I hope this letter finds you well. There have been a couple of developments that I think you will find interesting.
COLORADO UNIFORM TRUST DECANTING ACT. During the 2016 legislative secession, the Colorado Legislature enacted the Colorado Uniform Trust Decanting Act (the "Decanting Act") which became effective August 10, 2016. The Decanting Act allows changes to be made to irrevocable trusts through the distribution of assets of one trust to a second trust under specified circumstances. Decanting is used, among other things, to change the situs/governing law of a trust, alter trustee provisions (e.g., trustee succession, create a directed trustee arrangement, reallocate trustee powers), alter powers of appointment, add special needs provisions, and comply with changing tax laws. If you have an irrevocable trust which you think needs some tweaking, this new law provides a statutory framework within which to make those changes.
JUST ISSUED PROPOSED TREASURY REGULATONS. Another important development stems from just issued proposed Treasury regulations that specifically affect equity owners of family-controlled corporations (C and S), partnerships (general and limited) and limited liability companies. These regulations will change the playing field as it relates to gifting/selling equity ownership interests among family members. What they due, in brief, is virtually eliminate valuation discounts historically available to family patriarchs and matriarchs transferring equity ownership interests to younger family members or trusts for their benefit. Once finalized, these regulations will have a particularly harsh impact on family holding companies, and to a lesser extent, family operating companies too.
Act Now. Time is of the essence. Once the proposed regulations become effective, which could be as early as year-end, the ability to claim discounts might be substantially reduced or eliminated, thus curtailing your tax and asset protection planning flexibility. Furthermore, as the year winds to a close, it will become more difficult to structure planning transactions to conform to a variety of potential tax challenges. As the 2016 year-end gets closer, it will become more difficult and at some point, will become impossible to have banks and trust companies create trust accounts. If you are unsure of what you might wish to do, we recommend that you take the preliminary steps as soon as possible. For example, if you do not already have trusts that could serve as appropriate receptacles for 2016 discounted gifts, it would be wise to establish trusts immediately. You can always determine later which assets and how much to transfer.
What Are Discounts Anyway. Here's a simple illustration of discounts. Bob has a $20M estate which includes a $10M family-owned business. He gifts/sells 40% of the business to a trust for his children to grow the asset outside of his estate. The gross value of the 40% equity ownership interest is $4M. Since a minority 40% trust/equity owner cannot force a sale or redemption of its ownership interest, the non-controlling interest in the business transferred to the trust is worth less than the pro-rata value of the underlying business. Thus, the value should be reduced to reflect the difficulty of marketing the non-controlling interest. As a result, the value of the 40% equity ownership interest transferred to the trust might be appraised, net of discounts, at $2.4M. The discounts have reduced the estate by $1.6M from this one simple transaction.
Election Impact. If the Democrats win the White House and the Democratic estate tax proposals are enacted, the results will be devastating to wealth transfer planning. Pundits have prognosticated that a Democratic White House win could affect down-ballot races and flip the Senate to the Democrats. The Democratic tax plan includes the reduction of the life-time estate tax exemption to $3.5M, elimination of inflation adjustments to the exemption, a $1M life-time gift tax exemption and raising the tax rate from 40% to 45%. The Democratic plan will most likely include the array of proposals included in President Obama's Greenbook which seek to restrict or eliminate GRATs, note sale transactions to grantor trusts, and more. Wealthy taxpayers who do not seize what might be the last opportunity to capture discount planning, might lose much more than just the discounts. They might lose many of the most valuable wealth transfer strategies.
Not a Boy-Who-Cried-Wolf. Many of you might remember the mad rush to plan in late 2012 on the fear that the gift, estate and generation skipping transfer (GST) tax exemption might be reduced from $5M to $1M in 2013. After many incurred significant costs and hassles in implementing planning quickly, that change never occurred. For those who might be affected by discounts, the situation in 2016 seems vastly different. The proposed regulations could be changed and theoretically even derailed before they become effective. The more likely scenario is that they will be finalized after the December 1st public hearing, and thus, the ability to claim valuation discounts will be severely curtailed. If you do undertake planning, be cognizant of an important lesson from much of the poor planning that was done in 2012. Consider using wealth transfer strategies that provide you (or if you are married, your spouse) with access to funds transferred in the discount planning. The main regrets in 2012 planning were for those who transferred assets out of their own reach. That is really not necessary.
What You Should Do. The take away here is, if you have any interest in gifting or selling equity ownership interests in any one or more of your family-controlled companies, that must occur before these regulations become effective if you want to take advantage of any discounts for lack of control and marketability. With a gift, estate and generation-skipping transfer tax rate of 40%, every $1.00 of value sheltered by discounts will save you $0.40. For those looking to minimizing their future estate tax, these discounts can be essential.
If you are considering gifting or selling equity ownership interests in a family-held company, feel free to give me a call at your earliest convenience. Waiting could jeopardize completion of the transaction before the regulation's effective date.