AICPA Comments on Pomeroy FLP Discounts Bill HR 436

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March 20, 2009
The Honorable Charles B. Rangel
Chairman
House Committee on Ways and Means
1102 Longworth House Office Building
Washington, DC 20515
The Honorable Max Baucus
Chairman
Senate Finance Committee
219 Dirksen Senate Office Building
Washington, DC 20510
The Honorable Dave Camp
Ranking Member
House Committee on Ways and Means
1139E Longworth House Office Building
Washington, DC 20515
The Honorable Charles E. Grassley
Ranking Member
Senate Finance Committee
219 Dirksen Senate Office Building
Washington, DC 20510
Re: AICPA Comments on Legislative Proposal to Eliminate Valuation Discounts with
Respect to Non-Actively Traded Businesses
Dear Chairmen and Ranking Members:
As the newly elected Congress considers various issues and alternatives with regard to a
compromise on estate tax reform, the American Institute of Certified Public Accountants
(AICPA), the national professional association of approximately 350,000 CPAs throughout the
country, encourages you to enact a permanent form of the estate tax prior to the temporary repeal
of the tax in 2010 in order to provide certainty to taxpayers.
In addition to our priority list of suggested reforms of the current estate and gift tax system that
was submitted on January 21, 2009, we would like to comment on H.R. 436, introduced by Rep.
Pomeroy on January 9, 2009, and its proposed elimination of non-business valuation discounts.1
The proposal in H.R. 436, introduced January 9, 2009, would eliminate valuation discounts for
lack of marketability and minority interest in valuing an interest in an entity for estate and gift
tax purposes unless the interest is actively traded. The bill does not define “actively traded” but
references section 1092 whose regulations define the term as property for which there is an
established financial market (e.g., bonds and publicly traded stock on an exchange).2
The discount for lack of marketability is eliminated if the non-actively traded business does not
carry on a trade or business. If it carries on a trade or business but also has non-business assets,
1
Many of our suggested reforms were previously submitted to Congress on January 21, 2009, March 11, 2008, June
22, 2006 and July 28, 2005, and included in testimony before the Senate Finance Committee on April 3, 2008.
Many of these suggestions were published in 2001 as part of the AICPA’s Study on Reform of the Estate and Gift
Tax System, which we provided to Congress in 2005, and is available electronically at:
http://tax.aicpa.org/NR/rdonlyres/7C558E55-3E42-42D0-BD2C-9612E9E313E3/0/study0227FINAL.doc and our
AICPA testimony and letters at http://tax.aicpa.org/Resources/Trust+Estate+and+Gift/Legislation/.
2
Treas. Reg. § 1.1092(d)-1(a).
The Honorable Charles B. Rangel
The Honorable Dave Camp
The Honorable Max Baucus
The Honorable Charles E. Grassley
March 20, 2009
Page 2
those assets will be removed from the valuation of the entity and valued without discount. A
lack of marketability discount will still be possible for the valuation of the entity after taking out
non-business assets.
Minority discounts are not allowed in the valuation of a non-actively traded business if the
taxpayer (through attribution rules) owns or controls more than 50 percent of the business,
regardless of whether or not the business carries on a trade or business. For purposes of
determining whether a taxpayer has control, the bill uses a very broad “family attribution”
concept.
A similar proposal was included eight years ago in the Administration’s Fiscal Year 2001
Budget. The reasons for that proposed change included the proposition that the use of family
limited partnerships and similar devices is eroding the tax base and that it is implausible that
donors would intentionally take actions (e.g., contributing property to an entity) if the donor
really believed that such actions would cause the family’s wealth to decline substantially. H.R.
436 introduces the “family attribution” concept.
AICPA Opposes the Proposal to Eliminate Valuation Discounts with Respect to NonActively Traded Businesses
AICPA opposes this proposal to eliminate valuation discounts for estate and gift tax purposes
with respect to non-actively traded businesses for the following reasons:
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Closely-held entities are created for a variety of non-tax reasons.
Discounts are appropriate for fractional interests and are a function of economic reality.
The proposal in H.R. 436 will result in overvaluation.
The proposal in H.R. 436 will have a negative impact on small businesses.
Closely-Held Entities are Created for a Variety of Non-Tax Reasons
As we stated in 2001, the AICPA opposes the proposal to eliminate valuation discounts with
respect to non-actively traded businesses. This proposal is built upon the presumption that there
is no reason other than estate tax avoidance for the formation of a non-actively traded entity that
does not carry on a trade or business. We disagree. The most important reason for forming these
entities is not tax reduction but the proper allocation (i.e., division among owners) and
management of assets. Families create closely-held entities (e.g., limited partnerships, limited
liability companies, and corporations (both subchapter S and subchapter C)) for a variety of nontax reasons including: (1) to increase asset protection; (2) to reduce family disputes concerning
the management of assets; (3) to prevent the undesired transfer of a family member’s interests
due to a failed marriage; and (4) to provide flexibility in business planning. In many instances,
The Honorable Charles B. Rangel
The Honorable Dave Camp
The Honorable Max Baucus
The Honorable Charles E. Grassley
March 20, 2009
Page 3
these closely-held entities are created for estates that are not taxable for estate tax purposes; thus,
discounts for these estates are not the motivating factor in creating the closely-held entity.
Discounts are Appropriate for Fractional Interests and are a Function of Economic Reality
Discounts are appropriate for fractional interests where they reflect and are a function of
economic reality and market conditions. For example, an asset inside an entity may or may not
be worth face value, depending on the specific facts of each case. The discount is a function of
the terms of the entity agreement, state law, and the intent of the partners or shareholders. For
example, family investment limited partnerships are usually structured with significant
restrictions on the limited partners, such as to restrict or regulate access to partnership assets by
younger family members.
Specifically, some of the factors that may impact the magnitude of a discount are:
1. The ability and timing of the limited partners to withdraw capital from the partnership.
2. The level of control that the limited partners have over how their shares of partnership
assets are invested.
3. State laws that often grant limited partners certain rights.
4. The length of time that the partnership will remain in existence.
5. Whether or not there are mandatory distributions; and if not, the intent of the general
partner to make distributions and the frequency thereof.
6. The nature and level of liquidity of the underlying partnership assets. (This frequently
changes over time, thereby impacting the potential discount.)
When a closely-held entity is taxed for estate and gift tax purposes, the transfer taxes are
assessed on the value that is transferred. Where access to assets is restricted in any of the above
situations, the value transferred is decreased by the restriction, and, thus, the tax base is
appropriately adjusted.
The Proposal in H.R. 436 will Result in Overvaluation
H.R. 436 may result in entities being overvalued compared to what could be obtained on the
open market. In many markets, including oil and gas or real estate partnerships, hedge funds,
closed end mutual funds, and family limited partnerships, the real-world market value of
ownership interests reflects a value that is significantly less than the underlying assets because of
the impact of lack of control and lack of marketability. We note that if this bill is enacted, the
value of an interest in an entity for estate and gift tax purposes may be greater than the value for
which the interest is sold on the market.
The Honorable Charles B. Rangel
The Honorable Dave Camp
The Honorable Max Baucus
The Honorable Charles E. Grassley
March 20, 2009
Page 4
The Proposal in H.R. 436 will have a Negative Impact on Small Businesses
Prohibiting market value discounts for estate and gift tax purposes will discourage families and
businesses from pooling their investment capital. This comes at a time when our economy needs
the investment capital they offer.
Under H.R. 436, families may be subject to losing family businesses, or having to sell them at a
substantial loss just to pay estate taxes. Even with a section 6166 (referring to an extension of
time for payment of estate tax where the estate consists largely of an interest in a closely held
business) election in place, if the business is overvalued, the estate tax will be overstated and the
cash flow from the business may not be able to sustain the payments.
For example, we are aware of an estate which currently has a section 6166 election in place. It is
currently docketed in the Tax Court over valuation issues. Even with the discounted values, the
estate will be unable to sustain the payments on the estate tax due to the economic downturn and
a sizable decrease in dividends received by the estate. If no minority discounts were allowed for
estate tax purposes, the estate would be in even worse shape. If the estate is forced to have a fire
sale of its minority interest in the business, it will receive a severely discounted value over the
proposed date of death value. Operating businesses need some protection.
Suggested Changes to the Legislation
Despite the concerns expressed above, if it is decided that this legislation be pursued, we suggest
the following modifications:
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Expand the minority interest discount exception.
Narrow the family attribution rules.
Clarify and expand the definition of working capital.
Disallow discounts in situations similar to the section 7520 valuation regulations.
Expand the Minority Interest Discount Exception
The only minority interest discount exception in the proposal for actively traded interests is far
too narrow and will be of limited benefit. A majority of the private enterprises in the United
States are owned and controlled by families. Thus, this bill would essentially legislate a minority
discount out of existence for most minority interests in private enterprises. At the very least, a
minority discount should be allowed for bona fide, legitimate conflicts of interest among the
family members. It should not be presumed that family members act in unison.
The Honorable Charles B. Rangel
The Honorable Dave Camp
The Honorable Max Baucus
The Honorable Charles E. Grassley
March 20, 2009
Page 5
Narrow the Family Attribution Rules
As H.R. 436 is currently drafted, the application of the proposed section 2032A(e)(2) (referring
to the valuation of certain farm and real property for estate tax purposes) attribution rules too
broadly defines families. In the real world, family members do not always get along and
cooperate with each other. In fact, many families often do not act in unity. When it comes to
operating a closely-held business, family members frequently have economically adverse
interests (i.e., one family member’s financial goals are contrary to the other). These adverse
interests will generally cause the value of the business to decrease. Thus, such a broad proposed
attribution rule does not reflect reality among the taxpayers with whom our members have had
years of experience.
Instead, we suggest the section 318 attribution rules as an alternative to the section 2032A(e)(2)
attribution rules. A narrower attribution rule, such as that used in section 318, would cover
transactions between a parent and child or grandparent and grandchildren – which is typically
where concern for abuse by taxing authorities exists – but would not include siblings or cousins
or more remote related parties. The perceived abuses that H.R. 436 seeks to curb could be dealt
with by regulations and would be caught by limiting attribution to ascendants, descendents, their
spouses and entities controlled by them.
Clarify and Expand the Definition of Working Capital
We suggest that the provision for working capital be clarified and expanded, as there are many
circumstances in which it is appropriate to claim discounts on excess cash or marketable
securities held by an operating business. There may be legitimate reasons for a business to hold
excess working capital (e.g., to finance a future expansion of business, purchase equipment, etc.).
The law recognizes valid accumulations other than working capital. For example, businesses are
permitted reasonable accumulations of cash and securities beyond working capital under sections
531 through 537 to avoid the accumulated earnings tax penalty. We suggest H.R. 436 include
wording and acknowledgement similar to section 533, which permits accumulations for the
“reasonable needs of the business” and not just a narrow interpretation of “working capital.”
Disallow Discounts in Situations Similar to the Section 7520 Valuation Regulations
As an alternative, in order to limit potential abuse, the H.R. 436 could disallow discounts when
the individual is terminally ill at the time that the transfer is completed, similar to the concept in
Treas. Reg. section 25.7520-3(b)(3). Because the proposed legislation appears to be aimed at
abusive discounts, it should focus on discounts in situations where the individual dies shortly
after he or she makes a transfer to a closely-held entity. The legislation should not apply to
accidental deaths. Rather it should follow the regulations under section 7520, which create a
presumption regarding the transferor’s life expectancy.
The Honorable Charles B. Rangel
The Honorable Dave Camp
The Honorable Max Baucus
The Honorable Charles E. Grassley
March 20, 2009
Page 6
We hope you will consider our comments in your debate about estate tax reform. We look
forward to working with you to achieve simplicity, effectiveness, and efficiency as Congress
considers changes to the current estate and gift tax system.
If you have any questions or if we can be of further assistance, please contact Justin P. Ransome,
Chair, AICPA Trust, Estate, and Gift Tax Technical Resource Panel, at Justin.Ransome@gt.com
or (312) 486-9847; Roby Sawyers, Chair, AICPA Transfer Tax Reform Task Force, at
roby_sawyers@ncsu.edu, or (919) 515-4443; or Eileen Sherr, AICPA Senior Manager, at
esherr@aicpa.org, or (202) 434-9256.
Sincerely,
Alan R. Einhorn
Chair, Tax Executive Committee
cc: Rep. Earl Pomeroy
Ms. Diane Oakley, Tax Aide to Rep. Earl Pomeroy
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