Accountancy Associates, LLC

Exit strategies and buy-sell agreements – as a business owner, are you protected?

Taxes may not be everyone’s strong point. However, there are key questions that may bring about estate and tax issues you have never considered. As a business owner, you need a plan to protect what is probably the most valuable asset in your estate, the business.

What is your exit strategy?

Are you planning to "give" the business to your heirs? Do you intend to sell his/her shares to the corporation or other shareholder(s)? For all scenarios, a professional business valuation must be performed for tax purposes.

Valuations performed for estate and gift tax purposes must value the business, as required by the IRS, based on the standard of Fair Market Value (FMV) [Rev. Rul. 59-60: …property changing hands between a willing buyer and willing seller without compulsion to buy or sell, both parties having reasonable knowledge of relevant facts]. For gifting, the valuation determines the basis utilized to gift shares (annually tax free up to $11,000 per donee in 2005), should you choose to exercise this option.

Shareholders selling their interest to the company, or remaining shareholders, are best served by having a valuation that reflects FMV, as it will most likely portray a value that exceeds the company’s Book Value or Liquidation Value.

Do you have a buy-sell agreement?

80% of business owners do not have a buy-sell agreement and 60% of those who do, have one that is not funded or not properly funded.

If you do have a buy-sell agreement, what "standard of value" is utilized?

According to a recent study by Loyola University, fewer than 5% of buy-sell agreements value the business based on Fair Market Value. Buy-sell agreements may reflect a standard other than FMV (i.e. Book Value, Fair Value, Intrinsic Value, Investment Value, etc.). However, the IRS is very clear on this issue – the standard must be Fair Market Value or the Service will not accept it for calculating estate taxes due. Upon the death of a shareholder, stock valued at less than FMV will be revalued by the IRS and heirs will be responsible for any additional estate tax assessment. The IRS knows undervalued businesses represent a rich source of untapped tax revenue. A potential trap for unknowing shareholders is that the purchase price stated in a buy-sell agreement is not necessarily binding on the IRS for federal estate tax purposes. Therefore, the agreement should contain a clause indicating "the purchase price at death shall be no less than the value of the shares as finally determined for federal estate tax purposes." This ensures the estate of the deceased will not be forced to sell the stock for a certain price and owe the entire amount or possibly more to the government for estate taxes.

Would you consider your business the most valuable asset in your estate? If so, are you monitoring the value of your largest asset?

Usually the business is the most valuable asset in a business owner’s estate. As such, it should be monitored for tax planning purposes and updated regularly (typically every two years, depending on revenue increase or decrease, significant events, etc.)

Submitting an estate tax calculation to the IRS that includes undervalued stock can result in the IRS revaluing the stock and penalizing the estate up to 40% of the unpaid tax on the undervaluation in addition to the taxes associated with the higher value.

How will your heirs pay the estate taxes on your estate?

A professional business valuation is a critical tax savings aspect of your estate. Consider the alternative, the IRS audits close to 100% of ownership transfers between deceased business owners and their heirs. If the value reported is unsubstantiated, or the IRS disputes the value derived, they will assign their own recalculated value to the asset. Furthermore, the IRS may also assess undervaluation penalties, meaning heirs must deal with the tax difficulty of an undervalued estate. Heirs will experience not only the emotional devastation of losing a loved one but the unsympathetic IRS as well. To pay unplanned estate taxes and undervaluation penalties, heirs may be forced to: 1) Burden the business with large debt, 2) Sell shares of stock to outsiders, and/or 3) Divest all or a part of the business.

Did you, or do you, take advantage of ALL discounts available in valuing your stock or business for estate tax or gifting purposes?

There are more than 20 valuation discounts, including: lack of control, lack of liquidity, lack of marketability for controlling interests, lack of marketability for minority interests, minority interest discounts, key man discounts, thin management discounts, key customer dependence discount, key product dependence discount, discounts for obsolescence of technology or facilities, blockage discounts, partnership discounts, voting restriction discounts, transfer restriction discounts, corporate risk discounts, discounts for trapped-in (or built-in) capital gains, discounts for environmental, litigation and other contingent liabilities. Closely-held businesses are eligible for valuation discounts, which enhances gifting power, as long as the discounts are identified and substantiated. For example, on the Gift Tax Return – Form 709, Schedule A, Line A, requires taxpayers to identify all discounts applied in arriving at the asset valuation – answering ‘yes’ on Line A signals the IRS to take a detailed look at the valuations. The IRS has developed numerous catch-alls to target questionable asset valuations. The Accountancy Associates, LLC business valuation breaks down discounts and, most importantly, all discounts are quantified and qualified.

Have you had a professional business valuation performed on your business asset?

If so let us take a look at it. We would be happy to assess whether it meets the standards applied by the IRS.

Business valuations must withstand the scrutiny of the IRS and the Tax Courts. Tax Courts are infamous for disregarding valuations not performed by a professional, accredited appraiser. The Accountancy Associates, LLC business valuation report assures authority, credibility and legitimacy.