ESTATES AND TRUSTS

By Edward Mendlowitz, Mendlowitz Weitsen LLP CPA

It is common to use valuation discounts, or adjustments, for estate and gift taxation valuations of businesses. These discounts or adjustments are an important part of the valuation process. If only part of the business is being sold or transferred, there might be a discount to the pro rata value for a minority interest because the person with the minority interest has little or no control over the business. A minority partner or shareholder also has little or no say about whether dividends are declared, how cash flow is distributed, or whether the company is sold or liquidated. Minority interest discounts can range up to 40%, depending upon the type of business, the number of stockholders, and a myriad of factors that could limit the control of the minority stockholder.

A discount for the lack of marketability of the stock or partnership interest may also be appropriate. Lack of marketability adjustments reflect that stock in a closely held business is not easy to sell. These discounts could be 25% or more depending on circumstances, and they could apply to discounts and fragmentation in addition to the minority interest discount.

The following illustrates valuation adjustments. Note that the percentages are only for illustrative purposes and do not reflect what the discounts usually are.

The following table shows the effect of further fragmentation created by placing minority interest partnership units into a family partnership, where they will be further fragmented into other minority interests.

To the extent asset values grow, discounted assets will have greater future value than nondiscounted assets. Caution should be taken when fragmenting assets, however, because for estate tax purposes, an asset can be entitled to a discount when it passes to the spouse, but not when the gross estate is valued, triggering estate tax on amounts passing to the surviving spouse.

The following example shows how assets included in the gross estate have a lower value when they are fragmented and distributed to two different beneficiaries. The result would be the same if the two beneficiaries were related (e.g., a spouse and QTIP trust for the spouse that each received a 50% interest).

*Assuming 25% discount

When the estate tax gets paid, the marital and charity deductions will be reduced, increasing the estate tax.

Fragmentation Strategies

Fragmentation allows various discounts to be taken when valuing estate assets. The more the assets are fragmented, the greater the potential to decrease their value by applying the discounts or adjustment. Done correctly, control can be retained during the lifetime of the assets’ owner. Because none of the beneficiaries receive a majority of the interest upon the owner’s death, the discounts are available for estate valuation purposes.

A family limited partnership (FLP) provides a means to transfer the minority interest to children or grandchildren.

Voting and nonvoting stock is an alternative for S corporations that cannot have partnerships as shareholders.

A final strategy is to transfer part of the assets to trusts with different beneficiaries. For example, one half of the assets could be transferred to a QTIP and one half of the assets to a trust for the children with a spouse as the income beneficiary.