Valuing minority interests in a family-owned business can present a significant challenge to owners looking to take advantage of today’s high gift tax exclusion. Even after obtaining a professional appraisal of the business’ value, frequent IRS challenges to these appraisals have historically made it difficult to determine minority interests with any degree of certainty that your client will not incur gift tax liability. A recent Tax Court decision may have paved the way toward eliminating this problem for good, allowing your clients to give small interests in their companies without worrying about incurring gift tax liability if the IRS successfully challenges a valuation.
The Problem: Valuing the Gift of a Small Business Interest
Minority interests in a closely-held business are inherently difficult to value. Each case is unique, and there is usually no public market for the shares that would dictate their fair value. Because of this, the IRS requires that small business owners obtain a professional appraisal to determine the value of business interests for gift purposes.
Since the IRS is watchful of appraisals that may understate the value of assets to avoid gift taxes, it is difficult for a business owner to transfer portions of his or her business while taking full advantage of the gift tax exclusion. It may instead be tempting to give fewer interests and be certain not to exceed the annual limit.
For example, if your client owns a business and wants to make a gift of shares worth $13,000 (the 2012 annual exclusion), and an appraisal indicates that 100 shares can be transferred without exceeding this amount, the owner could transfer the shares without paying gift taxes. The IRS can later challenge this valuation and show that only ninety shares were worth $13,000. If the IRS is successful, the business owner would then be required to pay gift tax on the ten shares that exceeded the annual exclusion amount—a result that your clients would prefer to avoid.
The Wandry Case
In Wandry vs. Commissioner, the taxpayers owned a small business and wanted to give interests to their children and grandchildren while minimizing gift taxes. Because the value of the business had not yet been ascertained, the taxpayers specified in the documents governing the transfers of the business interests that the gifts were not to exceed the annual exclusion.