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Gift & Estate Tax Valuation

Gift & Estate Tax Valuation

An estate tax is a tax levied on estates whose value exceeds an exclusion limit set by law. Assessed by the federal government and a number of state governments, these levies are calculated based on the estate’s fair market value (FMV) after the death of the owner of these assets. However, the gift tax applies to assets that are given away in excess of certain limits while the taxpayer is alive.

If the value of gifts exceeds the gift-exclusion limit, they aren’t subject to tax immediately and may never be taxed unless the value of the estate is substantial. The amount above the gift limit is noted and added to the taxable value of an estate when calculating estate tax after death. Inheritance tax is sometimes confused with Estate tax. Both are levied after death, but the former is levied once assets are inherited to beneficiaries and are paid by the inheritor, whereas the latter is levied before the such inheritance is made and is paid out of the estate.

Estate taxes are applied on the FMV of estates, so a proper valuation is required to assess these tax levies. In addition, the main objective of estate planning is to maximize the value of transferred assets in after-tax terms; here comes an important role played by valuations. If FMV is overestimated, then there will be greater tax liability and a lower worth of total assets transferred. So, to avoid all these errors, a systematic approach is needed for valuation.

 

An ownership interest in a privately held business can be the most significant asset in a family’s estate. For estate planning or gift tax purposes, determining the value of this ownership interest can be challenging and involves consideration of many factors. Any valuation, whether it is for an estate tax filing or for a gift, is subject to IRS review.

The selection of the valuation technique will depend on the facts and circumstances of each case, and, in general, the following approaches to value will be considered:

  • Income approach: A typical discounted cash flow approach, where expected future cashflows are forecasted, and then these cashflows are discounted back to the present using an appropriate risk-adjusted discount rate to come out with the valuation.
  • Market approach: Also known as Relative valuation, here subject assets are valued based on how other similar assets are priced in the market. Key enterprise value (EV) and equity value multiples are used as proxies for the valuation of subject assets. These multiples can be taken from similar public companies (Comparable company analysis) or from the recent acquisitions of similar companies (Precedent transactions analysis).
  • Asset-based approaches: This approach does not have a solid theoretical base. But it could be used to get a floor value for subject assets. Also, it is suitable to value companies that are in a very early stage of the business cycle.

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

  • Marketability discount: It is the discount on the final value of subject assets for the lack of liquidity. Lack of liquidity can be defined as the inability to sell an asset quickly and at its fair value. It is especially relevant for closely held companies that don’t have an active market like their public counterparts.
  • Minority discount: Also called “Discount for the lack of control.” It is available when a small portion of a company is transferred. The rationale is that a minority owner cannot effectuate day-to-day management decisions or exert any control over the majority owners.

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