Over the last two years, the recession and general economic conditions have had a dramatic negative effect on the value of companies in all segments of the jewelry industry. For many companies, values are lower now than they have been for decades and possibly the lowest ever.
Given these low values and the changes to the estate and gift tax laws that will occur at the end of 2010, if not sooner, now is the perfect time to consider gifting an interest in the family business to the next generation. Unless Congress passes new legislation before year end, gift and estate tax laws will revert to 2001 exemption limits and rates at the end of 2010. For 2010, there is no federal estate tax. This tax was phased out between 2002 and the end of 2009. However, the current law has a “sunset provision” that, unless changed by Congress, revert estate and gift tax laws, exemption limits and rates to 2001 levels on January 1, 2011. At that point, the estate tax exemption limit will be $1million per individual and the maximum estate tax rate will be 55%. In 2009, the exemption limit was $3.5 million per individual with a maximum rate of 45%.
Will gift and estate tax laws revert to the 2001 provisions? Probably not. Will the current 2010 provisions now in effect be extended? Probably not. The government needs tax revenues. These are viewed as a tax on the rich, which makes this tax an easy target. What will be the final outcome? No one really knows. Tax attorneys and other tax experts have given a wide range of opinions. Many think the exemption will be in the $2.5 to $3.5 million range with a maximum tax rate of 35% to 45%. Some think it will revert to the 2001 exemption and rates, and others predict it will be somewhere in-between. The consensus is the estate and gift taxes will rise after December 31, 2010, and possibly before, if Congress chooses to act.
What can you do? Gifting an interest in the family business accomplishes at least two things. Future increases in the value of the interest gifted will be out of the owner’s estate and, therefore, not subject to estate taxes. Given the low business values we are now seeing, a business owner can gift a larger interest today than he will be able to do in the future, assuming the company’s value increases as the economy improves. The family business owner will generally want to retain a controlling interest in the company and gift a minority interest. A valuation discount will be applied to reflect the reduced value of that minority interest because it has no rights of control. Since few family owned businesses are publically traded, a marketability discount can also be applied which further reduces the value of the gift. The effect of these discounts lowers the value of the gift, thereby enabling the owner to gift a larger interest. While there has been recent legislation introduced in Congress to eliminate these discounts for family owned businesses, it did not pass. However, similar legislation could be reintroduced and passed in the future.
When preparing your estate and gift tax plan, the family business owner should work closely with an attorney who is experienced in gift and estate tax matters, an accountant, and a credentialed business valuation analyst.
When gifting an interest in a closely held or family owned business, the Internal Revenue Service requires a current fair market value valuation of the business. The valuation analyst must have credentials awarded by recognized organizations such as the American Institute of Certified Public Accountants, the National Association of Certified Valuation Analyst, and the American Society of Appraisers.
Determining the value of a business is both an art and a science. While valuations for estate and gift tax purposes must use fair market value as the standard of value, it is up to the valuation analyst to determine the most appropriate valuation approach to use and the best method within that approach. The valuation analyst will use the characteristics of the individual business, the industry, and the economy to make those decisions.
After the total value of the business has been determined, the valuation analyst will determine the appropriate discounts, such as those mentioned above, to be taken and the amount of the discounts.
The net result of this process is an opinion of value by the valuation analyst of the interest in the family owned business being valued.
Having a creditable valuation report prepared by a business valuation analysis with recognized valuation credentials and jewelry industry knowledge is an important and necessary part of the gift and estate planning process. Working with your attorney, accountant, and business valuation analyst may save you substantial amounts of gift and estate taxes. Under the assumption that gift and estate taxes will only go up from where they are today, preparing your estate plan now or making changes to your existing plan will be in your best interest.
This article appeared in the July 2010 issue of The Retail Jeweler