There’s no denying it, we’re living through a period of extraordinary uncertainty. This state of affairs has many business owners thinking about how their businesses will be affected. In an earlier article that can be found here, I outlined factors behind today’s lower company valuations (generally speaking). Despite lower values and business challenges, there’s a silver lining for business owners: an opportunity for estate and gift tax planning.
For business owners who are considering an ownership transfer to the next generation through gifting company shares, this is an opportune time. An ownership transition through gifting, while business valuations are lower, can lower your tax bill or allow you to gift more shares than originally planned. For gifts involving minority interests in businesses, current conditions support higher valuation discounts for lack of control and lack of marketability.
Timing is Everything
A business valuation is performed as of a selected date, referred to as the “valuation date.” A business valuer considers what was known and knowable at the valuation date, but not after.
For example, a company’s valuation as of June 30, 2020, when it’s experiencing lower customer orders and operating with a partially remote workforce, could be very different from that company’s valuation as of January 1, 2020 under conditions that we (used to) consider normal. Fast-forward to January 1, 2022 when the economy is hopefully in recovery, customers have returned and the company is back on track. Its value will be higher than the mid-pandemic value.
Here are key factors depressing current company valuations:
- Lower projected revenues and earnings caused by closures, lower customer demand, and new health & safety operating costs – to name a few causes
- Higher debt levels to fund payroll and general operations
- Increased company-specific, industry and macroeconomic risks due to current events
The Benefit of Acting Now
Current U.S. tax law allows for a historically high lifetime gift and estate tax exemption, at $11.58 million for individuals and $23.16 million for couples. With the election coming in a few months, a change in the balance of power in Washington could lead to a lower gift and estate tax exemption, a higher tax rate, or both. Even if the status quo holds into 2021, lawmakers on both sides of the aisle will be looking for new sources of tax revenue, putting current gift and estate tax policy at risk. After all, someone has to pay for the CARES Act and the inevitable future economic stimulus packages.
No one knows how long the negative economic conditions will last, be it months or years. But we know that today’s company valuations are generally lower, tax policy is favorable, and one or both might be gone before you know it. So, if you’ve been thinking about updating your estate planning, don’t wait. Talk to your attorney and/or CPA about the possibilities. As a business valuation pundit recently said, “if you wait until it’s too late, it’s too late.”
Shannon Lowther, CFA, ASA, ABV, is managing partner with Bakersfield-based Central Pacific Valuation. She specializes in the valuation of businesses, business interests and intangible assets. Shannon can be reached at firstname.lastname@example.org