Business owners: Understanding value is key to updating your estate plan

Summer is a great time for business owners to review their estate plans. Maybe your kids are home for summer break, so they’re top of mind. Or perhaps you’re vacationing with relatives or getting together for a backyard BBQ. Whatever the reason you’re spending time with your family, consider having an open discussion with them about your estate planning goals — and how your business fits in your overall plan.

Before you have a family meeting, however, you’ll need to get a handle on how much your business is worth today. In uncertain markets, the value of your business may differ from your expectations.

One more reason

There’s another important reason to have your discussion soon: Today’s generous federal gift and estate tax exemption is set to expire at the end of 2025 unless Congress passes legislation to extend it.

For 2024, the lifetime exemption is $13.61 million. (The amount is effectively doubled for married couples.) Next year, this exemption will be indexed for inflation.

But starting on January 1, 2026, the lifetime exemption is scheduled to revert to an inflation-adjusted $5 million, which is currently projected to be around $7 million or $8 million, based on inflation. Depending on the size of your estate and the value of your business, it might make sense to start transferring some ownership interests while the higher exemption is still available.

Eye on value

Knowing the value of your business will help you formulate a long-term strategy for transferring your wealth. The value determines how many shares can be transferred to your loved ones without incurring gift or estate taxes.

The appropriate standard of value for gift and estate tax purposes is fair market value. The IRS strongly discourages do-it-yourself valuations. Using a “qualified appraiser” demonstrates that you acted in good faith when filing a gift or estate tax return. A qualified business appraiser has earned a designation from a recognized business valuation professional organization or otherwise meets certain minimum education and experience requirements.

8 factors

Shares of closely held businesses aren’t readily traded on a public stock market. Without published stock prices to rely on, valuators turn to IRS Revenue Ruling 59-60 for guidance on how to value private business interests. It requires consideration of the following eight factors:

1. The nature and history of the business,
2. The outlook for the industry and economy,
3. Book value and financial condition,
4. The business’s earnings capacity,
5. Dividend-paying history or ability,
6. The value of goodwill and other intangible assets,
7. Prior sales of the business’s shares and the size of the block, and
8. The prices paid in comparable transactions.

In addition, certain ownership interests may be eligible for discounts for lack of control and marketability. Valuation experts use real-world empirical data to support their analyses, rather than gut instinct or industry rules of thumb.

Moving target

Typically, businesses appreciate in value over time. This is another reason to gift shares to loved ones sooner rather than later. For example, a stock that’s worth $100 per share today would be worth about $163 in 10 years or $265 in 20 years, assuming a 5% annual growth rate.

Proactive gifting strategies allow owners to transfer business interests during their lifetimes, while values are relatively low. This exposes less of their net worth to estate tax. Note that IRS regulations prevent gifts made during your lifetime from being “clawed back” and hit with estate taxes if the exemption is lower when you die. A qualified business appraisal can help maximize the exemption amount used up before the expanded exemption limit is scheduled to expire in 2026.

Need help?

It’s important to monitor the value of your business and meet regularly with your estate planning professional to discuss your options. Congress could pass estate tax law changes in the future that would extend the current lifetime exemption, increase or decrease the estate tax rate — or even repeal the estate tax altogether. We can help you prepare for a variety of scenarios.

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