Why Business Valuation is Heating Up for Estate and Gift Tax Planning Purposes
Forthcoming Changes in Gift and Estate Tax Thresholds
In the complex world of gift and estate tax planning, significant changes are on the horizon. The 2026 sunset, a date circled in red on the calendars of tax professionals and high-net-worth individuals, potentially signifies the end of the current, more generous tax-free lifetime estate and gift tax thresholds. The authors share their thoughts on how the upcoming sunset will impact the business valuation profession, the value business valuation professionals bring to the legal profession, and importance of being proactive and current.
In the complex world of gift and estate tax planning, significant changes are on the horizon. The 2026 sunset, a date circled in red on the calendars of tax professionals and high-net-worth individuals, potentially signifies the end of the current, more generous tax-free lifetime estate and gift tax thresholds.
Understanding Estate and Gift Taxes
The estate tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of your death.
The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether or not the donor intends the transfer to be a gift.
The gift tax applies to the transfer by gift of any type of property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift to which the gift tax applies.
Understanding the Current Tax Landscape
The Tax Cuts and Jobs Act (TCJA), which was enacted in December 2017, significantly impacted gift and estate taxes in the United States. One of the most substantial changes was the doubling of the federal estate tax exemption, effectively raising it to over $11.0 million per individual (approximately $22.0 million for a married couple) for tax year 2018 with planned increases to the federal estate tax exemption in each subsequent year through tax year 2025. This higher exemption has meant that fewer estates have been subject to federal estate taxes.
As of 2023, the federal estate tax exemption stands at $12.92 million per individual or $25.84 million per married couple. This means that in the event of an individual’s death, their estate will not be subject to the estate tax if they bequeath an amount not exceeding $12.92 million to their heirs (excluding their spouse) and including any gifts previously made. Anything more than that sum will incur a 40 percent federal estate tax, with an additional 40 percent applicable if bequeathed to a “skip person.” (A “skip person” is an individual who is younger than the transferor by at least two generations.)
However, it is important to note that these higher thresholds are set to expire when the TCJA expires at the end of 2025, potentially reverting to lower exemption levels. Without further legislative action, the thresholds are set to go down to $12.0–16.0 million for married couples and $6.0–8.0 million for individuals (adjusted for inflation) in 2026.
Gift Tax Rules
Currently, an individual can make a gift of up to $17,000 a year to any individual without federal gift tax liability. There is no upper limit on the number of individual gifts that may be given; in fact, couples who choose to divide gifts can contribute twice the amount. For example, in the absence of other taxable gifts and without utilizing any portion of their lifetime federally applicable exclusion amount, a married couple with two children may give $34,000 in annual individual gifts to each child, for a total of $68,000, without creating a taxable gift or deducting any portion of their exclusion amount. The money is removed from the taxable estate of the parents once the gifts have been completed. The taxpayer’s lifetime exclusion amount is not affected by their eligible gifts due to the annual federal gift tax exclusion.
A taxable gift is established when an individual bestows an amount exceeding $17,000 upon a single person within a single year; in such cases, the donor is obligated to submit a federal gift tax return (Internal Revenue Service Form 709). The individual may not, however, owe taxes as a result. If the value of the gift exceeds $17,000, the combined lifetime gift and federal estate tax exclusions of $12.92 million may be reduced. An example of a potentially taxable gift would be $200,000 if a father presented his daughter with a $217,000 gift this year (after deducting the $17,000 annual gift tax exclusion from the total amount brought to $217,000). For this taxable gift, the father is not obligated to remit payment to the IRS in the form of a check. Instead, the father’s applicable exclusion amount would be reduced from $12.92 million to $12.72 million by applying the overage towards his lifetime federal gift and estate tax exclusion amount.
Long-range lifetime gifting strategies may assist in preserving wealth for heirs and mitigating transfer tax exposure if taxpayers are concerned that their estate may surpass the $12.92 million threshold or the $25.84 million combined spousal applicable exclusion amount.
For individuals with a taxable estate above $13.0 million, or families with taxable estates above $24.0 million, it is important to shore up your estate plans and, where possible, take advantage of the current high exemption amount using estate and gifting strategies.
The IRS has provided clarity on how significant gifts will be accounted for prior to 2026 when a death occurs in 2026 or later. In general, you benefit if you gift more than the estate and gift exemption amount expected for 2026, where not doing so may cause the loss of this benefit of the currently historic high exemption amounts. For example, if an individual gifts $12.0 million now and the gift and estate exemption becomes $6.8 million in 2026, they have moved an additional $5.2 million out of their estate tax-free. However, this gets complex very quickly and should only be done with the guidance of a competent estate attorney and tax advisor.
It is important to mention that if you live in a state with a state estate tax or inheritance tax, you likely already have cause to review your estate plan. There are a host of estate and gifting strategies to explore. Again, due to complexity, you should utilize the guidance of your advisors, including your attorney and tax advisor. In Illinois, for example, the exclusion amount for Illinois Estate Tax purposes is $4.0 million. The exclusion amount is a taxable threshold and not a credit against tax. If an estate’s gross value exceeds $4.0 million after inclusion of adjusted taxable gifts, an Illinois Form 700 must be filed, regardless of whether a Federal Return is required by the Internal Revenue Service.
The Role of Business Valuation
Amidst this backdrop of shifting thresholds and evolving tax regulations, the importance of business valuation becomes increasingly apparent. Accurate valuation of business assets is not only essential for determining the value of gifts but also for strategizing the most tax-efficient ways to transfer ownership while preserving family wealth.
Allow me to elaborate. To help their clients navigate the intricate landscape of tax regulations, gift and estate tax attorneys should possess a fundamental understanding of the key principles of business valuation, especially regarding their client‘s interest in privately-held companies. Understanding valuation principles and methodologies will empower gift and estate tax attorneys to navigate the complexities of tax law effectively, ensuring their clients’ financial legacies remain secure.
Business valuation is the process of determining the worth of a business entity. For gift tax and estate planning purposes, accurate valuation is essential because it influences the calculation of taxes and aids in strategic decision-making. Fair market value is the standard of value used for gift and estate tax planning purposes. Fair market value represents the price at which property would change hands between a willing buyer and a willing seller, neither being under compulsion to buy or sell. With full knowledge of all relevant facts, this principle ensures that valuations remain grounded in the economic realities of the open market, providing a solid foundation for prudent financial planning and preserving wealth across generations.
Any of the three main valuation approaches—the income approach, market approach, and asset approach—can be used in a valuation for gift and estate tax planning purposes, as deemed appropriate by a valuation analyst. These methods individually assess a business’s future earnings potential, compare the subject company to similar public traded businesses and/or similar private-company sales transactions, and/or evaluate the fair market value of the subject company’s tangible and intangible assets. Depending on the specifics of the subject company being appraised, each approach may be utilized in determining the fair market value of the company for gift and estate tax planning purposes.
Depending on the circumstances and the ownership interest being transferred, certain discounts may apply, which can reduce the taxable value. Common discounts include a discount for lack of control (DLOC) which may be applicable if the transferred ownership interest does not provide prerogatives of control over the company. A discount for lack of marketability (DLOM) may apply to a privately held company since these companies are typically less liquid than publicly traded ones. A DLOM may be applied to account for the difficulty in selling the ownership interest.
In the context of business valuation for estate and gift tax compliance, the concept of “tax-affecting” comes into play. Tax-affecting entails the adjustment of a closely held business’s financial statements to account for the tax implications that the business entity itself would encounter. This becomes especially pertinent when assessing the value of pass-through entities, such as sole proprietorships, partnerships, S corporations, or limited liability companies (LLCs). Several crucial considerations are associated with tax-affecting in the realm of estate and gift tax compliance.
The Internal Revenue Service (IRS) provides guidelines on tax-affecting adjustments through various revenue rulings and court cases. Valuation professionals must stay informed about these guidelines and ensure strict compliance with IRS regulations during the valuation process. Professional judgment is a crucial element in tax-affecting adjustments. Valuation experts exercise their professional discretion, considering the specific circumstances of the business and the relevant tax laws and regulations.
The significance of accurate business valuation cannot be overstated in gift and estate tax planning and compliance. When determining the value of gifts made, the IRS relies on a precise valuation to ensure the correct assessment of gift tax liability. Inaccurate valuations can lead to costly disputes and penalties. Moreover, accurate valuations are crucial for devising tax-efficient strategies. Gift and estate tax attorneys, armed with precise business valuations, can help clients make informed decisions on when and how to transfer assets, optimize exemptions, and minimize tax liabilities. This proactive approach can ultimately be used to preserve more wealth for future generations.
Increased Demand for Business Valuation Services in Anticipation of the 2026 Tax Sunset
As the 2026 tax sunset approaches, there is a significant surge in demand for business valuation services. This heightened demand is driven by the impending changes in tax laws, specifically related to estate and gift taxes. High-net-worth individuals and their advisors are seeking accurate valuations to adapt to the evolving tax landscape effectively.
Business valuation services are particularly crucial in scenarios involving family-owned enterprises, closely-held companies, and complex asset portfolios. For instance, when individuals plan to gift shares of a family business to heirs, precise business valuations are essential not only to determine the gift’s value but also to accurately evaluate potential estate tax implications.
Moreover, comprehensive estate planning strategies that encompass diverse assets such as real estate, stocks, and intellectual property, precise valuations play a pivotal role. Business valuation experts enable gift and estate tax attorneys to create tailored strategies that align with their clients’ unique needs and circumstances.
The Role of Gift and Estate Tax Attorneys
Gift and estate tax attorneys serve as guides in estate planning, navigating clients through tax complexities to secure their financial legacies. They analyze clients’ finances, identify tax-saving opportunities, and create efficient tax strategies. With expertise in tax law, including gift tax regulations, they serve as the first line of defense against potential issues.
To excel in their role, gift and estate tax attorneys collaborate with valuation experts. Valuation professionals bring specialized knowledge in business valuation, ensuring accurate asset appraisals. Attorneys and valuation experts work together to determine the fair market value of assets, a crucial factor in gift tax calculations.
Gift and estate tax attorneys are architects of tax-efficient wealth preservation. Their collaboration with valuation experts and proactive planning helps high-net-worth individuals navigate the intricate world of gift tax planning. Through their expertise and communication, they ensure clients’ financial legacies remain secure and optimized for future generations.
Conclusion
The approaching 2026 tax sunset has triggered a notable increase in the demand for business valuation services within the realm of gift and estate tax planning because of the “use it or lose it” rules of the higher tax thresholds. Gift and estate tax attorneys are, or should be, working quickly to help their high-net worth clients take advantage of the higher tax thresholds before the 2026 sunset.
The 2026 sunset’s provisions and the potential rollback of gifting thresholds emphasize the need for proactive planning and vigilance among gift and estate tax attorneys. These attorneys stand at the forefront of this shift and should consider working closely with valuation experts to ensure their clients’ financial legacies remain secure and optimized.
In intricate valuation scenarios, the expertise of valuation professionals is essential. Their contributions align seamlessly with the proactive planning and communication skills of gift and estate tax attorneys, forming a dynamic partnership that safeguards and optimizes wealth transfer strategies.
Natasha Perssico Escobedo, MBA, CPA, ASA-BV, is a principal at the consulting firm Epstein Nach Escobedo. She holds a CPA certification and an MBA from DePaul University, with a concentration in forensic accounting. She is an Accredited Senior Appraiser in Business Valuation (ASA-BV) and Accredited in Appraisal Review and Management (ARM) with the American Society of Appraisers.
Ms. Escobedo specializes in delivering comprehensive business valuation and business valuation rebuttal services for privately held businesses across diverse industries, often in combination with litigation consulting and forensic accounting services. Her expertise is particularly valuable in cases involving shareholder litigation, marital dissolution, estate and gift tax compliance, and transaction planning matters. Her education, credentials, and extensive experience have equipped her with the knowledge and skills required to effectively analyze and resolve complex accounting and valuation-related issues.
Ms. Escobedo may be contacted at (773) 603-9240 or by e-mail to NPescobedo@epsteinnach.com.
Miranda M. Kishel, MBA, CVA, CBEC, supports team members to complete business valuations, forensic accounting, economic damages determination, litigation, and asset tracing engagements. Her previous experience includes banking, accounting, and real estate development. Her areas of expertise include financial analysis, forensic accounting, and small business strategic planning. She performs detailed economic, industry, and academic research.
Ms. Kishel may be contacted at (773) 603-9240 or by e-mail to MKishel@epsteinnach.com
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