Federal Estate Tax

Lesson 18: Valuing Closely Held Businesses

As part of the larger topic of Valuation of Estate Assets, this lesson focuses on the intricacies involved in valuing closely held businesses for estate tax purposes.

What is a Closely Held Business?

A closely held business is typically a corporation, partnership, or sole proprietorship with a limited number of owners. These businesses are often family-owned and not publicly traded. For a deeper dive, check out this book on Amazon.

Importance of Accurate Valuation

Accurate valuation is critical for determining the estate's value and ensuring compliance with Federal Estate Tax Law. Incorrect valuations can lead to significant tax liabilities or penalties.

Note: The IRS scrutinizes valuations of closely held businesses due to their potential for undervaluation.

Valuation Methods

There are several methods used to value closely held businesses:

Income Approach: This method estimates the present value of future income streams.
Market Approach: This method compares the business to similar businesses that have been sold.
Asset-Based Approach: This method calculates the value based on the business's assets and liabilities.

Income Approach

The Income Approach estimates the present value of future income streams. This is done by discounting future earnings to their present value.

Market Approach

The Market Approach involves comparing the business to similar businesses that have been sold. This method is useful when there is sufficient market data available.

Asset-Based Approach

The Asset-Based Approach calculates the value based on the business's assets and liabilities. This is often used for businesses with significant tangible assets.

Discounts and Premiums

When valuing closely held businesses, it's essential to apply appropriate discounts and premiums:

Minority Discount: Applied when the interest being valued is a minority interest.
Marketability Discount: Applied to account for the lack of liquidity of the closely held business.
Control Premium: Applied if the interest being valued includes control over the business.

Important: The application of discounts and premiums must be justifiable and well-documented to withstand IRS scrutiny.

Example Calculation

Let's illustrate the valuation of a closely held business using the Income Approach:

graph TD A["Future Income Streams"] -->|Discount Rate| B["Present Value"] B --> C["Business Valuation"]

Final Thoughts

Valuing closely held businesses is a complex and nuanced process. It requires a thorough understanding of various valuation methods and appropriate application of discounts and premiums. For more detailed guidance, refer to other lessons in our instructable on Federal Estate Tax Law.