The Build Back Better Act, as initially proposed, made significant changes that affected estate planning for high net-worth individuals. The Act proposed a significant reduction in the basic exclusion amount from $11.7 million to approximately $6 million. It also proposed to eliminate the grantor trust rules that estate planners have been using to reduce taxable estates for decades. If this Act had passed in its original form, it would have significantly reduced opportunities to reduce transfer taxes.
However, the Build Back Better Act has been sidelined for now, and the planning environment is still positive for those wishing to take advantage of the current law. That current law is the Tax Cuts and Jobs Act of 2017 (TCJA) however, it expires on January 1, 2026, and is then set to revert back to old law prior to 2017.
The IRS released Revenue Procedure 2021-45 announcing the increase in the 2022 estate, gift, and generation-skipping transfer tax lifetime exemption amount to $12.06 million. Opportunities to take advantage of these historically high exemption amounts still exist.
The closely held business is quite often the most significant asset in a business owner’s estate. Therefore, it is imperative that the business owner and his team of professionals develop gift and estate tax savings strategies.
The standard of value we use for wealth transfer is “fair market value.” This is the price at which the business would change hands between a willing buyer and willing seller, neither being under a compulsion to buy or sell and both having reasonable knowledge of relevant facts. Standard valuation theory for wealth transfer makes us look at what a buyer would be willing to pay for a particular interest. A buyer won’t be willing to pay full price if his percentage of ownership, voting rights and/or control are restricted.
Traditionally, discounts have allowed the closely held business owner to pass along his ownership interests by gift or through estates at lower values.
Marketability Discount
This refers to the discount that can be applied to the business for the lack of an existing market for its stock. Closely held businesses generally have a difficult time finding the right buyer. Basic valuation theory holds that publicly traded stocks can be easily traded on the open market, but a family-owned business is not as quick to buy or sell. There may also be transfer restrictions placed on the stock by the family.
Lack of Control/Minority Share Discount
Lack of control reflects a reduction in share value due to a potential buyer’s lack of ability to exercise control over the company. These shares are considered less valuable that a controlling interest because business decisions like setting policies, compensation or deciding to sell or liquidate are out of the shareholder’s hands.
Minority shares may be considered less in value because their power is limited to vote, participate in management, or transfer or sell their ownership interest.
Determining the Discount
A qualified business appraiser or skilled valuation analyst can determine an appropriate discount based on many different factors such as asset composition, size of the interest being transferred and restrictions in shareholder and operating agreements.
These discounts have a wide range based on several factors, usually between 10 and 45 percent. Estate planning is proactive not reactive. Strategic planning today can save significant tax dollars in future estates.
Some Final Thoughts
The TCJA doubled the estate tax exemption. However, this expanded exemption has a sunset provision, which means it will revert back to the 2017 exclusion amount in 2026. The IRS has clarified its position that making large gifts of business interests or other appreciating assets now won’t harm estates after 2025. This is a volatile time for the economy and market values are dropping rapidly, making it an advantageous time to gift. Councilor, Buchanan & Mitchell has experienced staff in both business valuations and estate planning available to assist you in moving ahead.
