Accountancy Associates, LLC

The tax benefits of gifting with valuation discounts

You have worked long hours and dedicated uncalculated time and effort to making your business profitable. As a result of your dedication, the business becomes the most valuable asset in your estate. But what you may have not dedicated yourself to is ensuring that the value of your estate, upon death, will be passed on to your heirs with minimal estate tax consequences.

Estate taxes can be as high as 47% (in 2005). In 2001, the IRS collected approximately $29.2 billion in estate and gift taxes, and in 2002, collections totaled $27.2 billion. Estate taxes can be reduced and the amount of assets gifted increased with proper estate planning and the utilization of valuation discounts.

It is permissible to gift up to $11,000 each year (in 2005) to as many people as desired, free of any gift tax. A hidden benefit of gifting is that the future income and any future growth in the assets transferred will be outside of the giftor’s estate. For example, assuming $10,000 is invested at a return rate of 6% per year (after taxes), the $10,000 will be come $20,000 in about 12 years. In 24 years, it will amount to $40,000 and in 36 years it will be $80,000. Thus, a $10,000 gift made now could remove up to $80,000 from the estate 36 years later and preserve as much as $40,000 from being taken by the IRS. A gift of $10,000 a year for 30 years would remove up to $790,000 from the estate - assuming that the money could have been invested at 6% after taxes.

When you combine gifting business ownership interests with substantial valuation discounts taken on the value of the business, exempt gifts can be increased by 50% or more. There are more than 20 valuation discounts available for closely held businesses. The most commonly used valuation discounts are: 1) discount for lack of marketability; 2) discount for lack of liquidity; 3) minority interest discounts; 4) stock redemption discounts; 5) discounts for lack of control; and 6) key person discounts. Moreover, approximately 26 states have their own individual standards for corporate shareholder interests that must be considered when arriving at the cumulative valuation discount. However, to be allowed, the discounts applied to the valuation of a closely held interest for gift and estate tax purposes must be quantified and qualified.

The Accountancy Associates, LLC Business Valuation qualifies discounts by citing and applying the applicable Tax Court case law and Internal Revenue Code citations. Without recognition of all these factors, the Internal Revenue Service may deem the discounts taken inappropriate. Beware of valuators who apply aggressive or inappropriate discounting, which could result in the undervaluation of the business. The IRS does not think twice about applying undervaluation penalties (up to 40% of the undervalued difference). In 2002, net civil penalties for IRS- assessed estate and gift taxes totaled approximately $61 million.