Estate Tax Planning Valuation – COVID-19 Update
by BRAD SMITH, CPA, CFA | 06 May 2020
OPPORTUNITIES TO MAKE GIFTS FOR ESTATE TAX PLANNING
While Covid-19 has created a scary and detrimental environment in terms of our health and safety, it has also created an opportunity for estate planning and gifting. For taxpayers looking to maximize the use of their lifetime gift and estate tax exemption, now is an opportune time.
The Covid-19 outbreak has caused a myriad of challenges and obstacles for business, including government-imposed temporary closures for many. Even for businesses that are allowed to continue operations, challenges have included supply chain disruptions, workforce restrictions, travel restrictions, and a reduction in consumer spending from social distancing and stay-at-home orders, among other impacts.
WHAT IS THE IMPACT ON A POTENTIAL GIFT’S VALUE?
One of the earliest provisions governing valuations for estate and gift tax purposes was IRS Revenue Ruling 59-60 (“Rev Rul 59-60”). Rev Rul 59-60 defines the Fair Market Value of a business as “the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.”
While sellers may only be “willing” to sell if they are able to command a value similar to their expectations a few months ago, many buyers, with knowledge of the current, relevant facts, will likely only be “willing” to transact if values come down. Supply and demand will ultimately determine whether business value declines or not, but in the meantime, the following are just a few reasons values are likely lower for Fair Market Value purposes.
- With many businesses ordered to be closed or customers staying at home to social distance, financial projections of revenue, net income, and free cash flow are likely to be much lower as compared to the forecasts from the beginning of 2020. This would likely lead to a reduced value from a cash flow approach.
- A common approach to valuing a privately held business is to compare the prices of stock from similar publicly traded companies to the private business. The value of these comparable company stocks has likely fallen anywhere from 10 – 40% since late February.
- For family partnerships or other entities that own real estate, there is reason to anticipate a fall in real estate prices as tenant’s ability to continue to pay rent, in both the residential and commercial markets, is questioned.
Further, as many know, if the gift or transferred asset is a minority interest, it may be appropriate to apply discounts for lack of control and lack of marketability. It is possible these discounts will be higher to compensate for the additional risks associated not being to control the course of the business during these turbulent times or dealing with the lack potential buyers, as mentioned above.
Finally, the Tax Cuts and Job Act of 2017 (“TCJA”) raised the lifetime gift and estate exemption base from $5 million to $11 million, subject to inflation adjustment thereafter. After being indexed for inflation, the exemption for 2020 is $11.58 million. The increased exemption is set to expire at the end of 2025; however, there are many estate planners that believe this increased exemption will be rolled back sooner if there is a change in the federal administration this November. Some speculate the reduction could be to the pre-2018 level of approximately $5.5 million or even 2009 levels of $3.5 million. The IRS has provided guidance to taxpayers that any gifts made which are non-taxable by utilizing the current exemption amount will not be clawed back if the exemption is lowered in the future. With this in mind, it may be the right time to pursue making gifts for estate tax planning while the current exemption remains in place.
With a potential reduction in the values of privately held businesses and relatively favorable lifetime gift and estate exemptions, it may be an advantageous environment to make a gift for estate tax planning. Intrinsic can help you navigate the valuation process, in order to ensure that your gift is compliant with Fair Market Value and tax standards.
For a discussion on the above and how COVID-19 may impact your 409A valuation, please reach out to me or any of our valuation team members.
// ABOUT THE AUTHOR
Brad serves as a Managing Director and head of Intrinsic’s Tax and Family Office practice. He leads the firm’s activities regarding tax valuation technical issues and resolution, as well as interactions with professional and industry associations. In addition, Brad fosters relationships with family offices, supporting their various needs from gift and estate, tax, and financial reporting matters to providing expertise in scenario analysis and financial modeling. His areas of expertise include the valuation of business enterprises, debt and equity securities, and options and warrants for purposes of financial and tax reporting, mergers and acquisitions planning, reorganizations and restructurings, employee stock ownership plans, minority-interest buyouts, stockholder litigation, and other matters. Brad has presented testimony as an expert witness on valuation matters for various district courts in Colorado, Wyoming, and Florida. He is experienced in valuing companies at all stages of their life cycle, from very early stage startups to established global companies. Brad is an active member of the Association for Corporate Growth and a Chapter Leader for the Rocky Mountain Chapter of the Alliance of Merger & Acquisition Advisors
Prior to joining Intrinsic, Brad spent over seven years at Karsh Consulting, an accounting and consulting firm, where he concentrated on business valuations for litigation and gift and estate tax purposes. Prior to Karsh, Brad spent time at industry leading firms Arthur Andersen and the Citigroup Private Bank. In these capacities, Brad advised clients on wide ranging matters including valuation, investments, tax, and accounting.