Yes, You. If you have an interest in a family business or benefit from a family business – and that is almost all of us – then you should know that on August 2 the IRS unveiled a proposal specifically designed to increase the taxes paid by family business owners versus the unrelated owners of identical businesses. Family farms, investment companies, real estate investors and developers, every sort of business and business entity are included within the scope of the IRS proposal. Thus you need to take immediate action.
What does this new proposal do? Let’s consider a business with four equal owners that’s worth $10,000,000. The economic reality is that none of those co-owners could sell a one-quarter interest for $2,500,000. Appraisers tell us that minority interests – less than 50% of the vote – in privately held businesses should be discounted by 30% – 40% in a typical situation, although sometimes more or less depending on the facts in the real world.
Now let’s move from the real world to the world of the IRS. If the four owners are unrelated, then real world rules will apply. But if they are family members the IRS proposes a pro rata valuation rule: multiply your percentage of the business, by the value of the total business, to get your value. So if you own 25% of a $10,000,000 business then you would have a $2,500,000 value. By the way, there is no requirement that the IRS be fair: if that 25% owner were giving her interest to charity the real world rules would apply and she would receive only a discounted income tax deduction!
The IRS has had this regulatory authority since October 9, 1990 so why attack family businesses now? We don’t know for sure but when Congress gave the IRS this authority it specifically noted that minority interest discounts in family businesses were not to be affected. Twenty five years later the members of Congress have changed and the IRS has also issued many other regulations this summer so perhaps it is relying on Congress being distracted and forgetful.
What should you do? The regulations are so controversial that they cannot become final until after a hearing on December 2. After that they will go into force unless the IRS agrees to make changes. Thus, what’s most impor-tant is for all of those connected with a family business to get your affairs in order quickly! If you plan now, before these changes become effective, you can achieve the same great tax results that have been available since the 1980s.
You may think that whenever the IRS cracks down in one place estate planners come up with something else. Although that’s been true enough for the last 30+ years, but we must be neither complacent nor arrogant. This proposal would allow the IRS to ignore state law and pretend that even a small corporate shareholder can liquidate a corporation upon command and would require that many gifts be made more than three years prior to death to be effective, a rule that was abolished by the Tax Reform Act of 1976. In short, the IRS hopes it can undo at least two generations of tax reform all at once and we mustn’t be caught unprepared.
What else might you do? The IRS (technically Treasury, but written by the IRS) has proposed these regulations under the authority of section 2704(b)(4) of the Internal Revenue Code. Ask Congress to repeal it so that the IRS cannot single-out family businesses for attack. That provision has never been used in almost 26 years and its repeal would affect nothing else in the Code. One line in one of these commonplace omnibus bills passed by Congress and signed by the President would be sufficient.
Of course, when you call or write your friends in Congress you will hear “we can’t do anything without agreement from the other side.” As if anyone in Congress will admit to being anti-family. Don’t believe a word of it. When someone in Congress cares, really cares, it’s a miracle what can happen as we’ve seen time and time again. Take last December, for instance, when Congress was alerted to the disparate treatment of apples and pears. It seems apple cider got tax breaks that pear cider did not. Next thing we see is the Protecting Americans from Tax Hikes Act of 2015 which expanded the definition of “hard cider” to include both.
So ask your friend in Congress, why would you sign on to end discrimination against pears but tolerate the IRS discriminating against families? I will be interested to learn what you hear.
*The article first appeared in the August 26th issue of Louisville Business First.