Our colleague Jessica Timmerman wrote about this issue of changes for “discounts” in FLPs and other family partnership vehicles recently… and now the old Gray Lady has weighed in as well. The Times […]
Adequate Disclosure:
What's Required in a Valuation
for Gift and Estate Tax?
Whether it’s a gifting strategy or simply a probate matter, meeting adequate disclosure requirements is a fundamental element of effect tax planning.
Adequate Disclosure for Estate and Gift Valuations
Although Tax Season may be over for this year, we should start talking about or at least considering issues for the future. Gifting strategies are an effective and popular way to manage estate tax issues. Gifting not only removes an asset from the estate – but it also removes any future appreciation in the value of that asset. It’s the latter part that’s perhaps most interesting. For assets that are not rapidly appreciating it’s less of a consideration. But for many businesses – especially high growth companies- appreciation is a paramount concern.
In many cases this quickly appreciating asset is a privately held business with no readily available market value. As such reporting that value can be troublesome as the part of the filing includes meeting adequate disclosure requirements. We routinely appraise these assets to provide safe harbor, and frequently field questions as to what constitutes adequate disclosure.
Critical to transferring the assets in a trust or estate is providing the necessary information, not only to receive an accurate valuation, but also to follow IRS rules. Those rules usually require the filing of a tax return, in the case of a gift, and a valuation that meets all the adequate disclosure requirements. That will begin the three-year statute of limitations that the IRS has to audit the transfer. Without this valuation and adequate disclosure, the statute of limitations does not begin to toll.
Information Requirements
In order to meet those adequate disclosure requirements, the following information must be included in the valuation:
- A description of the transferred property and any consideration received by the transferor
- The identity of and relationship between the transferor and each transferee
- A description of the method used to determine the fair market value of the property transferred
- Any financial data that was utilized in determining the value of the interest
- If the property is transferred in a trust – provide the tax identification number and a brief description of the terms of the trust or a copy of the trust
Transfers are conducted at Fair Market Value, which is traditionally defined as: “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.” (Treasury Regulation Section 20.2031-1(b)). In many cases gifts will be effected as non-controlling or non-marketable, thus triggering discounts for marketability (DLOM) or lack of control (DLOC). As such disclosure also requires:
- Restrictions: Any restrictions on the transferred property that were considered in determining the fair market value of the property
- Discounts: A description of discounts for blockage, minority or fractional interests, and lack of marketability claimed in valuing the property
These items are, principally, the same that we take into account in determining any discounts or premiums applied to a valuation. Support often comes in a variety of formats, ranging from reliance on academic studies, application of market data supporting such discounts, as well as more quantitative methods.
In furtherance of mitigating risk, it’s imperative to have the appraisal completed by a qualified appraiser. Ensure that you choose a qualified appraiser that satisfies all these requirements as stated in the Treasury Regulations (Treasury Regulation Section 301.6501(c)-1(f)(3)):
- Full Time Appraiser: The appraiser is an individual who holds himself or herself out to the public as an appraiser or performs appraisals on a regular basis
- Qualifications: Because of the appraiser’s qualifications, as described in the appraisal that details the appraiser’s background, experience, education, and membership, if any, in professional appraisal associations, the appraiser is qualified to make appraisals of the type of property being valued
- No Conflicts: The appraiser is not the donor or the donee of the property or a member of the family of the donor or done
A certified valuation firm that is familiar with these types of transactions is your best option. Getting this valuation done as soon as possible and have it included with any filings will begin the three-year timeline.
You should consult your tax and legal advisors prior to implementing any estate planning transactions.
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We routinely perform business valuations for estate planning and probate manners. Our work ranges from operating companies to FLP’s, Limited Partnerships, GRAT’s, and various estate planning vehicles. Get in touch to learn more.
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