The Value of a Gift is Different from the Value in an Estate

The Value of a Gift is Different from the Value in an Estate

A part of something is not always worth the proportionate value of the whole. This is particularlythe casewith a closely held business or real estate.

If only part of a business or real estate is being sold or transferred a discount might be necessary to determine its true value.

The reasoning being that the person with a minority interest has less say or no control over the affairs of the business. This includes decisions of officers’ salaries and compensation levels, declaring dividends, and merging, selling or liquidating the company. Accordingly, there is the belief and recognition that a minority interest is not worth its proportionate share of the whole. These discounts vary depending upon the type of business, number of stockholders, restrictions in agreements, lack of voting rights and myriad of other factors that limit the control of a minority owner.

Another reduction in value or discount that might be appropriate is for the lack of marketability of the minority stock, LLC or partnership interest. These downward adjustments reflect the reality that ownership of a non-control portion of a closely held business is not easy to sell. These discounts also vary depending on circumstances. This discount, where applicable, is in addition to the minority interest discount.

Other discounts could also be applicable but these are not as significant as the lack of control and marketability discounts just mentioned.

If someone wishes to sell a minority interest to someone that isn’t a relative or partner, it is his prerogative and that is his right to do no matter how the price is determined. However if the transfer or sale is to a related party, the IRS wants to make sure the transfer was at a reasonable value and that there was no circumventing of gift or estate taxes. And to make things a little more interesting, there are separate methods of valuing the same asset depending upon whether the transfer was a lifetime gift or due to a death.

Lifetime transfers can be valued taking into account adjustments (usually discounts) for minority interests and the difficulty in marketing them. The gifts or transfers are valued based on the value to the recipient of what they received. So, if a 100% owner transfers four 25% interests to each of his four children, each interest can be valued for gift tax purposes taking into account these discounts. So the four 25% interests will be valued somewhat less than the whole.

If that same 100% owner did nothing during his lifetime and left the four 25% shares to his children through a bequest in his will, the value for estate tax purposes would be based on his full 100% ownership without any discounts. The reasoning is that the owner’s estate is taxed on what he owned at the point of death, not what the recipient gets.

This is important for people with businesses and real estate with substantial value that they intend to pass on to their family. Lifetime transfers are valued based on what recipient gets. Death transfers valued based on what decedent owned. This can result in big differences in tax upon death, and could be especially important for illiquid estates. It takes planning to figure out what is the best tax approach. And planning means while you are still able to do something – yourself.