While the 2001 changes to federal estate tax laws have somewhat softened the impact of estate taxes, the economic recovery has increased the value of many businesses, so any potential estate tax relief ends up being negated by the increase in the business’ value. We have written frequently about the advantages of the use of family limited liability partnerships (FLPs) or family limited liability companies and other entities to reduce potential estate taxes. Most business owners are aware that discounts are available to help reduce the estate tax value of their business. However, the IRS continues its assault on business valuations and has come up with creative theories intended to countervail the use by taxpayers (and endorsement by the tax courts) of marketability, minority, key man, and blockage discounts. As a result, it is more important than ever to develop a plan that results in the business owner’s interest in the business being less than a majority interest at the time of his or her death.
The IRS has long challenged discounts taken for gifts of minority interests or minority interests owned by estates, but was finally forced to recognize that discounts may apply when the business interest gifted or bequeathed represents a minority interest and no market exists for the interest. While conceding the applicability of such discounts, the IRS has asserted new theories for increasing the value of a gift or bequest of a minority interest: the control premium and the swing vote premium.
The corollary to the minority discount is the control premium. The IRS has asserted that if a minority interest is entitled to a reduced value for lack of control, then a controlling interest carries with it a proportionately larger value.
The IRS has also occasionally taken the position that the value of a minority interest given to one person is enhanced if that person can join with another holder of a minority interest to achieve majority control of the business. Thus, the IRS says, a swing vote premium should apply to the value of a minority interest when the gifted interest represents a potential swing vote. The cases in this area are highly fact-specific and caution is prescribed whenever making gifts of minority interests.
It remains to be seen whether the IRS will ultimately be successful pursuing the use of control premiums and swing vote premiums to increase the value of a decedent’s interest in a business. However, by careful planning, the potential for such claims by the IRS can be reduced or eliminated. One such technique is to transfer the shares of one’s C corporation to a FLP, then make gifts of limited partnership interests, thereby defeating the possible argument that a swing vote premium could apply because the interests given do not give the donee any ability to control the business: all control remains vested with the general partner of the FLP. This is yet another of the many reasons we believe FLPs are outstanding estate, succession, and tax planning tools.
If you would like to discuss the tax issues relative to ownership of a majority position in a closely-held corporation in your estate and business plan, please do not hesitate to telephone us for a consultation.