Back

Minority Family Discounts: Use Them Or Lose Them

By Bernkopf Goodman on 09.17.2009
Posted In: Publications

In Revenue Ruling 81-253 the Internal Revenue Service took the position that transfers in family controlled entities should not be discounted, notwithstanding that the recipient lacked voting control, including, but not limited to, the right to decide when distributions of earnings would be made, when the entity would be liquidated and other issues affecting the financial benefits of interest ownership.  That revenue ruling was successfully challenged by numerous taxpayers and since then, longstanding precedence has supported the position that a transfer of a minority interest in a corporation or other entity necessarily should be discounted to account for a lack of voting control.  Typically, these discounts can be as much as thirty-five (35%) percent and are an attractive tool to transfer wealth from one generation to the next.

Earlier this year, HR436[1] was introduced into Congress by Representative Earl Pomeroy from North Dakota (no relation).  One of the main purposes of HR 436 is to eliminate any minority discount applicable to transfers of equity in family controlled entities.  The Bill assumes that, notwithstanding a lack of voting control, the family relationship by itself insures control, therefore, no discount should be applicable.

Prior attempts to limit the use and applicability of minority discounts in family entities have repeatedly been thwarted and transfers of minority interests with discounted values has continued to grow as an effective estate planning tool.  To some in Congress, this practice is perceived as an abuse of the discount concept when applied within family units.  Given the need to raise revenue and fund the numerous proposals proffered by the current Administration and the support the Administration currently enjoys in Congress, it is very likely that HR436 will pass, if not in the exact version introduced, then certainly in a modified version with similar restrictions.  Family run businesses should quickly avail themselves of the benefits currently available for minority transfer discounts before they are lost forever.  Similarly, owners of investment properties such as office buildings, hotels and other income producing assets owned and controlled by a family unit should evaluate the wisdom of effecting such transfers immediately, especially given the added benefit of reduced valuations due to the ongoing recession.  Even those persons considering the establishment of qualified personal residence trusts may want to accelerate their decision making to take advantage of current low residential values and discounts for fractional interests.  These reduced values, coupled with the minority discount described above, should provide percentage values significantly less than those from just 24 months ago and significantly lower than what they should be in the coming decade.  Failure to act timely will likely result in the loss of this important wealth transfer tool.

Any transfer of minority interests must be structured correctly to insure maximum benefits are achieved and to avoid unintended adverse results.  For example, loan covenants may restrict the amount of minority interests that can be transferred and to whom.  Thus, financial and legal advisors should be consulted to insure proper structure, address current and future operational needs of the company or property, and establish a smooth mechanism for transferring control in the most tax advantageous method feasible.

The window is closing.  The Federal Government will most definitely be taking whatever steps it can to reduce budgetary deficits and close perceived loopholes for the wealthy.  Careful tax planning consistent with permitted mechanisms under current law has never been so important.  If you would like to learn more about these and similar tax planning and asset protection strategies that we have developed and implemented for many of our clients, please call the undersigned at 617-790-3370 or send an e-mail to mpomeroy@bg-llp.com.  You are also invited to attend a workshop at the Wellesley Country Club in November that Bernkopf Goodman LLP will be sponsoring with Atlantic Trust Company and Eastern Insurance which will discuss family wealth succession and planning tools and other asset preservation topics.  Please contact the undersigned for further details or to register for that conference.

[1]   This Bill, entitled “Certain Estate Tax Relief Act of 2009”, in addition to eliminating the family minority discount, also intends to eliminate the sunset provisions that were added to the Economic Growth and Tax Relief Reconciliation Act of 2001.  As submitted, HR436 would provide for a fixed exclusion amount of $3,500,000 which would not be subject to future increases or decreases.  Likewise, the maximum Federal Estate Tax Rate would be set at 45% but it would also include a provision that would increase the estate tax for large estates.  In certain estates, as more fully delineated in HR436, the applicable exclusion amount would be reduced to zero.  These additional amendments further justify the immediate consideration of effective estate planning to reduce federal estate taxes.