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Proposed estate tax rules could disparately impact franchisees

The IRS has reportedly received more than 8,000 public comments regarding proposed changes to how the agency determines valuation discounts under Section 2704 of the U.S. Tax Code. This provision, contained in Reg-163113-02 of the agency's regulations, deal with discounts allowed for valuation of business holdings and assets for purposes of calculating estate tax.

Many of the comments received from the public, as well as the subject of a letter issued November 1 by the Office of Advocacy of the U.S. Small Business Administration, deal with the unique issues facing franchise operators. Specifically, franchisees fear that failing to account for the valuation concerns inherent in franchise ownership would leave them disparately impacted by estate taxes.

Franchises can be very lucrative, particularly if the underlying corporation is a successful one. Many franchise owners report high satisfaction with the franchise process, and appreciate the diverse opportunities possible through franchising (without the need to reinvent the proverbial wheel of a business model, etc.). That being said, there are certain drawbacks inherent in franchise ownership as well, some of which come into direct conflict with the proposed regulation at issue.

In particular, franchise owners - and Chief Counsel for the Office of Advocacy at the SBA - argue that the regulations fail to address estate tax-related valuation issues raised by:

  • Limited sales opportunities (because franchise transfers must be approved by the home corporation and are conditioned upon the proposed transferor being granted a franchise license)
  • The difficulty in transferring franchise interests among family members
  • The potential disruption of operating capital for the business if these concerns are ignored, which could lead to staff cuts, lost productivity, inability to stock products, or even loss of the franchise

The SBA is urging the IRS to reconsider implementing this regulation now that the public comment period has ended (as of November 2), and to reopen comments only after submitting a "valid factual basis for certification under the" Small Business Regulatory Enforcement Fairness Act.

With the future of this rule currently uncertain, many franchise owners could be facing questions concerning issues of business succession and tax planning. If you are a franchisee dealing with similar concerns, contact an experienced tax attorney in your area to learn more about how this and other IRS regulations and tax code provisions will impact your business now and into the future.

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