Farm Progress

Estate Plan Edge: Entity discounting remains a viable part of estate transfer planning for the foreseeable future. If it’s something that would help your family, don’t put it off … again.

Curt Ferguson

August 15, 2017

4 Min Read

About this time last year, the IRS issued proposed regulations to dramatically undermine a tried-and-true estate planning strategy, sometimes called entity discount planning. The proposed regulations will not be going into effect.

A bit of background might be helpful. For a variety of reasons, a farm family might establish a business entity such as a limited liability company. The purpose might be to get family members formally involved in management. If Pete’s LLC is the farm operator and Pete’s son and daughter are named as managers of the LLC, they can legally speak for the business: negotiate, buy, sell, etc.

A second reason might be to protect assets from liabilities. If Farmer Pete is involved in an accident and gets sued, but his land is held in the right type of LLC, it is nearly impossible for the lawsuit to reach that land.

Finally, Pete might form the LLC as a gifting tool: He wants his family to gradually start owning part of the farm, and it is simpler to give shares of the LLC each year than to give an acre or a fraction of some acres to each child each year. 

If you form and operate an LLC for such reasons, you may reap an added benefit related to estate and gift taxes: discounts. In the real world, what is 5% of an LLC worth? Is it 5% of the value of the assets held inside the LLC? Let’s say I own an LLC that holds farmland clearly worth $1 million. I offer to sell you 5% ownership of the LLC. Would you pay $50,000?

Good deal?
You might be looking for a short-term investment; when land prices go up, you plan to sell immediately and take your profits. That doesn’t work here, because you can’t sell your 5% unless all other owners agree. Once you are in, you are stuck until the other owners let you out.

Thinking of the rental income of the LLC (you estimate your 5% of the $30,000 rental income will be $1,500) you say, “Well, I’ll pay the $50,000 so I can get my $1,500 rent each year.” However, the managers of the LLC might not distribute any of the rental income, and you cannot force them to. On top of that, even when you do not receive the $1,500, you must pay income tax on it! The managers of the LLC can make everyone pay taxes on their share of the rent even though they don’t distribute a dime.

Knowing that these restrictions go with the 5% ownership of the LLC, would you pay $50,000 to buy in? No investor in his or her right mind would. In the real world, the value of 5% of the ownership of the LLC would be discounted by 30% to 50%, meaning 5% of the LLC is really worth somewhere between $35,000 and $25,000. The precise value will depend on more factors, such as the specific terms of the LLC operating agreement and the nature of its assets.

Consequently, the gift tax benefit is that you can give away a larger fraction of your estate if you are giving shares of the LLC than if you are giving the land itself. The estate tax benefit is that if you die owning shares of the LLC instead of owning the land, your taxable estate will be discounted in a similar way. This can save a family millions in taxes.

A second chance
A year ago I wrote that this planning technique was about to disappear. On Aug. 2, 2016, the IRS had proposed regulations designed to negate all discounting when transfers of LLC shares were made among family members. In essence, even though the shares are worth 50% to 70% of the underlying asset value, when transferring shares to family, you would have to pretend they were worth 100%. I urged readers who might need the benefits of discount planning to act quickly, before the IRS put the new regulations into full effect.

But that brings us back to the good news. President Donald Trump issued Executive Order 13789, directing the IRS to review all “significant tax regulations” issued on or after Jan. 1, 2016, and to take concrete action to alleviate the burdens of regulations. Last month, the IRS acknowledged that its proposal to eliminate discounts in family business transfers would create a significant tax burden, and will not be implemented.

The bottom line? Entity discounting remains a viable part of estate transfer planning for the foreseeable future. If it is something that would help your family, don’t put it off … again.

Ferguson owns The Estate Planning Center in Salem. Learn more at thefarmersestateplanningattorneys.com.

About the Author(s)

Curt Ferguson

Curt Ferguson is an attorney who owns The Estate Planning Center in Salem, Ill. Learn more at thefarmersestateplanningattorneys.com.

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