We receive newsletters from several CPA firms, and they are often both informative and useful. Recently, they are aflame with comment on proposed IRC §2704, issued by the Internal Revenue Service on August 4th. Section 2704 would limit or eliminate the use of discounts for lack of control and lack of marketability for businesses being valued for estate and gift tax purposes: raising values and taxation on intergenerational transfers; and challenging estate planners in crafting tax avoidance/minimization strategies.
To accomplish this, we understand, the proposed rule includes minimum valuation rules (pro rata share of net worth); mandated disregard of ownership agreement and state law restrictions on stock transfers; and close scrutiny of personal goodwill, size and customer concentration concepts as value reducers. Valuation experts and estate planners promise complexity, uncertainty, litigation and general misery ahead. Among other things, critics opine that treating highly illiquid assets, as most small businesses are, as liquid, indulges a fiction that will undermine families’ ability to preserve businesses across generations.
In divorce world, we have seen this movie before. Since 2007’s Bernier v. Bernier, Massachusetts has led the way in severely limiting -- all but abolishing -- the application of discounts in valuation: rejecting the concept that divorce valuation is based on a hypothetical sale, with attendant discounting; and analogizing divorce, instead, to that of the involuntary purging of a shareholder from a going concern for which sale is not, in fact, contemplated. Fair value, rather than fair market value,now holds sway in most cases since business owners can’t dispose of their firms – quite apart from market realities – because they, and their families, depend on the businesses for their economic support. As with proposed §2704, the result of Bernier is higher valuations that often disregard business realities, to the consternation of business owners.
Policy is shaped by goals. In Bernier, the Supreme Judicial Court felt it unfair to reduce the non-owner’s sharing of value when continued operation is the value to the holder, and ruled accordingly. The government wants more tax receipts and the I.R.S., exists to collect it. No surprise there.
Is Bernier the chicken to the federal government’s egg?