What a Minority Interest Is Actually Worth

The commercial proposition

Suppose an entity holds assets worth ten million dollars and a donor transfers a twenty percent non-controlling interest. The arithmetic share of the underlying assets is two million. What a willing buyer would pay is less.

There are two reasons, and they are independent of one another.

• Lack of control. The holder cannot compel a distribution, force a sale of the underlying assets, remove the manager, or determine strategy. They receive what the controlling party decides to distribute, when it is decided.
• Lack of marketability. There is no market. The interest cannot readily be sold, transfer is typically restricted by the operating agreement, and any buyer inherits the same absence of control.

Both are ordinary features of private ownership rather than tax artifices, which is why the discounts they support have survived as long as they have.

Why the deduction is larger than it looks

The two discounts are usually applied sequentially rather than added, which produces a combined effect smaller than the sum of the parts but still substantial. More importantly, the discount applies to the transfer, and the asset then continues to appreciate outside the estate on its full undiscounted value.

The statutory constraint

Section 2704 disregards certain restrictions when valuing transfers among family members. In broad terms, a restriction on liquidation that is more restrictive than the default rule under applicable law, and that lapses or can be removed by the family after the transfer, is ignored in the valuation.

Regulations proposed in 2016 would have curtailed family-entity discounts considerably. They were withdrawn in 2017. The result is that discounts remain available, and that practitioners have now spent the better part of a decade expecting them to be curtailed again.

Where these are actually lost

In practice the discount is rarely defeated by the appraisal percentage. It is defeated by the entity, on facts the taxpayer created themselves.

1. 01The entity has no purpose other than the discount. A line of cases has disregarded entities formed shortly before death, holding only marketable securities, with no business activity and no non-tax reason for existing.
2. 02Formalities were not observed. No meetings, no books separate from the transferor's personal accounts, assets used personally, distributions made to whoever needed money rather than pro rata.
3. 03The transferor kept using the assets. Continued enjoyment of property nominally transferred is the fact pattern that pulls the whole entity back into the estate, which costs far more than the discount was worth.
4. 04Funding happened at the wrong time. Transfers made on a deathbed, or after a liquidity event was already in motion, invite the argument that the interest was never genuinely subject to the restrictions relied on.

The appraisal and the clock

A qualified appraisal by an independent appraiser is not optional at this level. A discount asserted without one, or supported by a rule of thumb, is an invitation.

The filing matters as much as the number. Where a gift is reported with adequate disclosure on the gift tax return, the limitations period on the Service's ability to revalue it generally begins to run. Without adequate disclosure the period does not begin at all, and the valuation remains open indefinitely, including after death when the facts are hardest to reconstruct and the people who knew them are gone.