IRS Considering Backdoor Death Tax Hike

Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224
Pete Sepp, President
National Taxpayers Union
25 Massachusetts Avenue, NW Suite 140
Washington, DC 20001
Subject:  Docket ID: IRS-REG-163113-02, RIN 1545-BB71

On behalf of the members of the National Taxpayers Union (NTU), I write to express our concerns regarding the recently issued, “Estate, Gift, and Generation-Skipping Transfer Taxes; Restriction on Liquidation of an Interest.” This rulemaking proposes significant changes in relation to Section 2704(b) of the U.S. Tax Code and the manner in which valuation discounts are applied to family business shares when calculating death tax liability. By ignoring the legitimate resale dynamics at work concerning lack of control and lack of marketability due to restrictions or minority status, this proposed change would expose heirs to increased costs that could be significantly above the true value of their share, compounding the financial and economic harm already imposed by the death tax.

Currently, when transitioning a family business from one generation to the next, valuation discounts are permitted to reflect the true value of an heir’s interest. A minority stake in a business or other common restrictions (often aimed at ensuring the business stays intact) are worth less to potential buyers than majority ownership or a more easily liquefied asset. In these instances, there is no clear market to redeem the face value of the inheritance and it makes sense for a valuation discount in order to better reflect the true value of the shares.

Reducing the applicability of the standard valuation discount increases the death tax for many and exacerbates current problems with the death tax as an underlying policy. The relatively little revenue generated by the death tax is more than nullified by the economic damage imposed by the tax. When faced with a large estate or gift tax upon the death of a family farm or business owner, heirs can be forced to sell property, or lay off workers due to a lack of liquid assets – often at below face-value prices due to the aforementioned lack of market for these unique investments. Other consequences can include reduced entrepreneurial activity and a diminished expansion of wages.

Eliminating common-sense valuation discounts that accurately reflect real-world market scenarios exposes the true aim of the death tax: redistribution of wealth. Compared to the significant economic harm inflicted by the tax, the paltry sum it adds to Treasury coffers is by itself not justifiable. Changing valuation discounts – making it costlier for heirs to retain their stake in a family business – incentivizes sales, at artificially low prices, to satisfy the demands of the death tax.

It is undesirable to use the Tax Code to tear apart what entrepreneurs and families have jointly built over decades of hard work and sacrifice. This hurts individual prosperity, can damage familial bonds, complicates grief, and can negatively impact job creation.

Beyond the policy considerations surrounding the Section 2704 regulations, however, are factors of administrability. From this standpoint alone, Treasury would be wise to step away from this controversial proposal and instead focus on measures to simplify and reduce the burden of taxation on American family and businesses.

We do not employ the term “controversial” lightly. For example, after issuance of the initial rule under Section 385, proposing to treat the indebtedness of related party corporate interests as stock, numerous comments from affected entities voiced concerns that the government dramatically understated the compliance burdens and economic opportunity costs that the private sector would have to bear. Indeed, single companies submitted statements, providing credible detail, of how they alone would bear several times more costs in retooling their financial procedures than the Office of Management and Budget estimated for the entire economy. Treasury subsequently issued a more narrowly drawn rule.

We therefore note with alarm that Treasury seems to believe that there will be no significant impacts on individuals or businesses owing to the new rule regarding Section 2704. Yet, the proposed changes to Section 2704, and the three year “look back,” would compound the uncertainty created by the death tax. Already, family business owners expend a large amount of time and financial resources in planning for the end-of-life transition of property in order to avoid unnecessary disruption and costs to both family members and employees. Further complicating these scenarios would necessitate an increased diversion of these resources to tax compliance, leaving fewer funds for the capital and personnel investments that benefit our broader economy. Those businesses and individuals left intact by the Section 2704 changes will be on shakier financial ground and less able to absorb or adapt to other losses.

It is therefore little wonder that until recently the current Administration had itself implicitly acknowledged the sweeping nature of the changes to Section 2704 and the need to interact more closely with the legislative branch on their disposition. The federal budgets the President transmitted to Congress for fiscal years 2010 through 2013 all offered plans to scale back valuation discounts as they related to family-controlled entities. Furthermore, estate planning and tax experts widely acknowledge that the current changes under contemplation are, in part, a response to state laws enacted after the Kerr v. Commissioner ruling – laws that have effectively made the valuation discount fairer to family entities. Surely these two elements provide some validation to the notion that Treasury should work more collaboratively with Congress in carefully exploring underlying statutes rather than plowing ahead with a rulemaking in this area.

Although NTU strongly opposes these changes to Section 2704 (REG-163113-02) and urges Treasury to withdraw this proposal, there are other short-term options in lieu of the proposal that would be less disruptive. Writing in the Winter 2016 edition of Gift and Estate Tax Valuation Insights, Weston Kirk suggested that instead of a rulemaking the IRS should consider releasing a “Job Aid” on the topic of family-owned interest transfers for estate tax purposes. While this does not represent official guidance, the procedure would, in the author’s view, “provide clarity and understanding of the Service’s stance without creating significant disputes between taxpayers, their advisers, and the Service’s agents, saving the Service time and taxpayer money in attempting to pass and then properly enforce its regulations.” Important technical questions, such as how the IRS would target instances where an entity holds only cash and marketable securities as opposed to an operating family business, could be discussed in a structured manner.

I hope Treasury will find these comments useful in its deliberations.

Pete Sepp