If you recall, just more than one year ago the Treasury Department resurrected Proposed Section 2704 Regulation which disallowed discounting on closely-held businesses owned by families for estate and gift tax purposes.  This Proposed Regulation would have been devastating to all family-owned business but especially to farm and ranch operations given the high value of agricultural ground with relatively low cash flows.

The following scenario is painted to illustrate the lack of fairness to disallow such discounts.  Brother Earl lives in South Dakota where he operates the family ranch, Eden’s Acres.  Earl owns 60%, a controlling interest, in Eden’s Acres.  Earl’s sister, Ethel, lives out of state and is removed from ranching operations.  She owns a 40%, minority interest in the entity.  As the controlling owner, Earl determines what level of distributions will be paid to shareholders.  Earl decides to retain all available cash flow each year for future purchase of additional land rather than distribute to shareholders.  As a result, Ethel is an owner of dirt in South Dakota but has no economic benefit from such ownership.  Under the assumption that the Regulations would have made law, at Ethel’s time of death her estate will include the value of 40% of the value of the real estate (appraised at $8 million), or $3.2 million.  If Ethel has much wealth outside of Eden’s Acres, she could very easily have a taxable estate.  It seems absurd that her ownership of a minority interest in a family-owned entity that she received no economic benefit of would result in a value of $3.2 million, eating up nearly 60% of her estate exemption of $5.49 million!

The October 3, 2017 Treasury report helps to add a happy ending for poor Ethel.  Such report entirely withdrew the Proposed Regulation citing, “the Proposed Regulation’s approach to the problem of artificial valuation discounts is unworkable.”  It further noted that the Treasury Department and IRS could not determine an entity interest should be valued as if restrictions did not exist.

Do you or your clients have Business Valuation questions or needs?  Please contact me!