For many families, their ownership stake in a privately held business represents the most valuable asset in their estate. Valuing this ownership interest for estate planning or transfer tax purposes can be complex, requiring careful consideration of numerous factors. Any valuation report, whether prepared for estate tax filing or gift purposes, is subject to IRS scrutiny and must meet the stringent criteria of a “qualified appraisal.”    

Furthermore, thorough consideration must be given to the factors outlined in the Treasury Regulations and Revenue Ruling 59-60. The accounting firm Eisenamper wrote a helpful article about this subject. The choice of valuation methodology will depend on each case’s specific facts and circumstances. Generally, the following approaches will be evaluated: 

• income approach
• market approach 
• asset approach

Depending on the degree of ownership interest, various discounts and issues must be accounted for, such as “key person” and non-competition agreements, built-in capital gains, minority versus majority ownership, and the marketability of the ownership block being valued. 

When it comes to estate and gift tax planning, a proactive approach is far more effective than a reactive one  

To capitalize on the current tax laws, individuals and planners need to focus on leveraging today’s favorable tax treatment—rather than reacting to proposed changes. Over the past few years, Congress has been a whirlwind of activity, with numerous proposals and counter-proposals aimed at significantly altering the current tax code for estate and gift tax planning. In 2021 alone, legislation passed the House before ultimately being voted down by the Senate.

This underscores the importance of proactive planning that takes advantage of the existing favorable tax landscape, as opposed to reactively scrambling in response to potential future changes. By being proactive, individuals can strategically position themselves to maximize the benefits of the current tax laws.

As we enter the election year of 2024, the Congressional activity surrounding tax code changes has subsided. However, the threat of legislative changes has been replaced by the impending, mandated sunset of the Tax Cuts and Jobs Act of 2017 (TCJA) provisions on January 1, 2026. On this date, many tax provisions will revert to their pre-TCJA state. Notably, the estate and gift tax annual exemption will drop by approximately 50% from its current levels of $13.61 million per individual/$27.22 million per married couple as of 2024.

This change will have a significant impact on family business owners and high-net-worth individuals. If you fall into one of these categories, you will lose the ability to transfer substantial portions of your assets by utilizing current estate and gift tax planning options and taking advantage of the current annual exclusion limits. With these upcoming changes on the horizon, now is the time to begin planning and executing your estate and gift tax strategies for 2024 and 2025.

The window of opportunity to leverage the current favorable tax landscape is closing. Proactive planning in the remaining months before the TCJA provisions sunset is crucial for maximizing the benefits of the existing laws and minimizing the potential impact of the looming changes.

One of the most prevalent strategies for mitigating potential estate taxes is for business owners to gift some or all of their company’s ownership to their children or other family members during their lifetime. This gifting under the current law facilitates the transfer of ownership from one generation to the next. In doing so, business valuators can apply allowable discounts, often resulting in a substantial reduction in the value of the interest being gifted or valued for estate and gift tax purposes.

The following are a couple of the commonly utilized discounts when determining values for gifting purposes:

Discount for Lack of Control

Non-controlling ownership interests lack the ability to unilaterally control the management of operations or investments, demand payment of dividends or distributions, or liquidate assets to realize a return on investment. As a non-controlling owner, they are reliant on the decisions made by the controlling owner to generate a return on their investment, whether through dividends, distributions, or appreciation in the value of their ownership stake.

The lack of direct control over key operational and financial decisions creates a inherent disadvantage for non-controlling owners, warranting a discount to account for this diminished ability to influence the factors that drive returns on their investment.    

Discount for Lack of Marketability

A fundamental principle in investment analysis is that investors value liquidity, which refers to the ease and speed with which an investment can be converted into cash at the investor’s discretion. In the U.S. public securities market, investors can sell an actively traded security over the phone or internet within seconds at a known price, with minimal transaction costs, and receive cash within three business days. In contrast, an investor in a closely held company may not have the ability to convert their investment into cash as quickly and easily and will demand a price discount to compensate for this lack of liquidity (commonly referred to as a discount for lack of marketability).

Currently, there is a favorable environment for estate and gift tax planning. However, now is the opportune time to discuss strategies for wealth transfer with an advisor by leveraging the current tax code. With the historically high annual exclusion and allowable discounts for lack of control and lack of marketability, planning today can result in significant tax savings on future estate taxes.

Somethings to Consider Before Heightened Exemptions are Reduced on January 1, 2026      

Before the anticipated sunset of specific estate planning and gifting provisions at the end of 2025, individuals can leverage the higher exemption amounts currently in place. Significant benefits can be realized by taking action now and planning for the upcoming sunset, especially for single individuals with an anticipated gross estate exceeding $7 million and married couples with a combined anticipated gross estate surpassing $14 million. Some techniques worth considering include:  

Spousal Lifetime Access Trust (SLAT)

A SLAT allows a spouse to transfer assets (up to the current estate and gift tax exemption of $13.61 million in 2024) to a trust for their spouse’s benefit. Here’s what this means for you:

• Reduce Your Taxable Estate: Assets placed in the SLAT are generally excluded from your estate, potentially saving on estate taxes.
• Maintain Access for Your Spouse: The beneficiary spouse can still receive income and potentially principal from the trust.
• Appreciation Benefits the Trust: Any growth in the value of the transferred assets benefits the trust, not your taxable estate.

IDGT: Reduce Your Estate While Keeping Benefits for Heirs

An Intentionally Defective Grantor Trust (IDGT) allows you to transfer assets and potentially strategically reduce your estate tax burden. Here’s how it works:

• Transfer Assets with a Sale:  You initially gift a small portion of the asset to the trust, then “sell” the remaining asset to the trust in exchange for a promissory note with a low interest rate.
• Reduce Estate Taxes: Assets placed in the IDGT are generally excluded from your estate, potentially saving on estate taxes.
• Maintain Control (for Tax Purposes): While the assets are in the trust, you (the grantor) still pay taxes on their income. This avoids higher trust tax rates and keeps more money within the trust for your beneficiaries.
• Flexibility in a Changing Tax Landscape: If estate tax exemptions decrease, you can potentially “pay off” a portion of the promissory note using your remaining exemption, effectively transferring more assets to the trust tax-free.
• Long-Term Benefits for Heirs: The IDGT can be structured to benefit multiple generations without incurring additional taxes as assets pass down (often called a Dynasty Trust).
• Asset Protection:  Assets in the trust may be shielded from creditors, including a beneficiary’s spouse in a divorce.   

Gifts to Family Members 

While advanced strategies like those mentioned earlier can be effective, don’t overlook the power of more straightforward gift-giving options:

• Direct Transfers: Gift assets like cash, stocks, or even real estate directly to your loved ones.
• Gifts to Trusts: Establish irrevocable trusts for their benefit, potentially offering some asset protection and control over future distributions.
• Forgiving Loans: If you’ve loaned money to family members, consider forgiving the debt as a form of wealth transfer.      

Conclusion 

The window of opportunity to capitalize on the higher exemption levels is rapidly closing, with less than two years remaining until the scheduled sunset. While this may seem like ample time, the deadline will arrive sooner than expected. Now is the moment to initiate conversations about tax-saving strategies tailored to your unique circumstances.

If you are considering lifetime gifts, we encourage you to discuss the potential opportunities and implications with our team. We can provide valuable insights into the tax consequences, assess a beneficiary’s readiness to responsibly manage your assets, and ensure that your standard of living is maintained after making substantial gifts.

Proactive planning is paramount in this context. By engaging in these discussions now, you can position yourself to make well-informed decisions and execute strategies that maximize the benefits of the current exemption levels before the impending sunset.