Valuation Discounts for Estate and Gift Taxes

There's a lot on the line in determining the fair value of an interest in a closely held entity for estate and gift tax purposes. Here are some pointers.

July 2009
by Justin Ransome and Vinu Satchit/Journal of Accountancy

One purpose of fixing a value on an interest in a closely held business is to determine gift and estate tax liability. CPAs called upon to provide such valuations know that this can be a painstaking task. It is not an exact science but an educated estimate when, as often is the case, there is no identifiable market for the interest. This uncertainty can cause unintended gift or estate tax consequences for transfers between related parties during the transferor's life and at death.

The difference between what a person transferring an interest in a business believes is its fair value and any higher amount the IRS determines is its fair value can result in a greater gift tax liability. Likewise, a redetermination by the IRS of the value of such interests held in an estate can spell an underpayment of estate tax. Fortunately for CPA valuation analysts, there are methods that, while not always yielding uniformly accepted results, are recognized by taxing authorities and courts as providing a valid basis for those estimates. In applying those methods, however, CPAs must take stock of recent court decisions for guidance. This article gives an overview of valuation principles for gift and estate tax purposes, reviews some current trends in determining value for such purposes, and makes suggestions for seeking a qualified appraiser.

Willing-Buyer/Willing-Seller Test

For gift and estate tax purposes, the value of property transferred to another party is measured on the date of the transfer as "the price at which the property would change hands between a [hypothetical] willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts" (the "willing-buyer, willing-seller test," Treas. Reg. § 20.2031-1(b)).

This article has been excerpted from the Journal of Accountancy. View the full article here.