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The Forecast for Valuations in the Aftermath of the 2704 Hearing and the Election of Donald Trump

Since the release of the proposed changes to Internal Revenue Code Section 2704 (REG-163113-02) on August 2, 2016 (the proposed regs) and until the election of Donald J. Trump on November 8, 2016, wealthy taxpayers, family businesses, estate planners and business appraisers thought and talked about little else other than the possible valuation ramifications of these changes to the regulations.

Unexpectedly, the proposed regs didn’t exempt U.S. farms and family businesses. This was a great surprise to taxpayers and estate planning community; that it didn’t was a huge miscalculation by the Treasury. Many perceived the proposed regs as a message that U.S. farms and family businesses, already challenged by foreign competitors and beleaguered by government regulations, were now being unfairly targeted by the IRS. The IRS received over 10,000 comment letters, an unprecedented amount.

Also contributing to the strong reaction from taxpayers and their advisors were two terms — “Minimum value” and “Disregarded restriction”. Based on these, the first impression of the proposed regs was that it eliminated all valuation discounts. This belief was made more widespread by the publication of articles by well-known estate planners and appraisers stating that, under the proposed regs, the valuation of an equity interest of any member of a family control group must be made as it had a “deemed” put right at minimum value. Eventually, most came to realize that these terms were meant as tests to determine if IRC Section 2704 applied to the interest being valued or not. However, how such covered interests were to be valued was very unclear.

The hearing on the proposed regs that took place on Dec.1, 2016 was a bit anti-climactic. The unexpected victory of Trump and the Republicans, who now held majorities in both houses of Congress, meant the repeal of estate taxes had become very real. Furthermore, the “Protect Family Farms and Businesses” bills pending in the House and the Senate and seen previously as largely symbolic gestures had suddenly become powerful threats to the proposed regs.

Speakers, who either owned family businesses or represented them, bemoaned how the “loss of valuation discounts” would negatively impact the ability of family businesses to operate or effect succession planning. Then several appraisers who appeared all stated their beliefs, in one way or another, that the valuation assumptions embedded in the proposed regs are contrary to the definition of “fair market value.”

Many speakers asked that the Treasury to consider the comments and suggestions submitted and, later, re-propose changes based on this input. Until that might occur or the proposed regs are issued as final, very little is to be gained by further dissecting them. The comments have been submitted, and the hearing has been held. If the proposed 2704 regs ever see the light of day, it will be a long time. Well known trusts and estates attorney Ron Aucutt (McGuire Woods) says at least three years.

From an appraiser’s standpoint, with the “threat” of the proposed regs neutralized (for now, at least) what is the outlook for 2017? The crystal ball is clouded by a fog of what-ifs, Washington politics and budgetary constraints.

It is not all certain that estate taxes will be repealed. While the Republicans have the votes to make this happen through the use of the budget reconciliation process, there are a couple of major fiscal details standing in the way—the $600 billion budget deficit and the $20 trillion national debt.

Republican leaders like Speaker of the House Paul Ryan and Chairman of the House Ways Committee Kevin Brady are dedicated to tax reform, but corporate and individual tax reform are far more important to them than estate and gift taxes that generated only $20 billion dollars for the U.S. Treasury in 2016. It’s possible that, to gain some bi-partisan support for tax reform, outright estate tax repeal may morph into simply a lowering of estate tax rates.

If estate taxes are repealed we will most likely still have the gift tax. Very little has been said about the repeal of gift taxes. “I want to give” doesn’t have the same political cache as “Repeal the death tax!”

If estate taxes are repealed it seems highly likely that there will be a “death tax” based upon capital gains. Capital gains taxes aren’t governed by the IRC sections related to Chapter 14. If gift taxes aren’t repealed, Chapter 14 would continue to govern the valuation of such transactions. This would mean two very different sets of valuation rules for estate and gift taxes. Complicated but very doable.

Expanded article can be found in the January 2017 issue of Trust & Estates magazine. 

William H. Frazier, ASA is a Managing Director in the Valuation & Financial Opinions Group. He has over 35 years of experience in business valuation and corporate finance. Mr. Frazier can be reached at +1.214.389.3480 or wfrazer@srr.com.