Valuation Discounts for Business Interests
If a transferred asset represents a minority interest in a business, then a reduction in the value of the asset is typically allowed, known as the "Minority Discount."
If Nate has a 30% minority interest in ABC Company, it does not entitle him to several of the benefits awarded to majority owners; therefore, he could receive a minority discount of 20%, thus bringing his transfer value down to a 24% ownership.
Properties of the Minority Interest:
- Not a controlling interest (in terms of voting).
- Minority discounts range from 15 to 50% (for transfer tax purposes).
- Minority owners do not manage the business.
- Minority owners cannot initiate a sale or liquidation of the business.
- Buyers will pay less for minority interest versus a controlling or majority interest.
How do You Determine the Discount?
1) A pro-rata portion of the total business value minus a discount.
2) In comparison to market data involving similar minority ownership interest transfers.
3) As a present value of the economic benefits stream expected from ownership of the minority interest in the company.
A reduction in the value of an asset transferred is commonly allowed if the asset transferred has an inherent lack of marketability, such as a house, farm or collectible items. The interest in a closely-held business or partnership interests might also be short of marketability as they are often more difficult to sell than other interests, such as a bank certificate of deposit (CD) or marketable securities.
- The lack of marketability discounts can be used in conjunction with the minority discount.
- The discount range is 15 to 50% for both minority and majority interests.
Julie gave her daughter Alisha, a 5% interest in her closely held business. The business has a value of $400,000 and Julie applied a minority and lack of marketability discount that totaled 35% to the gift. What is the value of the gift?
Answer: $13,000. Julie would not have any gift tax due, since the amount falls under her annual gift exemption amount. [$400,000 x 5% x (1 - 0.35)]
A substantial amount (or block) of corporate stock, that is listed on a public exchange, may be found in a decedent's gross estate. If this occurs, the stock may be somewhat difficult to sell due to the size of the block and the current trading volume of the stock in the company.
Why discount large blocks of stock?
- Liquidity and volume selling issues.
- Large volume is harder to sell than small volume.
- Market price will be less for a large block versus a small block.
- Discounts would be based on the decrease in the realizable price below the current market price of the stock.
Key Person Discounts
A discount will usually be allowed for a business in which a key person has died or becomes disabled. The rationale behind this discount is that the closely-held business may experience an interruption in production, decline in stock price and change of management if a key person (such as a founder) died or becomes substantially disabled or unable to return to the business.
In some cases, a key-person (employee) life insurance is purchased on the life of this employee (payable to the corporation) to give the corporation some additional capital and time to find a replacement in the event of death of this key person. The discount may be reduced if such insurance is in force.
Valuation Techniques and the Federal Gross Estate
RetirementThe Uniform Transfers to Minors Act enables minors to receive property or gifts without a guardian or trustee’s aid.
RetirementLeaving liquid assets like cash or securities to minors can be a complicated procedure. Make sure you understand how your gift will be distributed, managed and taxed.
InsuranceMedical discount plans can help the uninsured or underinsured afford better healthcare.
Financial AdvisorWhen a project or investment faces higher amounts of risk or uncertainty, it may be appropriate to utilize the risk-adjusted discount rate.
RetirementWith next year's Social Security COLA raise a measly 0.3%, seniors have yet another reason to turn to discounts to save money.
Personal FinanceThe federal discount rate is the rate at which eligible banks or other depository institutions can borrow funds from a Federal Reserve bank.
InvestingDiscount rates have nothing to do with buying things on sale. Rather, it helps you figure out how much to pay today for a bond or cash flow in the future.
Managing WealthThe pending IRS rule changes for partnerships and LLCs could drastically curtail the way assets within them are valued and taxed. Here's why.
Personal FinanceGift cards can cost less when you buy them through a discount website. Just do the math before you cough up the cash.