Gift Tax Valuation
The issue of gift tax valuation may seem complicated but it doesn’t have to be. This page provides you an introduction to gift tax, IRS Form 709, and valuation for gift tax purposes – particularly in the case of gifting shares in privately-owned businesses.
Overview of the Gift Tax
The IRS definition of the gift tax is ‘a tax on the transfer of property by one individual to another while receiving nothing (or less than full value) in return.’ You make a gift if you give property (including money) without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.
Gifts that do not qualify for an exemption (see IRS gift tax rules) require completing IRS Form 709. Current tax law permits anyone to make gifts up to $13,000 a year to anyone without owing taxes on the gift. Furthermore, in 2011 and 2012 anyone can make gifts totaling up to $5 million ($10 million for married couples) without owing gift taxes.
Thus, for a brief period, a tremendous window of opportunity exists to make large gifts now because the ‘unified credit’ amount drops back to $1 million starting in 2013.
Gift Tax Valuation: Limitations You Need to Know
To begin running the statute of limitations on a gift, you need adequate disclosure of the value of the gift. Cash, stocks and bonds, mutual funds, even houses and cars are easily valued. But things like ownership interests in privately owned businesses, investments in oil or gas wells and artwork are hard to value.
In order to account for this issue, the IRS requests a gift valuation. “[A] gift will be considered adequately disclosed,” says the IRS, “if the return or statement provides the following…[e]ither a qualified appraisal or a detailed description of the method used to determine the fair market value of the gift.” 1
Hard-to-Value Assets (Sundry Assets)
Studies show the wealthier you are, the more likely you are to own hard-to-value assets. For example an IRS analysis of estate tax returns filed in 1993 found sundry assets represented only 9% of small estates worth under $1 million. Conversely they represented 31% of large estates worth $10 million or more. In fact for wealthy Americans, sundry assets represented more of their net worth than any other single asset class.
Approximately 7 million entities in the U.S. – C corporations, S corporations, partnerships, limited liability corporations etc. – file tax returns with the IRS each year, and every one of them issued stock or other ownership interests to their owners. No surprise then that securities issued by privately owned businesses are the most common type of ‘hard-to-value asset’. If you own such assets it is in your best interest to know how the IRS values them through a gift tax valuation.
Gift Tax Valuation and Revenue Ruling 59-60
In 1959 the Tax Court delivered Revenue Ruling 59-60:
“The purpose of this Revenue Ruling is to outline and review in general the approach, methods
and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift tax purposes. The methods discussed herein will apply likewise to the
valuation of corporate stocks on which market quotations are either unavailable or are of such
scarcity that they do not reflect the fair market value.”
Because it offers clear and useful guidance, appraisers rely on Revenue Ruling 59-60 to value business interests for estate and gift tax valuation purposes. One of the most important concepts articulated in Revenue Ruling 59-60 is its definition of ‘fair market value’:
“The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” (Regulation §20.2031-1)
Revenue Ruling 59-60 identified eight factors the appraiser should consider before arriving at a value conclusion. Those factors include:
- The nature of the business and the history of the enterprise from its inception.
- The economic outlook in general and the condition and outlook of the specific industry in particular.
- The book value of the stock and the 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.
- Sales of the stock and the size of the block of stock to be valued.
- The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over the counter.
Valuation Discounts for Lack of Control and Lack of Marketability
Valuing the enterprise itself is just the first step in the valuation process. The second step – arguably as important or even more important – is quantifying discounts (if any) for lack of control and lack of marketability. Discounts can reduce the fair market value of a share by 30% to 40% or even more – which in turn would reduce the taxable amount of the gift. No wonder gifting shares is such a popular tax strategy for business owners!
Valuing Shares in a Business for a Gift Tax Filing
When you are preparing to gift shares in a business to a relative or anyone else, preparation is key. A trust and estate attorney should be able to explain the options available to you. Engaging an independent and credentialed appraiser to value the shares legitimizes the transactions and should shield you from penalties (if your appraiser is any good). The IRS threatens:
There are also penalties for valuation understatements that cause an underpayment of the tax, willful failure to file a return on time, and willful attempt to evade or defeat payment of tax. A valuation understatement occurs when the reported value of property entered on Form 709 is 65% or less of the actual value of the property.2
Choose Valuation You Can Trust
Gift transfers are heavily scrutinized by the IRS and require skillful structuring if you want to maximize the transfer of your wealth.
Choose the valuation experts at SPARDATA to help you reap the tax advantages you’re entitled to through careful gift tax planning.
With over twenty years of experience and satisfied clients around the country, our team of gift tax valuation professionals are exactly who you need to help you prepare for the many milestones every business owner faces.