Estate Planning for Proposed Tax Changes: An Assessment Guide for Private Businesses


Federal estate tax laws have changed dramatically in recent years. Under the Tax Reductions and Employment Act 2017 (TCJA), the amount of the exemption for taxable estates has been doubled from $ 5 million to $ 10 million, indexed to the ‘inflation. In 2021, the exemption is $ 11.7 million per person. Originally, the termination of the TCJA allowed the exemption to be reduced to a limit of $ 5 million in 2026. The increase in the exemption allowed more wealth to be transferred to heirs before any taxation.

However, during his presidential campaign, Joe Biden proposed reducing the estate tax exemption to $ 3.5 million as well as increasing the rates of the estate tax itself. If adopted, these proposals will significantly increase the level of inheritance tax. The proposed changes could be adopted, perhaps as early as this year. As such, many people, especially small business owners, have an interest in planning their succession under the current TCJA arrangements rather than waiting for the TCJA provisions to expire or the proposals for succession. the Biden administration be enacted.

Additionally, in addition to the timing of reducing exemptions, wealthy individuals may benefit from the economic uncertainty caused by the global pandemic. The economic impact resulting from the pandemic has affected us all, but not all in the same way. While public markets have performed well during the pandemic, many private companies have been negatively affected. The return to normal is much more uncertain for these companies, increasing their risk.

Risk is the exposure that the owner of an interest in a business expects from the future returns of the business. Increased risk creates a demand for higher returns to offset the risk, which in turn can lower the valuations of these companies. Lower valuations in the current economic climate are useful for proper estate planning for high net worth individuals, as these valuations may be locked in under the provisions of the TCJA before hopefully reverting to more “normal” valuations in the future. coming years.

Business valuations for federal gift and estate tax purposes generally follow IRS provisions Income Decision 59-60. The factors listed in Rev. Rul. 59-60 include:

  1. The nature of the business and the history of the business since its inception.
  2. The general economic outlook and the condition and outlook for the specific industry.
  3. The book value of the inventory and the financial condition of the business.
  4. The earning capacity of the company.
  5. The ability to pay dividends.
  6. Whether the business has goodwill or some other intangible value.
  7. Size of the stock block to be valuated.
  8. If the stock is actively traded in a free and open market, whether on the stock exchange or over-the-counter.

Several current economic issues impact valuations. The current economic environment may be advantageous for private business owners and their estate planning in that lower valuations may increase current estate planning opportunities, and perhaps even more so if the Biden administration’s proposals are adopted.

Assessment at its most basic level consists of three elements: cash flow, risk and growth. There are many valuation techniques that make assumptions about these three things. The current economic environment created by the pandemic has a considerable impact on the three components of private business. For example, lower levels of business activity can reduce the cash flow generated by the business. Uncertainty about the long-term economic consequences of the pandemic can increase the risk of investing in the business. Business growth can differ significantly by industry sector.

Typically, estate planning that involves a private business involves the transfer of only a portion of the business’s equity. The interest in the transferred business is usually a minority and non-negotiable interest, which means that a particular interest does not have ultimate control over the management of the business, nor is it easily salable to another party. Both factors can increase the risk for the person transferring the stake in the business, lowering the prorated valuation of that stake. The lower valuation allows a higher percentage of the business to be included in estate planning below the current level of inheritance tax exemption.

As an example, suppose John Smith owns 100% of the company, whose equity is valued at $ 20 million. As part of his estate plan, Smith plans to transfer three 25% interests to three separate trusts for the benefit of each of his children. Assuming that the 25% interest is incapable of “controlling” the business and is not easily negotiable, each interest has a fair market value well below the $ 5 million prorated valuation of 25% of the business. whole entity due to the increased risk of lack of control and marketing. Conversely, if Mr. Smith were to transfer all of the 75% interest rather than three 25% interests, the facts and circumstances might indicate that the 75% are in control and are more readily negotiable, so their fair market value can be proportional.

The difference between minority and non-negotiable interests and prorated value is also affected by the current economic environment. Analysts have noted a reduction in M&A activity as sellers who can wait to sell on better economic terms do so. Reducing market activity can further increase the risk perceived by a holder of non-negotiable interests, thereby lowering the valuation of those interests.

High net worth individuals, who own private businesses and wish to maximize their inheritance tax exemptions, may have a shortened window of opportunity due to proposals to change the level of exemptions. In addition, valuations are expected to increase as economies emerge from the current conditions caused by the global pandemic. Now is a great time to check with your tax advisor about these changes and their potential impact.

This column does not necessarily reflect the opinion of the Office of National Affairs, Inc. or its owners.

Author Info

Mark L. Zyla CPA / ABV, CFA, ASA is Managing Director of Zyla Valuation Advisors, LLC, a valuation and litigation consulting firm based in Atlanta, Georgia. He can be contacted by e-mail at [email protected].

Bloomberg Tax Insights articles are written by seasoned practitioners, academics, and policy experts who discuss current tax developments and issues. To contribute, please contact us at [email protected].

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