Valuations in Estate and Gift Tax Planning for 2024

An ownership interest in a closely held business can be the most significant asset in a family’s estate. For estate planning purposes or transfer tax purposes, determining the value of this ownership interest can be challenging and involves consideration of many factors. Any valuation report, whether it is for an estate tax filing or for a gift, is subject to IRS review and must meet the requirements of being a “qualified appraisal.” 

In addition, adequate consideration must be given to the factors set forth in the Treasury Regulations and in Revenue Ruling 59-60. The selection of the valuation methodology will depend on the facts and circumstances in each case and, in general, the following approaches to value will be considered: income approach, market approach, and asset approach. 

Based on the degree of ownership interest, consideration must be given to various discounts and issues including “key person” and non-competition agreements, built-in capital gains, minority versus majority ownership, and marketability of the block of interest being valued. 

Planning for estate and gift taxes needs to be proactive rather than reactive. To take advantage of the current tax laws, individuals and planners need to focus on taking advantage of today’s favorable tax treatment—as opposed to being reactive during proposed tax law changes. Over the last few years, there has been a whirlwind of activity in Congress focused on potential changes to the current tax code that would significantly affect estate and gift tax planning. This has included several proposals and counter proposals (in 2021, legislation passed the House before later being voted down by the Senate). 

Given the election year environment of 2024, this Congressional activity has decreased. However, the threat of tax code changes by Congress has been replaced by the very real, mandated sunset of current Tax Cuts and Jobs Act of 2017 (“TCJA”) provisions on January 1, 2026. On this date, many tax provisions will revert to their pre-TCJA state. As such, the estate and gift tax annual exemption will drop by approximately 50% from its current levels of $13.61 million per individual/$27.22 million per married couple as of 2024.  

This change will significantly impact family business owners and wealthy individuals. If you fall into one of these categories, you will lose your ability to transfer sizable pieces of your assets through utilizing current estate and gift tax planning options and taking advantage of the current annual exclusion limitations. With these upcoming changes on the horizon, now is the time to begin planning and executing 2024 and 2025 estate and gift tax moves. 

The most common strategy for reducing potential estate taxes is by gifting some or all of a company’s ownership from a business owner to their children or a family member during their lifetime. This gifting under the current law allows for a transfer of ownership from one generation to the next. In doing so, business valuators can utilize the allowable discounts and, in many cases, allow for a sizable reduction in the value of the interest being gifted or valued for estate and/or gift purposes. 

The following are a couple of the discounts available when determining values for gifting purposes: 

Discount for Lack of Control 

Non-controlling ownership interests cannot unilaterally control management of the operations or investments of the entity, demand payment of dividends or distributions, or liquidate assets to receive a return on investment. A non-controlling owner relies on the decisions of the controlling owner for a return on their investment, whether it is in the form of dividends, distributions, or the appreciation of ownership value. 

Discount for Lack of Marketability 

One of the fundamental underpinnings of investment analysis is that investors value liquidity, which relates to how quickly and certainly an investment can be converted to cash at an investor’s discretion. In the U.S. public securities market, investors can sell an actively traded security over the telephone or internet in a matter of seconds at a known price, with little transaction cost, and receive cash within three business days. By contrast, an investor in a closely held company may not be able to convert their investment to cash so quickly and certainly and will demand a price discount for this lack of liquidity (commonly referred to as a discount for lack of marketability). 

There is still a favorable planning environment for estate and gift tax planning. However, now is the time to talk about planning for wealth transfer by utilizing the current tax code to do so. With the historically high annual exclusion and allowable discounts for lack of control and lack of marketability, planning today can save a significant amount of tax dollars in future estate taxes.