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COVID-19 Estate Planning Considerations

The COVID-19 pandemic has created a global economic slowdown and uncertainty on future prospects. As everyone is aware, this has caused a precipitous drop in the value of publicly-traded equities.

The uncertainty regarding the achievement of future cash flows, the ability to service debt, and, in some instances, even the survival of select industries, has caused a swift decline for many publicly-traded equities.

However, this tragic situation presents opportunities for prudent action. For executors of estates and those either contemplating or executing estate planning, now may be a time to consider taking action.

Estate Tax

First, executors of estates for individuals who passed away approximately six months ago should consider electing to value the estate’s assets as of the alternate election date. IRC 26 U.S. Code § 2032. Alternate valuation allows the fair market value of the gross estate, for assets not distributed, sold, exchanged, or otherwise disposed of, within six months after the decedent’s death, to be determined as of the date six months after the decedent’s death.

For example, an estate related to an individual, with a date of death on September 20, 2019, who held multiple real estate partnership interests may be a good candidate for the alternate election date. It is possible the fair market value of the underlying property has decreased from September 20, 2019, to March 20, 2020. This example is likely to be true as well for estates which held ownership interests in going concern businesses. Ultimately, the use of the alternate election date could result in a lower estate tax burden.

Gift Tax

Currently, federal regulations allow an individual lifetime gift exemption of $11.58 million with an annual gift tax exclusion of $15,000. Therefore, at a time when equity valuations have been lowered across sectors, it may be possible to transfer a greater interest in a closely-held corporation or family limited liability corporation while eliminating or lowering gift tax.

To illustrate, On December 31, 2019, ABC, Family Limited Liability Corporation (FLLC) held marketable securities with a value of $100 million and no debt, so that total equity was also $100 million.

On December 31, 2019, the maximum interest which could be transferred under the exemption was 11.58% without the consideration of discounts for lack of control and marketability. On March 24, 2020, the marketable securities owned by ABC had decreased by 25%.

For questions or more information on estate planning, please contact a member of Withum’s Forensic and Valuation Services Group.

As a result of changes in the market, ABC, FLLC’s marketable securities had a market value of $75 million. The reduction in market value would allow a maximum transfer of a 15.4% ownership interest, approximately a 4% increase from December 31, 2019, while still being under the lifetime gift exemption of $11.58 million.

The above example does not consider the effects of discounting. Under the fair market value standard, minority interest is subject to discounts for the lack of control and lack of marketability where applicable. Typically, the discount for lack of control is supported by price to net asset value discounts in publicly-traded closed-end funds. As this discount increases, the percentage interest which can be transferred while remaining under the exemption increases. The current market conditions increased these prices to net asset value discounts. For example, Liberty All-Star Equity closed-end fund is now trading at a price to net asset value discount of 15.55% whereas its historical discount was 10.95%.

The above factors all allow a greater transfer of wealth to the next generation while remaining below the lifetime exemption of $11.58 million.

Of note to the owners of closely-held businesses, the severe decline in valuations in the public markets may be even greater for closely-held businesses because of the greater degree of risk associated with privately-held businesses even in normal times. This fact has been true even within the public markets. While SPY ETF, which tracks the S&P 500, is down approximately 25% year to date, VBR, a Vanguard ETF which tracks small cap stocks has decreased approximately 40% over the same period. Smaller less diversified companies are generally just riskier, and, therefore, less valuable.

Many of our valuation assignments pertain to the gifting of business interests in conjunction with an overall estate plan. Often, family-owned corporation and partnership ownership interests are transferred to the next generation. The transfer of such interests must be completed at fair market value, supported by a business valuation. If you are considering making gifts of a minority interest in a privately-held business, a valuation as of today would likely support a lower value than one performed as of December 31, 2019. This would provide an opportunity for you to transfer a greater ownership interest than you could have earlier or later when markets hopefully return to normal.

Planning Opportunities

While COVID-19 has disrupted many individuals and businesses it has created an opportunity for those performing estate planning to reduce its ultimate tax liability. If you have any questions regarding how COVID-19 has impacted the value of your business or how to improve your estate planning efforts we are happy to discuss.

Forensic and Valuation Services

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