As estate planning attorneys, we are always mindful of changes in the tax laws or trust code that may have an impact on personal estate plans. Earlier this month, the Internal Revenue Service issued proposed changes to the Regulations under Section 2704 of the Code, which may substantially increase wealth transfer taxes by blocking a common estate planning strategy.

Many clients have taken advantage of this discount planning when entering into popular and effective freezing techniques involving gifts and sales to irrevocable grantor trusts. These savings are often accomplished by transferring assets for business and other non-tax reasons to a partnership, limited liability company or closely held business organized with Class A voting and Class B non-voting membership interests at a 1 to 99 ratio. Then, Class B membership interest are gifted and/or sold to Irrevocable Trusts which are generally for the benefit of children and future generations.

As mentioned above, when valuing the Class B non-voting interests being transferred, we have been able to comfortably assess a lack of control and lack of marketability discount on the Class B interests of 25-45 percent. This means that Class B interests valued at $1million can be gifted to the trust using only $650,000 of a client's lifetime transfer tax exemption. Should the value of the Class B interests exceed the available transfer tax exemption, we enhance the freezing technique by selling the Class B interests to the Trust for the discounted value, leaving only a promissory note (with very low interest rates) in the taxable estate, 'frozen' at the discounted value of the interests. All appreciation on the underlying assets in the entity grows estate-tax free. While these "freezing" techniques will likely remain attractive after the 2704 regulations because of the ability to remove future appreciation from a grantor's taxable estate, the recent proposed Regulations for Section 2704(b) will dramatically inhibit the ability to achieve tax savings through valuation discounting.

The good news is these Regulations are not yet in force. We anticipate they will not be effective until early 2017, so there is still (some!) time to plan and utilize valuation discounting techniques to reduce estate tax exposure.

If you have any questions regarding the new Regulations, please contact us at your earliest convenience.


Sincerely,
Michael W. Hoffman,
Attorney at Law
EXAMPLE 1:  No Estate Tax Planning
 
Clients Bob and Mary have a combined net worth of $20,000,000 comprised of securities, real estate, and a closely held family business.  With no planning, Bob and Mary's children will owe approximately $3,656,000 in estate taxes.  Estate taxes are due nine months from death and payable in cash. 
                                               
Estate Fair Market Value
 $20,000,000
Less both Estate Tax Exemptions
($10,860,000)
 
 $9,140,000
x Estate Tax Rate
40%
ESTATE TAX DUE
 $3,656,000*
 
EXAMPLE 2:  Estate Tax Planning in 2016 with Discounting Technique Currently Available
 
Clients Bob and Mary have a combined net worth of $20,000,000 comprised of securities, real estate, and a closely held family business.  Bob and Mary contribute all of their investment real estate worth $8 million to Family Land, LLC with Class A Voting and Class B Non-Voting interests.  Bob and Mary retain 1% Class A Voting Interest and transfer all 99% Class B Non-Voting Interest to the Family Trust for the benefit of their children and grandchildren. 
 
Family Land, LLC is appraised at $8 million.  After 35% discount for lack of control and lack of marketability, the 99% Class B shares are valued at $5,148,000, allowing Bob and Mary to transfer all of the Class B interests and use just under one of their estate tax exemptions to remove an $8 million asset from their taxable estate.
 
Family Trust holds $8 million worth of real estate, and all appreciation thereon, separate from the estates of Bob and Mary, for the benefit of children and future generations, free from creditors and estate taxes 
 
Estate Fair Market Value
 $20,000,000
Gift to Family Trust
($8,000,000)
Less Remaining Estate Tax Exemptions
($5,712,000)
 
 $6,288,000
x Estate Tax Rate
40%
ESTATE TAX DUE
 $2,515,200
 
 
Estate Tax Savings from Ex. 1
 $1,140,800
*Of course, after the death of one spouse, the assets continue to appreciate, and estate taxes (historically over 50%) are paid at the death of the second spouse.
 
 
EXAMPLE 3:  Mary Outlives Bob and Assets Appreciate with No Estate Tax Planning
           
Clients Bob and Mary have a combined net worth of $20,000,000 comprised of securities, real estate, and a closely held family business.  At Bob's death, the real estate is worth $8 million, and his entire estate tax exemption is used to shield estate taxes.  Mary outlives Bob by 10 years, and the real estate is now worth $16 million.  With no estate tax planning, the estate taxes now payable by their children are $6,856,000.
 
Estate Fair Market Value at Bob's Death
 $20,000,000
Less Bob's Estate Tax Exemption
($5,430,000)
Remaining assets for the benefit of Mary
 $14,570,000*
 
 
Estate Tax Value at Mary's death (+$8M)
 $22,570,000
Less Mary's Estate Tax Exemption
($5,430,000)
 
 $17,140,000
x Estate Tax Rate
40%
ESTATE TAX DUE
 $6,856,000
 
EXAMPLE 4:  Mary Outlives Bob and Assets Appreciate with 2016 Tax Planning Techniques
           
Clients Bob and Mary have a combined net worth of $20,000,000 comprised of securities, real estate, and a closely held family business.  Bob and Mary contribute all of their investment real estate worth $8 million to Family Land, LLC with Class A Voting and Class B Non-Voting interests.  Bob and Mary retain 1% Class A Voting Interest and transfer all 99% Class B Non-Voting Interest to the Family Trust for the benefit of their children and grandchildren. 
 
Family Land, LLC is appraised at $8 million.  After 35% discount for lack of control and lack of marketability, the 99% Class B shares are valued at $5,148,000, allowing Bob and Mary to transfer all of the Class B interests and use just under one of their estate tax exemptions to remove an $8 million asset from their taxable estate.
 
Mary outlives Bob by 10 years, and at her death the real estate in Family Land, LLC is worth $16,000,000.  Family Trust holds $16 million worth of real estate separate from the estates of Bob and Mary, for the benefit of children and future generations, free from creditors and estate taxes.
 
Estate Fair Market Value
 $20,000,000
Gift to Family Trust
($8,000,000)
Estate Fair Market Value at Bob's Death
 $12,000,000
 
 
Estate Fair Market Value at Mary's death (10 years later)
 $12,000,000
Less Mary's Estate Tax Exemption
($5,430,000)
 
 $6,570,000
x Estate Tax Rate
40%
ESTATE TAX DUE
 $2,628,000
 
 
Estate Tax Savings from Ex. 3
 $4,228,000
*Of course, after the death of one spouse, the assets continue to appreciate, and estate taxes (historically over 50%) are paid at the death of the second spouse.

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Atlanta, GA 30328
404-255-7400

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