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Valuations in Estate and Gift Tax Planning for 2022

Jan 26, 2022

An ownership interest in a closely held business can be the most significant asset in a family’s estate. For estate planning purposes or transfer tax purposes, determining the value of this ownership interest can be challenging and involves consideration of many factors. Any valuation report, whether it is for an estate tax filing or for a gift, is subject to IRS review and must meet the requirements of being a “qualified appraisal.”

In addition, adequate consideration must be given to the factors set forth in the Treasury Regulations and in Revenue Ruling 59-60. The selection of the valuation methodology will depend on the facts and circumstances in each case and, in general, the following approaches to value will be considered: income approach, market approach and asset approach.

Based on the degree of ownership interest, consideration must be given to various discounts and issues including “key man” and non-competition agreements, built-in capital gains, minority vs. majority ownership, and marketability of the block of interest being valued.

Planning for estate and gift taxes needs to be proactive rather than reactive. In order to take advantage of the current tax laws, individuals and planners need to focus on taking advantage of today favorable tax treatment—as opposed to being reactive in the midst of a proposed tax law change like we saw in 2021 with the language included in the sidelined “Build Back Better Act.”

Many people were not focused on the whirlwind of activity in Congress in the last half of the 2021, which focused on significantly changing the current tax code related to estate and gift tax planning. There were numerous discussions relating to proposals, counter proposals, and eventually legislation passed by the house and voted down by the senate around the Build Back Better Act. Ultimately, this legislation remains stalled in the senate after narrowly being voted down. The proposed act had several provisions that would cause a major tax law change affecting estate and gift tax planning by reducing the annual exclusion by about half, from $12.06 million per individual/$24.24 million per couple (2022) to $6 million for an individual by the end of 2021.

This change, if signed into law, would significantly affect family businesses owners and wealthy individuals. They would lose their ability to transfer sizable pieces of their assets by utilizing current estate and gift tax planning options and take advantage of the current annual exclusion limitations and allowable marketability and minority discounts. While the Build Back Better Act is on the sidelines for now, the current planning environment is positive for those wishing to make gifts and take advantage of the current law.

There is talk of another vote in 2022, but many pundits and politicians believe there will have to be some bipartisan compromise on various aspects of the bill to move legislators from the nay into the yea column. So now is the time to think about wealth transfer planning for 2022 and beyond by taking advantage of the prevailing favorable tax code.

As for the current law, The Tax Cuts and Jobs Act of 2017 it still stands. However, there is one thing clients and planners need to be aware of. The current law expires on January 1, 2026, and reverts to the old law prior to 2017. As such, the estate and gift tax annual exemption twill drop by 50% from its current levels. So now is the time to begin planning for 2022 estate and gift tax planning.

The most common strategy for reducing potential estate taxes is by gifting some or all a company’s ownership from the business owner to their children or a family member during their lifetime. This gifting under the current law allows for a transfer of ownership from one generation to the next. In doing so, business valuators can utilize the allowable discounts and, in many cases, allow for a sizable reduction in the value of the interest being gifted or valued for estate and/or gift purposes.

The following are a couple of the discounts available when determining values for gifting purposes.

Marketability Discounts

A marketability discount is a discount allowed for reducing the value of the business due to lack of an existing market. Generally, if the company is a closely held business, finding the right buyer may take a substantial amount of time and effort. This delay in potential time is a factor used to quantify and reduce the value of a business interest being transferred. The theory implied is that unlike publicly traded stocks, which generally can be easily bought and sold, a family-run business is not as quick and easy to buy and sell and could be subject to transfer restrictions.

Minority Discounts

A minority discount is available when a small percentage of a company is transferred. The theory is a minority owner cannot effectuate day-to-day management decisions or exert any control over the majority owners.

As it stands now, there is still a favorable planning environment for estate and gift tax planning. While still early in the new year, it is never too late to talk about planning for wealth transfer and utilizing the current tax code to do so. With the historically high annual exclusion and allowable marketability and minority discounts, planning today can save a significant amount of tax dollars in future estate taxes.

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Hubert Klein

Hubert Klein a Partner, the Firmwide Valuation Services Leader, and the New Jersey Forensic, Litigation & Valuation Services (“FLVS”) Market Leader, is a nationally recognized expert witness and professional educator in forensic accounting, damages, and valuation topics.

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