By Kevin Cannon
Here are five things to remember when valuing shares in a closely held corporation for gift and estate tax reporting.
Changes in political leadership, such as those that have taken place at federal level in recent months, repeatedly lead to questions about possible changes in tax law. Although taxation of personal and corporate income typically receives the most media attention, it’s important to remember that gift and inheritance taxes can also have a profound impact on an individual’s long-term financial planning. When an individual has an interest in a closely held company, the valuation of that company for gift and estate tax reporting purposes should be carefully considered and how that valuation affects their tax liability.
When evaluating shares in a closely held company for gift and estate tax purposes, it is important to consider the following five factors:
1. Valuations for gift and estate tax purposes must follow the principles set forth in IRS Revenue Ruling 59-60. Revenue Ruling 59-60, first published in 1959, outlines the approaches, methods, and factors to consider when valuing shares in a closely held company when market quotations are either unavailable or based on tight trades. The factors to consider under Revenue Ruling 59-60 are as follows:
- The nature of the business and the history of the company from its inception.
- The general economic outlook and the state and prospects of the specific industry.
- The book value of the stock and the financial position of the company.
- The profitability of the company.
- The ability to pay dividends.
- Whether or not the business has goodwill or other intangible assets.
- Turnover of the share and size of the block of shares to be valued.
- The market price of stocks of companies operating in the same or a similar industry and whose stocks are actively traded in an open and open market, either on a stock exchange or over the counter.
2. In the case of tax reports, great importance is attached to the quality of the narrative report. This report should detail the approaches and assumptions used and explain how each of the factors described above has been accounted for under Revenue Ruling 59-60.
3. Various valuation approaches should be considered when valuing closely held companies, including a discounted earnings analysis via discounted cash flows and the market approach via benchmarks for listed companies and/or benchmarks for transaction multiples.
4. Discounts applied in estimating the fair value of the relevant investment, which could constitute a discount for lack of marketability or a discount for lack of control, should be based on the facts and circumstances of the entity being valued and its size and the block of shares being valued. Such discounts should be based on market related data.
5. The process of evaluating closely held entities for gift and estate tax reporting purposes is not a standard practice for all cases. Great care and thought should be given to the analysis, both quantitatively and qualitatively. Each company is different, and even within each company, different classes and blocks of shares have different characteristics.
As more attention is paid to potential changes in gift and inheritance tax laws, so too will assessments of closely held gift and inheritance tax reporting companies. Individuals requiring reviews for this purpose should be prepared with defensible, verifiable analysis that can stand up to IRS scrutiny.
Kevin Cannon is a Director in Opportune LLP’s valuations practice, based in Houston. He has over 16 years of experience in conducting business and asset valuations and providing corporate finance advice. His particular experience includes evaluating corporate and intangible assets for purchase price allocation, impairment, tax planning and portfolio valuations for companies in a variety of industries including oil and gas, oilfield services and industrial manufacturing.