valuation discount

Can someone explain to me the concept of valuation discount in session 4? what does it mean and is there an easy way to remember which kind of trusts have it. Also, what is a defective trust and why isn’t it tax effective? Thank you

Valuation discount and defective trusts are somehow related. I mean valuation discounts provides a way to reduce the taxes in case of defective trusts. Defective trusts cannot benefit from tax exemption in themselves. Depending on whether the grantor retains the control or not, either the trust or the grantor should pay the taxes. However, in a defective trust you can hold the assets in a partnership or corporate structure which will enable you to enjoy valuation discounts.

to me, it’s quite a complex subject. here below is my understanding others please jump in to help piece together a better picture. say, at age of 75, john has an estate (may be a holding of bear stearns) valued at 10 millions at the time. he likes to leave the bulk of this asset to his children, but there will be a significant gift tax on the 10 millions charged by IRS. to avoid the gift-tax, john can create a trust and also make it “defective” by paying any income tax incurred (interest, dividend, etc.) on behalf of the trust. by doing so, the transfered estate becomes invisible to IRS. at end of the day, even the 10 millions grow to 20 millions at “fair market value”, his chirldren can simply sell the asset with zero tax consequence. so, “defective” leads to tax efficiency for sure. in addition, john can also put the 10 million trust asset under some structure like LLC. since the LLC would be illiquity asset, john would be allowed by IRS rule to mark down the face value of the trust asset, which is called “valuation discount”. according to available information posted on web, IRS allows up to 40% discount. so, 10 million becomes 6 millions. i guess, by doing this, john’s on-going estate tax bill would be reduced significantly. but, i am not very sure my understanding on this part is right .

these two issues become clearer to me after some further studies. valuation discount: available to almost all kinds of trusts and FP’s as long as created under LLC or the likes. the discount helps to reduce the base of gift tax. so, from wealth transfer perspective, it’s tax efficient. defective: guarantor pays income taxes on trust’s behalf to generate tax alpha. that allows the trust fund to compound tax-free. it’s tax inefficient however from guarantor’s perspective because he/she has to pick up additional tax bills every year. please ignore my previous post.

hi Rand0m, are there a reason why LLC or partnership will be eligible for valuation discount? I hope I can memorize it better if I understand that.

siushun Wrote: ------------------------------------------------------- > hi Rand0m, are there a reason why LLC or > partnership will be eligible for valuation > discount? I hope I can memorize it better if I > understand that. To my understanding, it is more of a “illiquidity discount”. Compare to regular stocks, bonds, MF which are liquid. Private LLC, partnership are not liquid, therefore you can take a valuation discount.

Got it. Thanks ws!

Those rules actually make me ill.

JoeyDVivre Wrote: ------------------------------------------------------- > Those rules actually make me ill. What? You got a rich uncle??