Valuation and estate planning go hand-in-hand. After all, the tax implications of various estate planning strategies depend on the value of your assets at the time they’re transferred.
The COVID-19 pandemic has had a significant impact on the value of many business interests and other assets, which creates some attractive estate planning opportunities. It also presents unique challenges for valuation professionals. As a result, it’s more important than ever to involve experienced valuation experts in the estate planning process.
With the value of many assets depressed (in many or most cases temporarily), now is an ideal time to gift them, either directly to family members or to irrevocable trusts and other estate planning vehicles. Doing so provides an opportunity to make the most of the record-high gift tax exemption (currently, $11.58 million) before it’s reduced (either by operation of law at the end of 2025 or sooner by act of Congress).
Transferring assets while values are low also allows you to use as little of your remaining exemption amount as possible, maximizing the amount available for future gifts or bequests. As the economy recovers and asset values rebound, your beneficiaries should enjoy substantial growth outside your taxable estate.
The pandemic has created a situation that’s truly uncharted territory for the valuation profession. Unlike other economic crises in recent years, most of the damage to the economy has resulted from lockdowns, business closures and restrictions, and other measures designed to help contain the virus.
For business valuations, the current environment presents several challenges, including: Known or knowable. A fair market valuation generally doesn’t consider “subsequent events” — that is, events that occur after, and weren’t “known or knowable” on the valuation date. Experts generally agree that the COVID-19 pandemic wasn’t known or knowable as of December 31, 2019. Yet for valuation dates in the early part of 2020, determining whether the pandemic was known or knowable and should be considered in valuing a business or other asset can be a formidable task.
Note that even if an expert concludes that a subsequent event wasn’t known or knowable on the valuation date, professional standards may require the expert to disclose its potential impact on value in his or her report. In some cases, the user may be able to act based on this disclosure.
Suppose, for example, that a valuation is conducted for estate tax purposes for an individual who died in late 2019 or early 2020. In light of the pandemic’s impact on asset
values, the executor may elect to use the alternate valuation date, which is six months after the date of death.
Valuation approaches. Generally, valuators consider all three of the major valuation approaches: the income, market and asset approaches. The pandemic may affect the relative appropriateness of each approach and the amount of weight they should be assigned.
For example, market-based methods, which rely on data about actual transactions involving comparable businesses, may be less relevant today if the underlying transactions pre-date COVID-19 (although it may be possible to adjust to reflect the pandemic’s impact).
Many valuators are emphasizing income-based methods, such as the discounted cash flow (DCF) method, which involves projecting a business’s future cash flows over a defined period (such as five years) and discounting them to present value. The advantage of DCF is that it provides a great deal of flexibility to model a business’s expected financial performance based on current conditions as well as assumptions about its eventual return to “normal” over the next several years.
Regardless of the method or methods used, it’s important for valuators to consider a business’s available cash and expected cash needs to assess its viability as a going concern. These considerations will be critical in evaluating a business’s risk and impact of that risk on value.
Low values create attractive estate planning opportunities, and while the pandemic has depressed the value of many assets, some haven’t been affected or have even increased in value. Obtaining a professional valuation of gifted assets — particularly closely held business interests and other difficult-to-value property — minimizes the risk that the IRS or state tax authorities will successfully challenge their reported values.