[Note: The paragraphs below provide a simplified overview of the US estate and gift taxes. There are several complexities to the tax law that are beyond the scope of this posting.]

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Sometimes valuation is a necessity; sometimes it’s an opportunity. The estate tax is a federal tax on the transfer of the estate of deceased person. It is also referred to by some as the “death tax.” For all estates that exceed the (ever-changing) exemption, a 40% (as of 2022) tax on the excess value above the exemption tax must be paid. A value for all assets in the estate is therefore required to determine the tax liability or lack thereof.

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Understanding the inevitabilities of death, taxes, and the death tax, estate tax planning is used to reduce potential payments to the IRS. Two common estate planning techniques involve the formation of a family limited partnership (FLP) or a family limited liability company (FLLC). Wealthy individuals form these entities and then contribute cash, marketable securities, and real estate to them. The contributors then gift interests in the entities during their lifetime to their children.

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The IRS requires the gifting taxpayers to report any gifts above the annual exclusion amount ($16,000 for individuals and $32,000 for married couples as of 2022) by filing a gift tax return (Form 709) that is due on April 15 of the following year the gifts are made. The interests or units in FLPs or FLLCs are to be gifted at their “fair market value,” which is defined by the IRS as is the price an unrelated buyer and seller would reach, not the price that the actual owner would accept or the price the actual recipient would be willing to pay. Unrelated parties are loath to purchase investment positions they can’t easily control or quickly convert to cash. To account for these unfavorable features of minority interests in private entities, investors typically demand discounts when purchasing them. The application of these discounts when valuing these fractional interests can result in substantial tax savings for the transferring parties.

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Because of the application of valuation discounts opined by appraisers, a $100 million business may be transferred fractionally, over time, at a cumulative value of less than $100 million. This strategy can create substantial tax savings. Rumors have circulated for years that Congress would legislate out of existence discounts for FLPs and FLLCs, but they remain available as of 2022. Mercovus can help value fractional interests and determine the discounts applicable to them. If you need a valuation report that can withstand the highest level of IRS scrutiny, contact us at info@mercovus.com.