New Tax Legislation Introduced: H.R. Bill 436 has Potential Changes to Estate and Gift Taxes and Available Discounts

H.R. Bill 436: Potential Changes to Estate and Gift Taxes and Available Discounts  

On January 9, 2009, Bill 436 was introduced to the House by Representative Earl Pomeroy (D-ND). The bill, referenced as H.R. 436 and similar to other proposals, would:  

– Eliminate minority and marketability discounts for “non-business assets” (Defined below)

– Eliminate minority discounts on the transfer of non-actively traded entity ownership interests between family members

– Preserve the federal estate tax exemption equivalent at $3,500,000

– Set the marginal tax rate for estates exceeding the exemption at 45% for estates under $10,000,000

– Set the marginal tax rate for estates over $10,000,000 at 50% due to an additional 5% surcharge that phases out when the estate reaches $23,500,000; estates over $23,500,000 are taxed at a maximum of 45%

– Repeal the new “carryover basis” rules scheduled to be effective next year 

Even though the bill is in the initial stages, it is receiving significant commentary by estate planning professionals. Its enactment would have major implications on widely used transfer techniques for family limited partnerships and other pass through entities due to elimination of minority and marketability discounts for non-business assets.  

Current Environment

Today, a lifetime or testamentary transfer of assets is valued at the price a willing buyer would pay to a willing seller. Practitioners often assign minority interest and marketability discounts when reporting a transfer of interests held by a family limited partnership, family LLC, or other family owned pass through entities to reflect the fact that a willing buyer would not pay as much for a minority interest as he or she would for a controlling interest. In addition, the transferee cannot easily sell his or her interest in this family entity on an open market.  

Impact of the Proposed Bill

If the proposed bill were to become law, valuation discounts for transfers of non-business assets held by an applicable entity would not be allowed. The bill proposes that a new code section be enacted that would define non-business assets, also referred to as passive assets, as “any asset which is not used in the active conduct of 1 or more trades or businesses”. Among other items, passive assets include marketable securities, cash and cash equivalents, debt instruments, commodities, collectibles, certain royalty producing assets, and real estate activities where there is not material participation by the transferor.  The proposed legislation would affect minority and lack of marketability discounts applied to investment partnerships, real estate partnerships where the transferor does not materially participate, and corporations and other entities holding passive assets beyond working capital needs. It would also eliminate minority discounts on the transfer of ownership interests in non-actively traded entities where the transferee and members of the transferee’s family have control of the entity.  

What to Expect

The section of H.R. 436 that references eliminating valuation discounts for non-business assets would become effective for transfers occurring after the date of enactment, although there is a slight possibility that the bill could be retroactive. The section of H.R. 436 that discusses the estate tax exemption, tax rates, and carry-over basis rules would become effective after December 31, 2009. The bill has been referred to the House Ways and Means Committee.  In 2006-2007, over 10,000 bills were introduced into Congress; however, only 6% were passed. Since January 1993, Rep. Pomeroy has sponsored 114 bills of which only 2 were successfully enacted. According to the January 14, 2009 Heckerling Report, Rep. Pomeroy has introduced such legislation before without success.

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