Under the proposed regulations, traditional valuation and appraisal concepts will no longer apply to closely held family businesses and farms, regardless of whether they are investment assets or operating businesses. The impact of this estate tax could force many small family businesses (including farms) to be sold at the owners’ deaths from lack of liquidity to pay the estate tax and could result in employees losing their jobs when the business is sold to a larger company or liquidates.
The effect of these regulations is a practical elimination of a taxpayer’s, or the estate of a deceased taxpayer’s, ability to apply traditional lack of marketability and minority interest (lack of control discounts) when computing the value of an interest in a family-owned business for transfer or estate tax purposes.
These broad, expanded limitations will go into effect 30 days following the final publication of the regulations, which will not occur until sometime after a ninety-day period for the receiving comments and an official hearing scheduled for Dec. 1.
Here is a simple example of how these rules apply:
Assume Joe Smith died with an estate composed primarily of a family-owned, manufacturing business with a fair market value of approximately, $8.5 million before any discounts are applied. If a 40 percent combined discount for minority interest and lack of marketability is applied, then the value for estate and transfer taxes would be approximately $5.1 million. The estate would not exceed the current $5.45 transfer tax exemption and thus, no estate taxes would be owed. If the new regulations are applied, then the 40 percent discount would not apply, and the full $8.5 million, less any expenses, would be subject to federal estate taxes. Assuming the estate expenses and liabilities were $100,000, the $8.4 million estate would be subject to a federal estate tax of approximately $1.2 million, which could place the heirs in a position of having to liquidate, sell or mortgage the business in order to pay Uncle Sam. This would be after Joe spent a lifetime paying income taxes, sales taxes, property taxes, and accumulated this business, and now upon death, Uncle Sam wants a final tax bite.
Owners of family businesses and investments should consult their tax advisors to determine if these regulations may potentially impact them and to determine what steps can be taken to minimize the adverse consequences. The regulations are not retroactive and there remains a window of opportunity to implement an estate tax plan prior to the regulations becoming effective. Thus, the regulations bode well for tax attorneys and accountants, like me, but not so well for small business!
We can expect many comments and criticisms of these anti-business regulations and ultimately, if they become final, which could happen early next year, a challenge in court as to whether the Obama administration has exceeded its authority under the Constitution and/or applicable law (e.g. as President Obama’s immigration plan has been blocked by the courts). The dispute may take years to resolve, but after the regulation becomes final (possibly early next year), it will be difficult to take a position contrary to the published regulations while they are being challenged.
A common theme of the Democratic Party is that the rich should pay more in taxes, but we need to help small business. Ironically, the constituency most impacted by these regulations is families whose primary wealth is composed of a small business that created substantial jobs (and tax revenues) for their communities. According to the U.S. Census Bureau data, 5.73 million employer firms in the U.S. with fewer than 500 workers accounted for 99.7 percent of those businesses and those with less than 20 workers made up 89.6 percent. According to the SBA’s Office of Advocacy, small firms have accounted for 63 percent of the net new jobs between 1993 and mid-2013 and 60 percent since the recession (mid-2009 to mid-2013). Approximately 28.2 percent of small businesses were “family-owned” and account for 42 percent of small business receipts. In my view, the small family business cannot afford this tax, and neither can our economy.
» David P. Webb is a shareholder in the Jackson office of Baker, Donelson, Bearman, Caldwell & Berkowitz, PC, where he concentrates his practice in the area of tax, estate planning, mergers and acquisitions and business law. The views and opinions expressed herein are those of the author and do not necessarily represent the views of Baker Donelson.
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