3 Reasons to Use Valuation Pros in Estate Planning

Some business owners design their estate plans without consulting a business valuation professional. They use simplified rules of thumb or other do-it-yourself techniques to estimate the value of business interest gifted to family members or donated to charities.

However, this approach can lead to unwelcome surprises down the road. Here’s why business owners need a credentialed valuation expert to plan for the future.

Rules of Thumb May Be Unreliable

Valuation formulas often are shared at trade shows or in trade journals. They can give owners a feel for their business’s worth and serve as a “sanity check” when evaluating the results of other valuation methods. But they’re no substitute for a professional valuation.

Typically, rules of thumb may be expressed as a multiple of gross revenues, earnings before interest, taxes, depreciation and amortization (EBITDA) or some other financial measure. But these simplified formulas are based on averages passed along by word-of-mouth, without regard to specific characteristics — such as management strength, location, debt levels, competition, expected growth and costs — that drive the subject company’s value. They’re basically folklore that’s been collected over time, and they don’t usually stand up to IRS or Tax Court scrutiny.

For example, suppose a rule of thumb for a particular industry is three times EBITDA. Using that formula, two industry participants with $500,000 in EBITDA would each be worth $1.5 million. But what if one of the companies isn’t investing in R&D, advertising its products or maintaining its assets? These shortcuts may temporarily boost EBITDA, but they’re also likely to compromise future earnings and, ultimately, lower its value.

Or what if one business owns its real estate, but the other rents its space? What if one has $1 million of excess working capital on its balance sheet? Blindly applying rules of thumb can also lead to apples-to-oranges comparisons — and erroneous conclusions.

Valuation Offers Peace of Mind

When business owners transfer business interests to their loved ones, the IRS generally has three years to challenge the valuation for gift tax purposes. But that period doesn’t begin until an owner “adequately discloses” the gift on a timely filed gift tax return.

To satisfy this requirement, the return must provide various details about the transferred interest, the terms of the transfer and the relationship between transferor and transferee. It must also provide either:

  1. a detailed description of the method used to value the transferred property, or
  2. a qualified appraisal by an independent, qualified appraiser

Start the clock ticking on the statute of limitations by filing a timely gift tax return that includes a qualified appraisal — even if filing a return isn’t required because, for example, the owner hasn’t exceeded the lifetime gift tax exemption. A qualified appraiser is one who meets certain minimum education and experience requirements or has earned a designation from a recognized professional appraiser organization.

In addition, the IRS requires business owners who donate more than $10,000 in closely held stock to substantiate charitable deductions with a qualified appraisal by a qualified appraiser. For shares valued at more than $500,000, the appraisal report must be attached to the owner’s tax return.

A Solid Valuation Lays the Foundation for All Planning

In general, timely valuations are necessary to make informed business and financial decisions. Otherwise, it’s difficult for owners to set a price for their business, forecast retirement income, determine whether their heirs are treated fairly, weigh the potential impact of taxes and explore estate planning options.

Moreover, because value can fluctuate dramatically over time, it’s essential to routinely update business valuations. For more information on valuing your business, contact a business valuation expert.

Bowers & Company CPAs aims to offer helpful information to our clients and friends. Learn more about how we can help should your business need business valuation services.

Disclaimer: To ensure compliance with requirements imposed by the Department of Treasury, we inform you any U.S. federal tax advice contained in this document or video is not intended for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

 

© 2019 Thompson Reuters

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