The Treasury Department has been attacking valuation discounts for a number of years, but the attack has finally come to an end. Valuation discounts are unique planning tools that estate and wealth planners utilize to minimize the value of certain assets, allowing property to pass from one generation to another with significantly fewer tax consequences. As such, valuation discounts have been a powerful tool in planning for the transfer or sale of farming operations from one generation to the next since the 1990’s.
Farmers often have different transition goals between generations. Most businesses work on ways to increase the value of their business before it is sold or the owners retire. However, farming families (and other family owned businesses) consistently present a desire to keep the family farm (or business) in the family. Unfortunately, the current tax and legal landscape can make achieving that goal difficult without proper planning. Many estate planning attorneys use valuation discounts (such as lack of marketability and lack of control) to help family farms and other family businesses transfer from one generation to the next with significantly fewer tax ramifications.
A little over a year ago, the Treasury Department introduced proposed Section 2704 regulations, which would effectively end valuation discounts on closely-held businesses owned by families for estate and gift tax purposes. Not only did this put a fire sale on family farms to make transfers outside of the planning timeline, the proposed regulation, if enacted, would have had devastating effects on family-owned farms, ranches, and other businesses. As we all know, most farmers and ranchers have relatively low cash flow compared to the high value of the ground. Valuation discounts presented successive farming and ranching operations the opportunity to keep the farm without selling off land to pay taxes (or other business assets).
Meet Dave. Dave lives in South Dakota and owns a 60% interest in ABC Land and Livestock. Dave’s sister, Cindy, lives in Minnesota and owns 40% of the farm. ABC Land and Livestock is worth around $8 million. Cindy is a doctor and is not involved in the farming operation.
Every year, Dave decides how much money each owner receives in distributions, as Dave owns the controlling number of shares in the corporation. Given the hard times, Dave has decided to retain all available cash in the corporation and use it to secure the purchase of additional land. Dave believes that growing the operation will help maintain better cash flow in the future and ensure the farm is able to be passed to the next generation. As such, Dave does not make any distributions to Cindy. The result? Cindy is an owner of land in South Dakota but has no financial benefit of such ownership. If proposed Section 2704 regulations were enacted, at the time of Cindy’s death, her estate would include the full value of her 40% interest in the farm (or $3.2 million). Cindy already has a sizeable net worth herself and is hoping a few of her early investments have large returns. In short, Cindy’s estate could face a large tax burden from an asset in which she derived no financial benefit, but devours nearly 60% of her estate tax exemption. This seems absurd, right?
On October 3, 2017, the Treasury Department finally helped Cindy by withdrawing proposed Section 2704 regulations citing, “the Proposed Regulation’s approach to the problem of artificial valuation discounts is unworkable.” Further comment revealed that the Treasury Department and the IRS could not determine a way to value entities as if certain transfer restrictions did not exist.
Many family businesses modified their planning based on the removal of valuation discounts. If you did not include valuation discounts as part of your estate and business plan, contact your qualified estate and business planning attorney today to ensure you are taking advantage of these discounts; increasing the likelihood that your farm and business is able stay in the family for many generations to come.