Valuation Discounts and Estate Planning

Entrepreneurs Face a Challenge in Valuation Discounts and Estate Planning

America is a nation of entrepreneurs. And for many, the equity they’ve established in their businesses represents a substantial portion of their net worth. Unfortunately, owners of closely held businesses face a daunting challenge in the high tax rates of the federal transfer tax system.

In response, estate planning attorneys can take advantage of various valuation discounts to transfer nonvoting stock on a gift and estate tax-advantaged basis.

A common approach is to utilize a discount for lack of control (aka a minority discount). Here, the fair market value of the subject interest is reduced based on the owner’s lack of control over the business (e.g., the ability to direct business policy and/or direct payment of dividends). In theory, this makes nonvoting stock in a corporation less attractive to a hypothetical buyer.

Similar is the discount for lack of marketability (DLOM), which reflects the amount that can be “written down” on the value of the business due to an inability to sell the investment for a specified price.

valuation discountsCase law concerning valuation discounts is constantly changing, and the IRS has consistently attacked valuation discounts applied to interests in limited partnerships and LLCs used primarily for estate planning purposes.

The good news is that in client situations where proper steps are taken to document the underlying transaction, the IRS has been largely unsuccessful in eliminating these valuation discounts. Yet, as Washington struggles with deficit reduction, estate planners should be on the lookout for legislation prohibiting discounts. For example, 2009’s H.R. 436 contained wording to this effect but did not become law.

 Sophisticated estate planning techniques demand sophisticated guidance. Saville’s experienced professionals would be pleased to assist you and your clients.  

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