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SBA letter to IRS seeks more info on valuation discount rule

On Behalf of | Nov 6, 2016 | Tax Law

The Small Business Administration (SBA) has weighed in on the side of small businesses in an effort to seek additional clarification from the Internal Revenue Service regarding the ending of the valuation discount under section 2704 of the Internal Revenue Code. The practice has become commonplace for transfers of interests in small family businesses or farms. The SBA is concerned that the IRS has underestimated the effect the change will have on continuity and succession planning for these entities.

When interests in small businesses or family farms are transferred from parents to their children, the children typically receive minority interests. These interests, because they lack control or the ability to be easily liquidated, have been afforded discounts for lack of control (LOC) and for lack of marketability (LOM).

Aggressive estate planners have often designed transfers based on 30 percent or greater discounts. The IRS often contested these more extreme discounts in court and proposed the regulations to stop some of these practices. The regulations would disregard discounts for transactions that occurred within three years of the death of the owners who transferred the interests.

SBA has asked that the IRS extend the comment period and provide a more detailed analysis of the effect the regulations will have on many small businesses. While it appears the regulations are likely to go into effect, it may not be as problematic as the SBA or many businesses believe. The estate tax exemption remains at $10.9 million for a married couple, and transfers that made sense with the discount may still make sense with less of a discount.

It is important to remember that even estate planning decisions related to a business should be grounded in what is best for the business in the long run and that not all tax avoidance transactions are in that best interest. Minimizing taxes can be important, but tax planning should occur in the context of a holistic perspective of the operations of the business.