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Articles From Lumsden McCormick

Three Reasons to Use Valuation Pros in Estate Planning

Some business owners design their estate plans without consulting a business valuation professional. They use simplified rules of thumb or other do-it-yourself techniques to estimate the value of business interest gifted to family members or donated to charities.

However, this approach can lead to unwelcome surprises down the road. Here’s why business owners need a credentialed valuation expert to plan for the future.

1. Rules of Thumb May be Unreliable

Valuation formulas often are shared at trade shows or in trade journals. They can give owners a feel for their business’s worth and serve as a “sanity check” when evaluating the results of other valuation methods. But they’re no substitute for a professional valuation.

Typically, rules of thumb may be expressed as a multiple of gross revenues, earnings before interest, taxes, depreciation, and amortization (EBITDA) or some other financial measure. But these simplified formulas are based on averages passed along by word-of-mouth, without regard to specific characteristics — such as management strength, location, debt levels, competition, expected growth, and costs — that drive the subject company’s value. They’re basically folklore that’s been collected over time, and they don’t usually stand up to IRS or Tax Court scrutiny.

For example, suppose a rule of thumb for a particular industry is three times EBITDA. Using that formula, two industry participants with $500,000 in EBITDA would each be worth $1.5 million. But what if one of the companies isn’t investing in R&D, advertising its products or maintaining its assets? These shortcuts may temporarily boost EBITDA, but they’re also likely to compromise future earnings and, ultimately, lower its value.

Or what if one business owns its real estate, but the other rents its space? What if one has $1 million of excess working capital on its balance sheet? Blindly applying rules of thumb can also lead to apples-to-oranges comparisons — and erroneous conclusions.

2. Valuation Offers Peace of Mind

When business owners transfer business interests to their loved ones, the IRS generally has three years to challenge the valuation for gift tax purposes. But that period doesn’t begin until an owner “adequately discloses” the gift on a timely filed gift tax return.

To satisfy this requirement, the return must provide various details about the transferred interest, the terms of the transfer and the relationship between transferor and transferee. It must also provide either 1) a detailed description of the method used to value the transferred property, or 2) a qualified appraisal by an independent, qualified appraiser.

Start the clock ticking on the statute of limitations by filing a timely gift tax return that includes a qualified appraisal — even if filing a return isn’t required because, for example, the owner hasn’t exceeded the lifetime gift tax exemption. A qualified appraiser is one who meets certain minimum education and experience requirements or has earned a designation from a recognized professional appraiser organization.

In addition, the IRS requires business owners who donate more than $10,000 in closely held stock to substantiate charitable deductions with a qualified appraisal by a qualified appraiser. For shares valued at more than $500,000, the appraisal report must be attached to the owner’s tax return.

3. A Solid Valuation Lays the Foundation For All Planning

In general, timely valuations are necessary to make informed business and financial decisions. Otherwise, it’s difficult for owners to set a price for their business, forecast retirement income, determine whether their heirs are treated fairly, weigh the potential impact of taxes and explore estate planning options.

Moreover, because value can fluctuate dramatically over time, it’s essential to routinely update business valuations. For more information on valuing your business, contact a business valuation expert.

Limited Time Offer: Expanded Estate Tax Breaks are Only Temporary

For 2018 through 2025, the Tax Cuts and Jobs Act doubled the federal gift and estate tax exemption per individual from $5 million to $10 million, with annual indexing for inflation. For 2019, the inflation-indexed exemption is $11.4 million, or effectively $22.8 million for a married couple.

These doubled limits will expire on December 31, 2025, but they may be reduced sooner if Congress needs revenue to fund expenditures.

The higher exemption provides an opportunity to minimize transfer taxes by gifting business interests or other assets to family members before it expires. But some business owners are concerned that a portion of these gifts may be “clawed back” and hit with estate taxes if the exemption is lower when they die.

In 2018, the IRS issued proposed regulations that would avoid clawbacks by providing that the applicable exemption amount is the greater of:

The exemption amount used to shelter gifts made from 2018 through 2025, or

The exemption amount that’s applicable in the post-2025 year of death.

If the IRS proposal is finalized, a qualified valuation will help maximize the amount of the exemption that’s used up before the expanded exemption limit expires.

Three Reasons to Use Valuation Pros in Estate Planning

for more information

Cheryl has extensive experience working with business owners and individuals on minimizing taxes, with a focus on succession planning. With a thoughtful approach, Cheryl helps clients explore their long-term goals and plan accordingly. Leveraging Cheryl’s expertise in this area, the goal is to implement plans that achieve the wishes of the client and provide for tax efficient transitions. Cheryl’s passion for working with corporations and individuals has allowed her to become a trusted business advisor. She has worked with clients not only in the Western New York region but throughout the country. The breadth of this experience has allowed her to collaborate with other professional advisors to ensure that plans are flexible and innovative in the ever-changing world in which we live. Cheryl started her career with the Firm in 1991 and rejoined in 2019 adding additional strength to the tremendous talent of the Lumsden McCormick tax team. 


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