Jan 03, 2024

Maximizing Legacies: Navigating Business Valuations for Estate and Gift Tax Purposes

Written by Dalton Hopper, CFE, CVA

As part of the 2017 Tax Cuts and Jobs Act, the gift and estate lifetime exclusion amount was raised and is currently set to sunset at the end of 2025. Consequently, many individuals are leveraging the increased exclusion amount by making gifts to remove assets from their estate. One commonly gifted asset includes ownership in a privately held business. Gifting ownership in a privately held business comes with several advantages, along with challenges that need to be addressed to fully benefit from this tax planning strategy.

One essential requirement when making a gift, whether to a charitable organization, an individual, or a trust, is assigning a dollar value to the gift. While determining the value of cash or publicly traded stock is straightforward, assessing the value of a privately held business or a share of one requires a business valuation. This appraisal not only attests to the business’s value but also serves as a strategic tool for managing tax liabilities. The IRS mandates that a “qualified appraisal” by a “qualified appraiser” value the business, or business interest, so the value can be determined and disclosed. This article explores what constitutes a qualified appraisal, who is considered a qualified appraiser, and what requirements must be met when conducting the valuation.

What is a qualified appraisal?

First, let’s clarify what the IRS means by a “qualified appraisal.” A qualified appraisal is a document prepared by a qualified appraiser following appraisal standards. Crucial components of a qualified appraisal include a description of the business, the effective date of the valuation, an explanation of the methodology for valuing the business, and the fair market value of the business, or business interest. According to this definition of a qualified appraisal, several conditions must be met.

  • First, the qualified appraisal is a document or a valuation report. Therefore, an oral opinion will not suffice. The report should be detailed enough so that the IRS can understand how the valuation expert arrived at his or her conclusion.
  • Secondly, the appraisal must be completed by a qualified appraiser (more on that later). This means that not everyone will meet this definition, and a qualified appraisal by someone other than a qualified appraiser, will not qualify.
  • Finally, the qualified appraisal must meet appraisal standards, which requires an understanding of the various applicable standards. In the case of valuing a closely held business, it must meet the requirements of IRS Revenue Ruling 59-60.

Who is a qualified appraiser?

The IRS places a premium on the independence and expertise of the appraiser. A qualified appraiser for estate and gift tax purposes should possess a combination of education, experience, and professional designations. This ensures an unbiased assessment that accurately reflects the fair market value of the business, a critical parameter in estate and gift tax calculations. A “qualified appraiser” is a valuation expert who is independent and has verifiable education and experience in valuing businesses.

  • Education and Experience: The appraiser should have relevant education and experience in valuing the type of property being appraised. The appraiser should also demonstrate expertise in the specific area of valuation and communicate their expertise in the report.
  • Professional Designations: The IRS recognizes certain professional designations that indicate an appraiser’s expertise. At BMSS, our valuation professionals have obtained the Certified Valuation Analyst certification.
  • Independence: The appraiser must be independent, without any financial interest in the property being appraised, and should also follow the applicable professional standards. Adhering to these standards helps ensure the integrity and reliability of the appraisal.

What should the valuation include?

In addition to following professional standards, a valuation of a closely held business should include several factors, including those outlined in Revenue Ruling 59-60. Revenue Ruling 59-60 outlines the approach, methods, and factors to be considered in valuing shares of closely held corporations. The ruling applies to valuations performed for estate and gift tax purposes for the valuation of closely held stock. While the IRS does not mandate specific methods that must be used when valuing assets for tax purposes, there are several factors that must be considered, including:

  • The nature of the business and the history of the business,
  • The economic outlook and outlook of the industry,
  • The book value and financial condition of the business,
  • The earning capacity of the company,
  • The dividend-paying capacity,
  • Whether or not the enterprise has goodwill or other intangible value,
  • Previous sales of the company’s stock and the size of the block of stock to be valued, and
  • The market price of stocks of similar companies that are freely and openly traded.

Navigating the terrain of business valuations for estate and gift tax purposes is a strategic maneuver for those seeking to preserve wealth and maximize legacies. By engaging a qualified appraiser that adheres to the guidelines set by IRS Revenue Ruling 59-60, taxpayers not only fulfill their tax obligations, but also lay the groundwork for a robust estate and gift tax planning strategy. In the realm of wealth preservation, a well-executed business valuation is not just a compliance necessity; it’s a pivotal step toward securing a lasting financial legacy.

If you would like more information or if you would like to discuss your unique situation with the BMSS Business Valuation team, please contact Dalton Hopper, CVA, CFE at (256) 952-1924 or dhopper@bmss.com.