Government Overreach Continues Even After You Die

By Rob Branca

The U.S. Internal Revenue Service has issued long feared proposed regulations (REG163113-02) that intend to take more of the estates of small business owners, preventing family businesses from being passed on to their children. As has been often lamented about children being forced to sell the family farm to a McMansion developer or a large corporate farming interest to pay the punitive “Death Tax,” so too does this fate befall franchise owners.

The IRS seeks to eliminate the common discounts taken for lack of marketability, minority ownership status and lack of control, among others. Family businesses often place these restrictions on shares in the business that they gift to their children. These are not publicly traded shares of Bank of America that can be routinely and easily sold for a publicly known value. There simply are no non-family buyers for a share in a family business, regardless of how successful it is; thus the discount in valuation down from fair market value.

The IRS now wants to value those gifts as if they were indeed arms lengths sales for full fair market value in order to apply the Death Tax to them and confiscate parents’ equity in their businesses. This eliminates room in the exclusion of assets that may be gifted from one’s estate ($5.45 million per grantor) by inflating the value of every gift, leaving anything outside of the exclusion subject to the massive Death Tax.

Franchises are especially vulnerable if these regulations are amended because of factors particular to franchising that naturally depress share price. Most notably, there is an omnipotent third party in franchise transfers that is not present in a non-franchised family business: the franchisor. Franchisors typically posses the power to not only apply not insubstantial fees on transfer, franchisors can also deny them outright. Franchisors also typically possess a right of first refusal to step into the shoes of any transferee.

Transferees often price the uncertainty created by these franchisor rights into the purchase price, knowing that the time and money spent on due diligence, negotiation, attorneys and accountants can be completely lost.

However, perhaps the most discounting factor in valuation of an interest in a franchise is the severely limited pool of buyers. Only an approved franchisee of the system is even eligible to buy at all.

One would ike to believe that the federal government would understand these natural limitations on value. However, the entire joint employer debacle now unfolding on the franchising industry is ample evidence that this is not true. Or, it may simply be that regulators do not care that their actions can wipe out small family businesses in the pursuit of tax revenue and appeasing special interests which are allied against franchising’s often wildly successful business model.

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