AB VALUATIONS INC.

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estate & gift tax
valuation

Business valuation for estate and gift tax purposes is a critical component of estate planning, especially for individuals who own interests in closely held businesses. The primary goal is to determine the “Fair Market Value” (FMV) of the business interest being transferred, which then forms the basis for calculating estate or gift taxes.

Here’s a breakdown of key aspects:

Fair Market Value (FMV) Standard

The IRS defines FMV as “the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” This is the standard used for estate and gift tax valuations.

Why is Business Valuation Important for Estate and Gift Tax?

  1. Tax Liability: Your business value will determine the amount of taxes you will owe. This is either through taxes accrued from capital gains on the sale of shares, taxes on dividends paid in a wind-up of the business or estate taxes on your property after passing.  A proper business valuation can help you understand the potential taxes owing and assess your options for minimizing or deferring taxes.

  2. IRS Compliance: The IRS requires a well-supported valuation report by a qualified appraiser when business interests are gifted or transferred at death. This helps ensure compliance and reduces the risk of audit challenges.

  3. Strategic Planning: Valuations assist in structuring trusts, gifting shares to family members, and generally planning for the seamless transfer of wealth and business succession.

  4. Equitable Distribution: For estates with multiple heirs, an accurate valuation ensures fair asset allocation and helps prevent conflicts.

VALUATION APPROACHES

Qualified appraisers typically use a combination of approaches to determine FMV: 

  1. Income Approach: This approach estimates value based on the business’s ability to generate future income or cash flow. Methods include discounted cash flow (DCF) or capitalization of earnings. 

  2. Market Approach: This involves comparing the business to similar businesses that have been sold (Guideline Transaction Method) or publicly traded companies (Guideline Public Company Method). 

  3. Asset Approach: This method values the business based on the fair market value of its underlying assets and liabilities. It’s often used for asset-heavy businesses or as a “floor” value for operating companies.

IRS Guidelines and Revenue Ruling 59-60

The IRS provides guidance for business valuations, most notably in Revenue Ruling 59-60. This ruling outlines eight key factors that appraisers should consider:

  1. Nature and history of the business. 
  2. Economic outlook in general and the industry in particular. 
  3. Book value of the stock and financial condition. 
  4. Earning capacity. 
  5. Dividend-paying capacity. 
  6. Goodwill and other intangible value.
  7. Sales of the stock and the size of the block of stock to be valued. 
  8. Market price of stocks of comparable public companies.

Key Valuation Discounts

For privately held businesses, two significant discounts are frequently applied to reflect the realities of non-public ownership:

  1. Discount for Lack of Marketability (DLOM): This discount reflects the reduced value of an interest due to the difficulty and time required to sell it in the open market, compared to readily marketable, publicly traded securities. Factors influencing DLOM include transfer restrictions, company performance, and liquidity.

  2. Discount for Lack of Control (DLOC): This discount applies to minority ownership interests that do not have the power to control business decisions (e.g., compensation, dividends, sale of the company). A non-controlling interest is generally worth less per share than a controlling interest.

Importance of a Qualified Appraiser

Given the complexities of business valuation for tax purposes and the scrutiny from the IRS, it is highly recommended to engage a qualified business appraiser. A professional appraiser can:

  1. Conduct a thorough analysis of the business.
  2. Apply appropriate valuation methodologies.
  3. Properly calculate and support any applicable discounts.
  4. Prepare a comprehensive and defensible valuation report that meets IRS requirements.
In summary, business valuation for estate and gift tax purposes is a specialized field that requires expertise in both financial analysis and tax regulations. Proper valuation can significantly impact tax liabilities and is a crucial element of effective estate planning.