The Tax Cuts and Jobs Act of 2017 (TCJA) doubled the amount of exemption for taxable estate from $5 million to $10 million, with the 2024 exemption indexed for inflation at $13.61 million per person. While this exemption increase allowed more wealth to be transferred to heirs before tax kicked in, recent tax law proposals could have Americans facing increased estate tax rates in the future. Learn more about how a business valuation may be a critical tool for the future of estate planning.

Recent Proposed Changes
In recent years, President Biden has proposed to reduce the estate tax exemption to $6 million. While these proposals have yet to become legislation, if passed, they would significantly increase the level of taxation on estates.

While we cannot guarantee if or when possible tax law changes would pass, they could be enacted effective immediately. Many taxpayers, specifically those who own a small business, are racing against the clock to plan their estates under the more tax-friendly TCJA provisions rather than wait until one of two things happen – either the TCJA exemption rates sunset at the end of 2025 or new tax laws come into effect. It should be noted that unless Congress passes laws to the contrary, the expanded estate tax exemption will sunset and decrease on January 1, 2026 to approximately half of the current amount.

A Deep Dive into Business Valuations
A business valuation is a process like an appraisal of a home, in which a professional financially analyzes your entire business. This process includes several different steps, including a valuation of your business’s assets, among other factors, in effort to determine the monetary value of the business at a certain date.

There are a few different methods for valuing a business, and the method selected typically depends upon the circumstances of the valuation. While all methods are considered during the valuation process, the valuator ultimately selects the method that demonstrates the best representation of value.

Business Valuations & Estate Planning
Most commonly, estate planning that includes a business involves the transfer of a portion of the equity in the business. Because this portion of the business being transferred does not have control over the direction of the business and is not ready to sell to a third-party, the risk increases, and the valuation of this interest is lowered. The lower valuation allows for a larger percentage of the business to be included as part of the estate planning under the current level of estate tax exemptions.

A Gifting and Discount Example

• James Johnson is the 100% owner of a manufacturing business. James has a net worth of $20 million.
• The equity of the business is valued at $10 million.
• As part of his estate plan, James Johnson plans to gift his business equity to his three children equally.
• Assuming the gifted interests are unable to control the business and are not ready to be marketable for a potential sale, each interest has a fair market value that is less than the valuation of $10 million.
• Compare this scenario to the one in which James Johnson were to not have the gifted business equity formally valued with discounts. With an implied discount of 42%, James’ taxable estate was reduced by $4.2M. At a 40% federal estate tax rate, this saves his heirs $1.68M in estate tax.

A lower valuation of the business works in James’ favor as he aims to reduce the amount of his overall estate. Taking advantage of available business valuation discounts and the higher exemption rate that exists under TCJA will help him maximize his estate tax exemption.

We Can Help
Many additional factors come into play when completing effective estate planning, including individual estate tax laws, annual gifting exclusion and income tax change. If you are interested in learning more about estate tax planning strategies, including a business valuation performed for your business, we encourage you to call us today. Together we can analyze your overall goals and strategize different scenarios for the uncertain future of estate tax.