Tax Reporting

It is no secret that the burden for an estate’s executor can be immense even before the often-challenging valuation reporting is brought forth. With the ever-increasing regulatory scrutiny from the IRS, obtaining an estate’s fair market valuation (FMV) is oftentimes a complex process in which penalties can arise should it be handled improperly.

In simplified terms, the IRS defines all of an estate’s assets (cash and securities, real estate, insurance, trusts, annuities, business interests and other assets) as the “Gross Estate.” When you subtract deductions including mortgages, other debts, estate administration expenses, property that passes to surviving spouses and qualified charities, the “Taxable Estate” remains. The value of lifetime taxable gifts (gifted after 1977) is added to the Taxable Estate to compute the associated estate tax. A filing is required for estates with combined gross assets and prior taxable gifts exceeding $11,700,000 as of 2021.

Should an estate fall below the gross asset (and prior gift) filing threshold, it is still strongly recommended that an estate valuation be performed by a qualified professional as of the date-of-death (DOD) or an Alternative Valuation Date (six months after the DOD) to mitigate any potential disputes with the IRS, heirs, and/or family. In some circumstances estate valuation disputes can surface several years later where the IRS may claim the estate’s assets were valued lower than the executor thought, triggering penalties.

A qualified estate appraisal by Intrinsic can provide you with an accurate FMV of the estate’s assets at the DOD or the Alternative Valuation Date which will help to diminish these potential penalties and disputes.

At Intrinsic, we have extensive experience valuing both complex and simple estates for the country’s top estate attorneys, wealth managers, high-net-worth families, and accountants. We stand by our accurate, timely, and defensible valuations for any of your estate valuation needs.

Please contact us if you have any questions about estate tax valuations or to get started.

Transferring business interests in a tax efficient manner comes with many challenges. Intrinsic works with estate tax planners to understand the nuances of the interest to be transferred, the goal of the intended transfer and provides an objective third-party valuation to meet these goals.
One major component to accomplishing this goal, and complying with IRS rules, is to determine the fair market value of the property, or business interest, to be transferred. For gift tax purposes, the fair market value of property transferred is defined as “the price at which the 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.”

Intrinsic can provide the insight and knowledge needed to perform gift tax valuations of:

• Closely held business interests
• Family partnerships and LLCs
• Private Equity LP and GP interests
• Interests in Hedge Funds
• Undivided interests in real estate, and
• Thinly traded stock

Please contact us if you have any questions about gift tax transfers or to get started.

When entities and individuals make charitable contributions (donations) to qualifying organizations, the fair market values (“FMV”) of donated noncash assets are generally reported on IRS Form 8283 for income tax deduction purposes. Noncash assets over $5,000 require a qualified appraisal and if such noncash assets are worth more than $500,000, the qualified appraisal must also be attached to your return. Noncash assets often take form in the transfer of marketable securities, equity interest in private companies, equipment, and real estate. In the past, both individuals and entities have had to relinquish significant deductions by not working with a qualified independent appraiser to properly value such charitable donations.

Intrinsic will provide you with an industry-leading appraisal report which will be signed by a qualified appraiser to satisfy the requirements of IRS Form 8283.

Examples of our experience as a qualified appraiser for charitable deduction valuations includes:

• Common and preferred shares of a privately held software company transferred to a prominent US university.
• Limited partnership interests in offshore and domestic private equity funds.
• The establishment and early termination of a charitable remainder trust (“CRT”).
• Non-voting shares in a family limited partnership with underlying domestic and foreign marketable securities as well as multiple real estate properties.

Please contact us if you have any questions about valuations for charitable contributions or to get started.

Carried interest is a form of a compensation attributable to general partners in Private Equity, Hedge Fund and Real Estate investment structures. It is represented by residual proceeds from realized investments remaining after all limited partners in the fund have received their invested capital back with a predetermined hurdle rate of return.

The General Partner entity is the manager of the fund. (In most structures, the GP and the management entity are separated, but are usually run by the same team of investors.) The General Partner chooses the investment strategy, investment management personnel, finds companies to invest in, and sells the investments during the fund’s realization period. Therefore, the General Partner only receives carried interest proceeds, i.e., residual profits, after meeting the predetermined and agreed upon criteria for fund’s realized return.

Upon initiation of a fund, all partners (general and limited) agree upon all the terms of the fund, including its waterfall structure, which specifies how the returns will be distributed among all partners.

Waterfall structures vary depending on type of the fund and agreement between partners. However, typically, after returning all invested capital back to limited partners and paying the agreed upon hurdle rate of return, general partners get a portion of the residual profits received by the fund, which constitutes the carried interest.

Thus, carried interest is a projected stream of future cash flows to the General Partner. Therefore, after all projected fund returns are calculated based on the amount of committed capital, fees and expenses, and estimated return on invested capital, and, thereafter, allocated to all limited and general partners according to the fund’s waterfall distribution structure, the tax-affected free cash flows are discounted back to present time by the applicable cost of capital discount rate and summed up to arrive at the present value of the future carried interest profits.

Finally, appropriate discounts for lack of control and lack of marketability are applied to pro rata value of carried interest proceeds to determine the fair market value of the portion of carried interest attributable to a particular partner.

Please contact us if you have any questions about carried interest valuations or to get started.

The fair market value of a share of publicly traded stock is simply equal to the market price. However, the fair market value of a block of publicly traded stock is not so simply valued. The dilemma occurs when the block becomes so large relative to the daily trading volume that it could not be sold without depressing the price of the stock. As such, the FMV of that block is less; and how much less is the question.

The two primary factors that affect the size of the blockage discount are:

• The size of the block in the subject company; and
• The daily trading volume of the subject company shares.

Every block of shares is subject to unique considerations and therefore every block must be evaluated to determine the discount applicable. Some blocks include restricted or control securities that are subject to Rule 144 resale conditions. In some cases, a block may be so large that it would command a premium; this scenario may occur if the block is large enough that its purchase would give another shareholder control of the company. However, in most cases, the block of stock in question does not offer control to other shareholders but is still large enough that liquidating on the open market would noticeably depress the price of the security and therefore a discount to the quoted share price is applicable.

Please contact us if you have any questions about blockage discount analysis or to get started.

On the date of the S corporation conversion, the corporation must determine the Fair Market Value of the assets and compare to the adjusted tax basis of assets. The S corporation should be valued as if it remained a C corporation and had sold all its assets at fair market value to an unrelated party.

Determining the fair market value depends on the circumstances in each case. However, the most common method is to get an appraisal of all assets. Any excess fair market value is considered a “built-in” gain and will be subject to the corporate tax rate of 21% if the assets are sold within 5 years of the date of the S corporation conversion.

Please contact us if you have any questions about C-Corp. to S-Corp. conversions or to get started.

Internal Revenue Code Section 704(b) requires that an LLC maintain capital accounts for its members. The number and type of shares issuable by the corporation upon conversion need to be based on those relative capital account balances, but only after the capital accounts have been booked to reflect the current fair market value of the LLC and its assets immediately prior to the conversion. To properly book up capital accounts, it is necessary to obtain a valuation of the LLC immediately prior to the conversion. The valuation will typically be necessarily for both the equity as well as separately identifiable assets of the LLC to show the current fair market value.

When profits interests are issued, there is a “hurdle rate” attached to them which is equal to the value of the company on the date they are granted. This hurdle rate is important so that the issuance of these interests are not taxable as immediate income. If the LLC has increased in value since the date the profits interests were granted, then they would have an unrealized gain, which is recognized by the IRS. If you convert these into options of a C-corporation, on an economic equivalency basis, they would be “in the money” options and you would fall afoul of IRC 409A – namely, you would be creating an immediate tax event for all recipients of those options. External expertise can be useful in navigating these nuanced LLC valuation pitfalls.

If the corporation is issuing options, the company may need a valuation to establish the strike price of those options under the new corporate structure.

Please contact us if you have any questions about LLC to C-Corp. conversions or to get started.

An interest in a private company may be a 100% interest, a very small partial interest, or any size in between. It can be voting or non-voting. It can have different degrees of control. It can be marketable or hardly at all.

Valuation discounts are quantitative adjustments that market deems appropriate to be applied to interests in private companies and partnerships, based on specific characteristics of the interest being transferred, such as prerogatives of control inherent in shares, and interest’s marketability. After determining the value of 100% of equity in a business, it is usually necessary to adjust its pro rata value by applying appropriate discounts for lack of control and lack of marketability.

International Glossary of Business Valuation Terms defines a discount for lack of control as “an amount or percentage deducted from the pro rata share of value of 100% of an equity interest in a business to reflect the absence of some or all of the powers of control.”

Marketability is defined as the ability to quickly convert property to cash at minimum cost.
When assessing value of an interest in a private company, it is necessary to recognize that the level of liquidity of an interest in a private business is not equivalent to that of the same economic interest in a public marketplace. An interest in a public company can usually be converted to cash within hours, whereas the same would not be the case for a private company’s interest. These differences affect the interest’s fair market value.

Various studies were done to estimate how different characteristics of interests in different business structures affected those interests’ prices in the marketplace. Relevant studies are used in analyses of discounts for lack of marketability and lack of control in order to determine the sizes of the appropriate discounts. Thereafter, the applicable discounts are applied to pro rata share of 100% equity to establish the fair market value of the interest on a non-controlling, non-marketable basis.

Please contact us if you have any questions about valuation discounts for LLCs and FLPs or to get started.

It is not uncommon for real estate to be owned by multiple owners, often held as tenants-in-common. This arrangement provides each owner an undivided interest in the total real estate as it gives each owner a right to use and possess the shared property, with no particular owner having exclusive rights to any portion of the property. As a result of this shared ownership, all owners must collectively make decisions affecting the use or disposition of the property.
These characteristics of shared ownership result in each owner having a lack of control over the property. Furthermore, these limitations severely impact the marketability of an undivided interest. As a result, the market value of these undivided interests are often discounted when compared to a pro-rata percentage of the whole.

The determination of the appropriate discounts for these types of interests can be very complex and it is essential that a proper analysis be conducted. Intrinsic has the required expertise needed to perform these analyses and help clients transfer undivided interests in the most effective way.

Please contact us if you have any questions about undivided interests in real estate or to get started.

§409A (“409A”) is a tax provision of the Internal Revenue Code which was added to the code in 2005 due to perceived abuse of deferred compensation arrangements. If the series of rules detailed under 409A are not followed, employees who have been issued stock options could be subject to punitive tax consequences. However, an exclusion to the tax consequences is allowed if an option is issued with an exercise price that is at least equal to the fair market value of the underlying stock on the date of grant.

Further, the regulations under 409A provide a safe harbor that allows a company to rely on a valuation from an independent, third-party firm that specializes in valuations for 409A and follows consistent valuation methodologies. If the current fair market value is challenged, the burden of proof shifts to the IRS to prove that the fair market value at the time of option issuance was unreasonable.

Therefore, a 409A valuation is used to set the strike price of equity options issued to employees at the current fair market value of the common stock. Generally, a company can rely on a 409A valuation for a 12-month period, as long as there are no events or circumstances during that period that would materially affect the valuation of the company. Unfortunately, there is no definition of what constitutes a material change. Raising a financing round of new equity or debt, M&A activity by the company, or significant changes to a company’s financial outlook are all events that likely indicate a material effect on valuation.

Please contact us if you have any questions about valuations for compliance with IRC §409A or to get started.