Estate and Gift Tax
When shares are held at death or gifted to the next generation, it is a potentially taxable event.
If the business interest is privately held and there is no clear market for the interest, a valuation performed by an independent appraiser is required by the IRS to determine whether the interest is above or below taxing thresholds. In Oregon, the taxing threshold for estate tax is a fraction of what it is for Federal purposes.
For estate and gift tax purposes, the IRS requires the property to be valued using the fair market value standard. This is also known as the “willing-buyer, willing-seller test” (Treas. Reg. § 20.2031-1(b)). The fair market value is 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.
To arrive at fair market value, it is widely accepted that two discounts should be considered:
Discount for lack of control
Discount for lack of marketability
The discount for lack of control reflects the absence of some, or all, of the powers of control. For example, if a business was valued using the asset approach, a minority owner would not have the control to sell the assets and convert them to cash. The discount for lack of control recognizes that a hypothetical buyer would not pay the full value for a partial ownership because they may have trouble unlocking the value of the assets purchased.
The discount for lack of marketability reflects the relative absence of marketability or liquidity. There is no marketplace to quickly sell a private business interest and convert it to cash. A primary concern driving the price reduction is that, over the uncertain time frame required to complete the sale, the final sale price becomes less certain and with it a decline in value is quite possible. Accordingly, a prudent buyer would want a discount for acquiring such an interest to protect against value loss in a future sale scenario. 1
The IRS and the Department of Labor (DOL) require that the appraisal of privately held shares for transfer and other tax related purposes be a “qualified appraisal” by a “qualified appraiser.” We are that qualified appraiser, and we have experience putting together credible, IRS compliant valuations for operating companies, single-asset LLCs, and complex multi-tiered asset holding companies.
On a recent valuation, our client was audited by the IRS for an estate tax return filed six years prior. Our client did not have a formal valuation of the ownership interest prepared at the time of death. We performed a valuation as of the date of death six years prior which we knew would be subject to IRS scrutiny. The IRS Revenue Officer came back without any comments on the discount for lack of marketability.
If you need a valuation for estate or gift tax reporting, contact Cogence Group to provide a credible, IRS compliant valuation with appropriate discounting.