While the current estate tax exemption is quite high, a closely held family business may put your estate over the limit. Careful planning is necessary to lower or completely avoid the tax, and minority valuation discounts are one strategy.
Families that want to pass on their business may run into the estate tax. Estates valued at more than $11.7 million (in 2021) are subject to federal estate taxation. If you decide to give your business away before you die, you need to consider the gift tax. The lifetime federal gift tax exclusion – the amount you can give away without incurring a tax – is also $11.7 million (in 2021). You can also give any number of other people $15,000 each per year (in 2021) without the gifts counting against the lifetime limit.
One estate planning strategy for reducing estate taxes is to gift some or all of a company's ownership to your children. When you transfer a minority interest in a company, that stake is not as valuable because the minority owner doesn't have the right to make all the decisions or vote on important issues relevant to the company. This is called a “minority discount.” So, for example, if a company is worth $10 million, a 10 percent interest in the company would be discounted to less than $1 million. The amount of the discount depends on each individual case, but usually ranges between 10 to 40 percent of the undiscounted value.
By using discounts, you can reduce the value of your company for estate tax purposes while at the same time gift your children a percentage of the company at a reduced rate. These discounts apply even if everyone who owns a stake in the company is a family member.
In 2016, federal regulations were introduced to eliminate this type of discounting. The regulations were withdrawn in 2017, but under the Biden administration it is possible that they will come back.
To find out if a minority valuation discount is the right strategy for your family business, give us a call.