IRS Looks to End Popular Estate Planning Tool
Tax laws are very complex, as are IRS regulations. The tax code is often criticized as being overly complex, and every election year there are calls to simplify it. But sometimes, tax laws and proposed tax changes can be explained in normal real world terms. Such is the case with a proposed new IRS regulation, which unfortunately looks like it will take away a tax and estate planning tool often used by small businesses.
The Value of a Business Isn’t Simple Math
Let’s assume that a business is worth $5 million, and there are 5 equal partners. How much is each partner’s interest worth? Simple math tells you: $1 million each. That would mean that if you wanted to sell your share, you would be taxed at $1 million, or if you died and a relative inherited your share, there would be an estate tax assessed on the value of $1 million.
In fact, the tax code isn’t that simple. Indeed, when it comes to businesses, the IRS has been allowing business owners to reduce the value of their ownership based on marketability.
Let’s go back to our previous example. Assume you wanted to sell your 1/5th share. Could you sell it for $1 million? Maybe not. Potential buyers may not know the other four partners, may not like them and may not want to work with them. Potential buyers may not like the governing documents of your business. Potential buyers may not like the fact that because they would only be a 1/5th owner, they would be a minority partner, with no control over how the business is run.
So in truth, the value of your share may be less than $1 million, because these issues reduce the marketability of your share. What it’s worth and what you can sell it for are two different things. So the IRS allows you to reduce the value of your share when it comes to taxes, to account for this reduced value.
IRS Looks to End Practice
But now the IRS is cracking down because this benefit has been abused. Many people have funneled assets into businesses. If an asset is worth $1 million by itself, but you can transfer it into a business, and now it’s property of the business, and your share of the business is worth $500,000 after discounting for marketability, you’ve reduced your taxable estate.
New regulations will prohibit the use of marketability factors in valuing business interests in closely held businesses. Now, in many cases, 1/5th of a $5 million business will really be $1 million.
The good news is that the change eliminating the ability to reduce for marketability is only for owners who are giving assets worth $5.4 million or more. Below that, taxpayers can still use marketability reductions as an estate planning and tax planning strategy.
Make sure your assets aren’t being taxed at a higher value than they’re worth. Contact Tampa business, asset and probate attorney David Toback to discuss a comprehensive personal and business tax and estate plan.