Estate Planning

Business Valuations and Their Role in Estate & Succession Planning

ESTATE PLANNING

An estimated 90% of all businesses in the U.S. are closely held family owned businesses.

Estate planning is the process of developing and coordinating the transfer of an individual’s property/assets to designated beneficiaries in a manner that will minimize or even eliminate the taxes levied by way of the U.S. Unified Gift and Estate tax program. One of the most overlooked assets in many estate plans is the family business and its impact on an owner’s estate and the resulting tax obligations. However, it is only after an owner has deceased that the true understanding of this asset’s tax liability comes to light. In many cases, the tax liability is so exorbitant that other family assets must be liquidated, which leaves heirs with nothing more than a non liquid business and no one to run it. (Also, for high net worth individuals holding real property and marketable securities, a valuation is essential to preserve their assets for future generations.)

Therefore, there should be a conscious effort in estate planning to focus on the value associated with a retained and/or continued ownership interest in the family business. Conducting a periodic valuation of the business operations enables the owners and family members to better understand the nature of the estate tax concerns. The valuation also provides a basis by which the business owner can evaluate the appropriateness of ownership transfers and alternatives; provides a basis for the valuation of gifts; and can even guard against future conflicts with the IRS. (A properly prepared valuation helps to avoid an IRS challenge that could overturn an estate plan, exposing the estate to under valuation penalties and disputes among heirs.)

An estate tax planning valuation needs to be clear about the interests being valued. Discounts must be evaluated and documented. The most common discounts are for a minority interest and the lack of marketability.

Our reports document the methods used to arrive at these discounts to comply with the IRS guidelines described in Revenue Ruling 59-60. Each situation is different and a valuation professional needs to carefully consider which discounts apply and to what extent. Many business owners undervalue their business entities for estate and gift tax purposes. This can have severe financial consequences. In determining the fair market value of a business entity the IRS requires more than a simple calculation. The methodology, theory, and empirical evidence behind the fair market value determined in accordance with Revenue Ruling 59-60 must be well documented. Business owners, high net worth individuals, and executors should substantiate the estate and gift tax planning process by engaging a qualified attorney, a financial planner with tax knowledge, and a qualified valuation firm to value their assets. This will ensure that the value determined is supportable.

SUCCESSION PLANNING

Like estate planning, business succession planning is emotional. Be emotionally smart about the planning. The business valuation exercise often forces the business owner to re-think his/her position on who will carry on the operations once they are gone or no longer able to maintain the leadership role.  Not all businesses are designed, nor have the ability, to survive their founders. In many cases the children simply aren’t interested. In order to preserve family wealth, business owners must either find an outside manager to carry on with operations or sell the business. To do nothing, however, could tragically deplete an otherwise valuable asset. One which often times took a lifetime of sacrifice and effort to build.

The most successful estate and succession plans are designed by a team of specialized professionals. The business valuation exercise is an integral part of these plans and should not be overlooked. In fact, it may be the first place to start.

Contact me directly on LinkedIn. Thanks for reading!

Darrin Maddox MBA, CPA, CVA

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