Current Volatility Necessitates Exacting Valuation Methods 

Gift and estate planning has grown more complex in recent years, in large part due to a confluence of tax laws, demographic trends and market forces that are unusually volatile. As a result, valuation of assets for gift and estate planning purposes requires increasingly exacting methods used by valuation professionals and an understanding of changing tax laws and IRS practices. 

Business valuations are an essential support tool for gift and estate planning. Most business owners have nearly all of their personal net worth tied up in their companies, a factor that can complicate estate planning. If the business is part of the estate, a valuation can be done before estate planning and gifting of assets and updated every couple of years to ensure that the plan is realistic. 

In cases where a business owner is not planning to exit the company anytime soon, obtaining a valuation for estate planning purposes can deliver the double benefit of providing insight into the business’ value drivers and what steps can be taken to enhance the value over time. 

On average, 350,000 business owners who are members of the baby-boom generation exit their businesses annually. Many of those businesses, including family farms, small businesses, manufacturers and local retailers, are included in gift and estate plans, as well as trusts. Structuring these plans and trusts to accomplish the owners’ goals while avoiding or minimizing estate taxes is a key goal for owners and their advisors. 

But current volatility is leading many business owners and their advisors to review their estate plans and carefully consider how they may be restructured – and how assets may be valued – in the next couple of years. The volatility comes from several sources. 

Sources of Volatility 

First, there is the Tax Cuts and Jobs Act of 2017 (TCJA), which significantly increased federal estate tax exclusions to the current $12.9 million for individuals and $25.8 million for married couples. But, like many other provisions of TCJA, the expanded estate tax exemption is scheduled to expire on Dec. 31, 2025. Unless Congress acts to extend or make permanent the current exemption, it will revert to pre-TCJA levels of approximately $5.5 million for individuals and $11 million for married taxpayers. Such a dramatic contraction of the federal estate tax exemption would push many taxpayers’ estates over the line, subjecting them to estate taxes unless they proactively restructure their estates before the change. 

Second, market forces such as inflation and the rapid pace of business exit by baby boomer owners are impacting valuations, a situation that was compounded by the COVID-19 pandemic, which accelerated business exits. 

Third, with additional funding from the Inflation Reduction Act of 2022, the IRS will be ramping up enforcement in the next few years, potentially increasing IRS challenges to business valuations included in gift and estate plans. 

Structuring an estate or gift plan to avoid estate taxes makes sense. The top tier estate tax rate is 40% for estates that are larger than $13.9 million for an individual. Depending on where you live, you may be subject to state-level estate taxes, as well. Kansas and Arkansas do not have estate or inheritance taxes, but Nebraska and Iowa do. 

Valuation in the Gifting Context 

Valuations are a helpful tool in the gifting context as owners prepare for exit. A valuation enables wealth to transfer from one generation to the next in a tax-smart manner and satisfies the IRS’ requirement for adequate disclosure of assets. Once the IRS accepts a valuation report, it can still lodge a challenge within the next three years.  

A valuation enables owners to transfer pieces of the business to heirs or other successors over several years, minimizing tax consequences while keeping the estate below the estate tax threshold. 

In the event a trust is created to hold a business, beneficiaries are typically given nonvoting shares or a minority interest with restrictions on their ability to transfer the interest to someone else. In these cases, a valuation would reflect a discount for lack of control and lack of marketability. The IRS often challenges these discounts, so it’s important to work with a valuation professional who understands the best methods to use to be in compliance with the IRS’ standards. 

If you are preparing for gift or estate planning and would like to discuss a valuation for your business, or if you are concerned about changing laws relating to your existing estate plan and business valuation, contact an Adams Brown advisor.