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Valuation Discounts for Gifts & Estate Tax Savings

Valuation Discounts for Gifts & Estate Tax Savings

Valuation discounts, commonly used for business appraisals for private equity firms, family limited partnership (FLP), and minority interests in LLCs, are extremely beneficial for saving on taxes on gifts and donations property taxes. The reduction can reduce property tax assessments while still allowing you to give your children a percentage of the business, trust, LLC, or FLP at a reduced rate.

It is important to know that the valuation standard for tax purposes on gifts and estates is defined as the fair market value (FMV). This is the price at which the company, LLC, trust, or FLP would change hands between a willing buyer and an interested seller, with no obligation to buy or sell and both with reasonable knowledge of the relevant facts. Fair market value (FVM) is the selling price that a hypothetical buyer and seller would get, not the price the beneficial owner would accept or the price that an actual buyer would be willing to pay.


Gift and Estate Tax Savings Strategy

To be eligible for valuation reductions, a person can choose to split the ownership of their business, LLC, trust, or FLP, especially family assets or closely held assets. While it is good to develop an equity strategy based on life insurance assets, these same valuation discounts will apply to someone's equity. If someone dies as the owner of their own business and leaves all of their belongings to their five children, the five children would be entitled to many of the discounts.


Common Valuation Discounts

The most common valuation discounts are those due to lack of marketing, control, minority interests, and future interest discounts. These discounts can range from 10 to 45%, depending on several factors:

  • Future interest: Future interest reductions are common in creating trusts, such as Qualified Personal Residence Trusts, which give the beneficiary the right to have assets for several years into the future. Since this is a gift of future interest, the asset can be discounted at an assumed increase in the interest rate.

  • Lack of control: A reduction in the value of a company's shares due to the inability of shareholders to exercise control over the company is a discount for lack of control. In this case, business interest is considered less valuable than a controlling interest in a business because business decisions, such as determining compensation, establishing policies, deciding to sell or liquidate, and declaring dividends, are not within reach of shareholders. Thus, when valuing uncontrolled or non-voting shares of a private company, a discount for lack of control is often applied.

  • Lack of marketability: This is the discount that can be applied to the valuation of a company that is not publicly traded. This is usually the calculation of the value of closely-held businesses or restricted shares of public companies. There is a gap between publicly traded stock (and therefore a market) and privately held security, which often has little or no market. In other words, because a private stock has no clear market value (just like a public stock), it deserves a discount.

  • Minority Share: Minority interest discounts can be achieved by making each donation a commercial interest rate low enough to qualify for the minority interest reduction. The reduction in minority stake reflects the idea that a stake may be less than its (proportional) stake in total assets. For example, owning a 30% stake in the business may be worth less than 30% of the total value of the business. Indeed, a 30% property right may be limited under its control over critical aspects of the business, such as management, financial or accounting supervision, regulatory or legal matters, and even hiring decisions and dismissal.


Determination of the discount

Individuals will need a qualified business valuator or qualified valuation analyst to determine an appropriate discount based on an analysis of the entity's assets held and their condition, amount of interest presented and restrictions described in the operating contract.

Many factors affect the valuation of a business, and the specific facts related to the transfer will greatly affect the discount. These limitations often significantly limit the power of minority shareholders to vote, participate in management, replace directors, impose distributions, liquidate assets and transfer or sell their interests.

If people are giving gifts for several years, experts recommend that each gift be appraised as close as possible to the time of transfer.


Current tax legislation and valuation discounts

In the commercial frenzy linked to possible changes in tax legislation, valuation discounts are specifically addressed. If the bill is approved, no valuation discount would be allowed with respect to interests under common family control.

Under current tax legislation, individuals can donate $11.7 million per person over their lifetime without having to pay tax on donations. However, this provision will expire at the end of 2025. The many tax proposals under discussion could be reduced to an even smaller number sooner.

To take advantage of the possible protection of transactions entered into before the effective date of any proposed regulations, those already involved in planning transfers with LLCs and limited liability companies should complete the process promptly. In contrast, those wishing to rely on existing laws should begin planning immediately.


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