Five estate-planning steps for business owners

Oftentimes business owners do not understand the importance of an estate plan. Creating an estate plan will not only help organize and manage the assets of an individual or family but it can protect those assets in case something happens to you. The purpose of having an estate plan is to transfer family wealth from one generation to the next with the lowest tax consequences. An estate plan is imperative when the estate includes the ownership of a business. To ensure that the business ownership interest is transferred to a person or persons of your choice upon death or incapacitation, a written estate plan is imperative. In the event of death of an owner, the failure of having an appropriate valuation could result in the forced sale of the business or other family assets. If your estate involves ownership in a business, the following steps are general guidelines to help you plan your estate and give you peace of mind for years to come.

Step 1: Hire qualified estate professionals

Too often this step is skipped, which can be detrimental. Creating an estate plan is complicated. There are laws which vary from state to state which set forth requirements on form and function of estate planning documents. A qualified estate-planning attorney and a certified public accountant specializing in estates will be able to assist in decision making and in creating an estate plan to fulfill your wishes, minimize resulting taxes and ensure the proper laws are being adhered to. Skipping this step may lead to an estate plan that is more burdensome than useful.

Step 2: Determine net worth

When meeting with qualified estate professionals discussed in Step 1, it will be helpful to have a statement of net worth. The fair market value of assets and liabilities must be established. Examples of assets are bank and investment accounts, personal property (jewelry, vehicles and boats), retirement plans (401(k), IRA, pension plan), death benefit of life insurance, business ownership interests, monies owed to you, oil and mineral rights and real estate. Once the fair market value of the assets is determined, the fair market value of the liabilities (what you owe) must be subtracted. Examples of liabilities include credit card debt, car loans, mortgages and any other amounts owed. Understanding the entire net worth of your estate is important in determining whether a business valuation is necessary.

Step 3: Determine whether a business valuation is necessary

Upon meeting with the qualified estate professionals you will need to have determined whether a business valuation is necessary. It may be difficult for an estate planning attorney to recommend one estate planning option over another until the value of the business ownership interest is known. If it is determined that a business ownership interest will be included in the estate plan, retain a business valuation expert.

Step 4: Retain a business valuation expert

Since there are certain intricacies to valuing a business ownership interest for estate and gift tax purposes it is important to find an experienced expert who has professional credentials in business valuation. Examples of widely recognized business valuation credentials include the Certified Valuation Analyst (CVA), which is a national certification in the field of business valuation, and the ABV certification which is a business valuation designation awarded by the American Institute of CPAs. A business valuation expert will understand the intricacies to a valuation for estate and gift tax purposes that others may not. Valuation of closely held business is an imprecise science and reasonable people may differ in their estimates of value. Therefore, a business valuation expert must substantiate any decisions made. Some important factors that must be considered include:

Standard of value: The standard of value varies based on the purpose of the valuation. For estate and gift tax purposes, the standard of value is fair market value. If the correct standard of value if not utilized, the entire valuation may be considered null and void and as a result, there may be tax implications. The purpose of creating an estate plan is to ensure the lowest tax consequences possible. By obtaining a valuation from a qualified and experienced business valuation expert, the valuation is more likely to withstand scrutiny from the Internal Revenue Service.

Premise of value: The premise of value is an important consideration. Examples of premise include going concern and liquidation value. Going concern means that one is valuing the ongoing business operations. Liquidation value includes the value in exchange when business assets are being disposed of. The premise of value will impact how the valuation assignment is performed.

Capitalization and discount rates: One of the most disputed aspects of a business valuation is the determination and use of a capitalization/discount rate. There are subjective factors which are considered and included in determining an appropriate rate. A valuation expert with experience and credentials should be aware of the potential scrutiny on the determination of this rate and will ensure that any subjective decisions are supported and explained.

Discounts for lack of control and lack of marketability: Discounts are often contested by the IRS. To ensure that any business valuations submitted with a gift or estate tax return will hold up against an IRS audit, it is important to ensure that the discounts are based on the types of assets underlying the business interest and that the methods and sources relied up by the expert are sufficient.

Step 5: Review and update your estate plan

Once you have made your estate plan it should evolve with you. Too often once an estate plan is completed, it is never reviewed again. As we age and as our circumstances change, so do our estate planning needs. Changing circumstances includes getting married or divorced, birthing or adopting children, buying or selling a business and retiring. Consideration should also be given to federal estate and gift tax laws and any anticipated changes in such laws.

Michelle L. Salazar is president of Litigation and Valuation Consultants Inc. in Reno. Contact her at 775-825-7982 or through www.lvcreno.com.