By Dwight Buracker, CPA, CVA
This article addresses the following for business owners:
- The expiring high estate tax exemption
- Gift-giving considerations, including:
- For business valuation purposes, what qualifies an appraiser in the eyes of the IRS?
- Is sooner better than later to transfer business interests?
- Choosing a date for the valuation
- Should tax-affecting be considered in the valuation of a pass-through entity?
Sunset of the High Lifetime Exemption
The current $12.92 million per-person lifetime exemption is set to expire in 2025 and the exemption will revert to 2017 levels. After adjusting for inflation, the exemption is estimated to be half of what it is now — less than $7 million for individuals and less than $14 million for married couples.
Gift-Giving Considerations for Business Owners
Many financial planners plan to increase gifting efforts now rather than wait. This is especially pertinent for successful business owners and the IRS recognizes this fact.
Engaging a Qualified Appraiser
As lifetime gifting by business owners surges to minimize estate/transfer taxes, complying with strict standards is made easier by engaging “qualified” professionals to conduct an independent valuation of the business.
When the assets being transferred are business interests, tax examiners will likely enforce standards set by Revenue Ruling 59-60. However, when the appraiser is duly “qualified” in the eyes of the IRS, the business valuation will be considered more legitimate and reliable.
- Engaging a Qualified Appraiser. In Sec. §1.170A-17, the IRS outlines requirements for what the IRS deems a “qualified appraiser” for gift and estate tax reporting. Although quite strict, these requirements will be helpful to satisfy Rev. Rul. 59-60 for business valuations:
- The appraiser holds themselves out to the public as an appraiser who performs appraisals on a regular basis.
- Details in the report must include reference to the appraiser’s background, experience, education, and membership, if any, in professional appraisal associations.
- The appraiser is not the donor or the donee of the property or a related party therein.
- Providing Adequate Disclosure. Instructions for the gift tax return include another simpler option to ensure the appraisal qualifies. This can be done by attaching a return “adequate disclosure” in connection with (a) the assets being transferred and (b) the qualifications of appraisers.
Timing of Transferring Business Interests to Family Members
Knowing when to transfer business interests can be challenging.
Business owners who feel their estate isn’t sizable enough to trigger federal estate tax can be tempted to ignore lifetime gifting altogether. After all, shifting a large amount of wealth out of reach can be unsettling. Strategies such as basis step-up, upon the business owner’s death, could result in significant tax savings for future generations.
Some business owners take a “use-it-or-lose-it” approach for estate planning purposes. In certain cases, there is nothing to be gained and too much to be lost by waiting to transfer business interests — especially while the current estate tax exemption still exists.
How to Value Pass-Through Entities for Gift/Estate Purposes
When valuing a business for gift/estate purposes, two additional considerations include timing of the valuation and tax affecting.
- Timing of the valuation. The IRS prefers using a precise date for determining the value of a business when gifting is involved. The valuation should be representative of any and all facts and circumstances that might have existed at the time. In today’s economic and political climate, historic valuations can appear distorted.
- Tax affecting. ‘Tax affecting’ is a valuation approach that applies a hypothetical entity-level tax to a pass-through entity’s taxable income, which reduces the value of the business. Some business owners wonder if tax-affecting should be considered in the valuation of a pass-through entity. Tax affecting is a complicated issue. In 1999, the Tax Court in Gross v. Commissioner answered no because pass-through entities are not directly liable for the taxes on income. But others argue that a ”zero tax rate” will unnecessarily inflate the value of the business.
Developing justification — like corroborating evidence, projections, testimonies, tax benefits, etc. — is important. Emerging in a few landmark cases is evidence that tax-affecting, in general, will likely be permitted when it is the best available option. For example, Estate of Aaron U. Jones v. Commissioner in 2019 indicates that experts agree tax affecting should be considered.
Rev. Proc. 2022-32: Expanded Portability
Issued in 2022, this revenue procedure addresses a tax-saving opportunity called “portability” that is sometimes overlooked by estates and/or fiduciaries. Portability enables a surviving spouse to preserve their deceased spouse’s lifetime exemption from estate and gift tax.
Although Rev. Proc. 2022-32 addressed surviving-spouse taxpayers, many estate planners recognized that making lifetime gifts now, before the high estate tax exemption expires, could result in significant tax savings. If those gifts include an interest in a family business, the appraiser will need to take extra steps to accurately arrive at the historic value for a specific, earlier date.
Prior to the procedure, portability allowed a married taxpayer to preserve a deceased spouse’s (unused) lifetime exemption. To make this possible, the surviving spouse needed only to file a Form 706, United States Estate (and Generation-Skipping Transfer) tax return. The filing could be as late as two years after the spouse’s death.
Rev. Proc. 2022-32 makes even more relief available for the surviving spouse, who now has up to five years from the anniversary of their spouse’s death to make this special election.
Unless Congress makes an unexpected move, most people will see their lifetime estate exemption fall to less than $6.5 million in 2026. If your estate’s value could surpass this amount in your lifetime, learn more about conducting a business valuation with a qualified appraiser.
Contact us today to learn about new guidelines that might justify a lower and more favorable valuation for tax reporting purposes.