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Estate planning tax discounts at risk with new IRS proposal

The Internal Revenue Service (IRS) has proposed changes that will impact the use of certain deductions used to reduce the taxable assets in an estate for estate planning purposes.

More specifically, the IRS is attempting to cut the minority discount often used when valuing interests held in family limited partnerships (FLPs). FLPs are common legal tools utilized by estate planners to reduce the estate tax obligations of certain estates.

How does an FLP work? Essentially, a family would put assets into an FLP. These assets can be those of an active business or assets just passively held within the FLP business structure. The family members would then have varying interests in the FLP. Those with a minority share may be taxed at a lower rate than the actual value of the interest.

This discount is based on common business principles used when valuating business interests. The valuation process is complex, but the basic principle in this situation states that if the interest is a minority share, or less than 50 percent, there is a discount applied. The reason behind this discount is the fact that in the real world of business transactions it is unlikely that anyone would purchase a minority share of a business at full price.

The discount can be sizeable. Depending on the details of the assets held in the business and the percent interest to be taxed, the discount can range from 20 to 50 percent of the value of the share in question.

What would the proposal change? As noted in a recent article in the Financial Advisor Magazine, a number of changes could go into effect. One that specifically addresses the FLP structure noted above in the proposal is a target of any transfers that occur within three years of the death of the original owner of the asset. These transfers would be disregarded, and the asset would be viewed as the property of the original owner for tax purposes.

How can I make the most of my estate plan? Estates that qualify for this discount still have time to take advantage of the current system. The proposals, if passed, would not go into effect until 2017. 

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