regulations pertain to IRC Section 2704, which provides (1) special rules for valuing intra-family transfers of interests in corporations and partnerships subject to lapsing voting or liquidation rights; and (2) restrictions on liquidation in determining the value of the transferred interests. According to the proposed regulations, this will affect certain transferors of interests in corporations and partnerships and was designed to prevent the undervaluation of such transferred interests.  

Business owners, the legal community, tax advisors and valuation professionals expressed concern as these proposed rules would eliminate or restrict the use of discounts on the valuation of minority interests, such as the lack of control discount. Eliminating or restricting the use of a discount for lack of control would result in a higher valuation of the business from which taxes would be assessed (e.g., the occurrence of a gift).  

The following is an example of the potential impact of the proposed Section 2704 regulations on valuations:

  Without Discount      With Discounts
Fair Market Value (FMV) $10,000,000 $10,000,000
Discount Example 0% 25%
Discounted FMV $10,000,000 $7,500,000


The application of the discount here reduced the tax basis by $2.5 million. Keep in mind, the applicable discounts and fair market value vary based on the individual facts and circumstances for each valuation.

In April 2017, President Trump issued Executive Order 13789, which was designed to reduce tax regulatory burdens. It required the Secretary of the Treasury to review all “significant tax regulations” issued on or after January 1, 2016. The Secretary would then prepare an interim report to identify regulations that (1) impose an undue financial burden on U.S. taxpayers; (2) add undue complexity to the federal tax laws; or (3) exceed the statutory authority of the IRS.  The Treasury concluded that the proposed regulations under Section 2704 were identified for burden reduction, as were seven other regulations (read more on "IRS Identifies Tax Regulations Imposing Financial Burdens or Adding Undue Complexity"). The Treasury and the IRS currently believe that these proposed regulations should be withdrawn in their entirety and plan to publish their withdrawal in the Federal Register, according to the October 2017 “Second Report to the President on Identifying and Reducing Tax Regulatory Burdens.”

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