Valuation is a crucial process in determining the fair value or fair market value of an asset or equity. Under federal tax laws, tax valuation encompasses various aspects, including 409a codification, gift and estate tax valuation, purchase price allocation, goodwill accounting valuation, and more. This in-depth article examines the factors that influence estate and gift tax valuations, with a specific focus on U.S.-headquartered entities operating under the Internal Revenue Service (IRS).
Eton Venture Services, as a leading provider of valuation services and advice for private companies and venture capital firms, offers deep expertise in IRS norms for estate and gift tax reporting and compliance.
Our comprehensive, independent, and audit-defensible estate and gift tax valuation services help privately held firms fulfill their regulatory and tax compliance requirements.
The fair value of an asset is estimated, assuming that the price of the asset could be obtained from the sale in an open market. Key considerations embedded in the valuation process include the selection of standardized valuation approaches designed for different purposes, adherence to IRS norms to avoid tax penalties, and the assignment of the asset’s fair worth before starting the valuation process to prevent undervaluation.
Section 2501(a) of the Internal Revenue Code imposes a gift tax for gifts made during the calendar year by individuals. The donor is liable for this tax, which is based, in part, on the aggregate sum of gifts made during the taxable year. Sec. 2502(a), (c). The value of a gift is the fair market value of the property on the date the donor made the gift. Sec. 2512(a). Unless an alternative valuation date is elected, the value of a decedent’s gross estate is the fair market value of the property included in the estate on the date of death. Secs. 2031(a), 2032.
For both estate and gift tax purposes, the fair market value of property is the price a willing buyer would pay a willing seller when neither is acting under compulsion and both have reasonable knowledge of the facts and circumstances. Sec. 20.2031-1(b), Estate Tax Regs.; sec. 25.2512-1; see also United States v. Cartwright, 411 U.S. 546, 551 (1973). After determining the value of the gross property, that value may increase or decrease if premiums or discounts are applicable. Estate of Stevens v. Commissioner, 2000 T.C. Memo. 53, 79 T.C.M. 1519, 2000 Tax Ct. Memo LEXIS 67.
All information material to the valuation that is reasonably probable must considered. Olson v. United States, 292 U.S. 246, 257 (1934) (“Elements affecting value that depend upon events or combinations of occurrences which, while within the realm of possibility, are not fairly shown to be reasonably probable should be excluded from consideration for that would be to allow mere speculation and 49*49 conjecture to become a guide for the ascertainment of value.”)
In addition to these basic tenets of estate and gift tax valuation, several crucial factors play a vital role in designing the valuation process for gift and estate tax, such as:
Minority shareholders in closely held corporations often face limited control over the company’s management and direction due to their non-majority voting share positions. This lack of control can lead to disadvantages for minority owners, such as a reduced value of their ownership interest. Appraisers recognize this challenge and frequently apply a discount for lack of control when valuing minority ownership interests in closely held corporations for estate and gift tax purposes. This discount accounts for the diminished influence minority shareholders possess, ensuring a more accurate reflection of the ownership interest’s true value in the valuation process.
Closely held private corporations lack a readily available market for buying and selling ownership interests, which can make it challenging for owners to find buyers and often necessitates accepting lower prices for their interests. To account for this reduced value due to the lack of marketability, appraisers apply a marketability discount when valuing ownership interests in closely held private corporations. The size of this discount varies, taking into consideration the corporation’s unique circumstances and the specific minority position, resulting in a more accurate and fair valuation.
The degree of control an owner has over an asset plays a significant role in determining its value. As such, the valuation process must consider the rights associated with asset usage, including transferring, selling, or leasing. By factoring in these rights, the valuation more accurately reflects the asset’s true value, accounting for the owner’s ability to exercise control over its disposition and use.
Assets may carry capital gain tax liabilities that critically influence their valuation for gift and estate tax purposes. When an asset is sold or transferred, additional capital taxes apply, making it essential to consider these tax implications when determining the asset’s value. Incorporating capital gain tax liabilities in the valuation process ensures a more accurate and comprehensive assessment of the asset’s value, accounting for the potential tax burden associated with its transfer.
Accurately determining the extent of ownership is vital in the valuation process, as multiple owners with varying interests in the asset can significantly influence its fair value. Evaluating the ownership structure and each owner’s share of interest ensures a more precise and fair valuation, taking into account the influence and control exerted by each owner. By considering the extent of ownership, the valuation process can provide a more comprehensive and accurate representation of the asset’s true value.
While the fundamentals of the valuation process remain consistent across different cases, the scenarios can vary significantly, making it essential to understand each situation to select the appropriate methodology.
At Eton Venture Services, our team of experienced professionals, including CFAs and valuation experts, offer unparalleled valuation services. Our expertise and commitment to excellence make us the preferred choice for private companies, venture capital firms, wealth advisors, founders, business owners, and high-net-worth individuals.
The valuation process for estate and gift tax is a complex and nuanced endeavor that demands expertise in IRS norms, understanding of various factors that impact fair market value calculations, and the ability to select the appropriate valuation methodology based on individual scenarios. As a leading professional services firm, Eton Venture Services is well-equipped to navigate these complexities and provide detailed, insightful, and accurate valuations to help you meet your tax compliance requirements.
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Chris co-founded Eton Venture Services in 2010 to provide mission-critical valuations to venture-based companies. He works closely with each client’s leadership team, board of directors, internal / external counsel, and independent auditor to develop detailed financial models and create accurate, audit-proof valuations.
