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Proposed IRS Regulations May Lead to More Phantom Assets

Published on: 12:42PM Oct 11, 2016

~~Back in August the IRS proposed some new Regulations to curtail the benefit of taking discounts for transfers of family owned business interests such as farms.  In our post regarding these Regulations, we showed an example of how a "phantom" asset may show up in the estate and be subject to an extra 40% estate tax.

This is not the only phantom asset that may show up in an estate.  The proposed Regulations also require an estate to take discounts when valuing any transfer to a charity when that is part of the overall estate plan.  This can lead to certain harsh consequences.  The overall value of the business interest may have to be valued at 100% of the enterprise value, while the charity portion would be valued at a lower value resulting in additional estate tax.  Let's look at an example:

Farmer Benton owns a LLC with 2,000 acres of good Illinois farm land.  At the time of his death, the total value of this LLC is $20 million.  His will provides that half will go to his heirs and half will be given to his local church.  Normal valuation principles would call for the LLC to be valued at $13 million.  However, the proposed Regulations would likely require the estate to value the LLC at $20 million and then value the 50% going to charity at $6.5 million ($13 million times 50%).  This results in the estate having to pay 40% estate tax on the $3.5 million phantom asset ($10 million minus $6.5 million) or an extra $1.4 million of estate tax.  This would be in addition to the extra $1.4 million estate tax owed by heirs on their portion.

This is another case of where "heads the IRS wins and tails the taxpayer loses".