www www.fiskeco.com om
Yo Your Presen esenters Sheri Fiske Schultz CPA/ABV/CFF Katie Gilden CPA/ABV/CFF, CFE, CVA
3 About About Fisk Fiske & Com Compan any • Business Valuation • Forensic Accounting • Litigation Support • Tax & Accounting • Consulting Services Fiske & Company is an independent member of the BDO Alliance USA, a nationwide association of independently owned local and regional accounting, consulting and service firms with similar client service goals. The BDO Alliance USA presents an opportunity for firms to expand services to clients without jeopardizing our existing relationships or our autonomy by accessing the resources of BDO USA, LLP and other Alliance members.
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• Why Get an Estate/Gift Tax Valuation? • Terms of Engagement • Defining FMV • Documentation • Valuation Methodology • Determining Discounts • IRS Considerations • Court Case Examples and Case Study • Questions and Wrap ‐ up 5
Why Get an Estate/Gift Tax Valuation • Investment Holding Companies (FLP, LLC, etc.) • Real Estate • Securities • Art • Fractional Interest Discount • Establish Basis 6
Terms of Engagement Why should a potential client hire you? There is no requirement that a taxpayer engage the services of a professional appraiser ‐ BUT – IRC Sec. 6662 imposes penalties for undervaluation of estate and gift assets • Penalties computed as a percentage of tax underpayment • Penalties may not apply if the value reported was made in good faith and had a reasonable basis 7
Terms of Engagement Hiring a valuation analyst can help establish a “ reasonable basis ” • Note: Estate that relied upon an unsigned draft appraisal, performed by a practitioner who had valuation experience and had previously testified several times, but had no valuation/appraisal credentials was considered not to have been a “reasonable basis” and was still assessed penalty (see Estate of Richmond) • Beware – IRS Sec. 6701 imposes penalties on valuation analysts for “aiding and abetting an understatement of tax liability” 8
Item Current Law Annual gift exclusion 15K per person Exemption Amount (2020) $11,580,000 per person Basis of Assets Gift = Carryover Basis Inheritance = FMV on Date of Death or Alternate Valuation Date Tax Rates – Gift Tax 40% Effective Dates On or after 1/1/2018 & on or before 12/31/2025 Tax Rate & Exemptions 9
“The price at which the property would change hands between a willing buyer and a willing Defining Fair seller, neither being under any compulsion to Market Value buy or to sell and both having a reasonable knowledge of relevant facts”. Fair Market Value ( FMV ) is used for: • Gift Tax Purposes ‐ Treasury Regulation 25.2512 ‐ 1 • Estate Tax Purposes – Treasury Regulation 20.2031 ‐ 1(b) • Revenue Ruling 59 ‐ 60 • FMV defined as: “The price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having a reasonable knowledge of relevant facts”. 10
What do you need from the client? • Partnership Agreement/Operating Agreement • Copy of Certificate of Limited Partnership filed with state or Private Organization Documents • Valuations of real estate or other assets held by the FLP as of the valuation date ( if the FLP owns interests in other closely held businesses, these must be separately valued before the value of the FLP interest can be determined ) 11
Documents What else do you need from the client? • Financial statements and/or tax returns for the FLP (Generally 3 to 5 years – or since inception if more recently formed). • Copies of bank account, brokerage account and mortgage statements as of the valuation date and closest month end. • List of owners as of date of formation and as of Valuation Date. Details respecting any ownership changes in the last five years. • Minutes of meetings of partners. • History of distributions made to partners, if any. • A balance sheet as of the valuation date. 12
Factors to Consider Factors to Consider in the Partnership Agreement: • Term provision (i.e., how long will the FLP exist?) • No guarantee of return of capital contributions or distributions • Capital call provision • Limitation on transferability (voluntary or involuntary) of GP and LP interests and/or limitation on rights of GP/LPs to withdraw from partnership • Right of first refusal • Approval rights of LPs for major decisions – exclusion of LPs from participating in management otherwise • Method for electing new managing GP • Provision distancing the LPs from the assets of the FLP • Whether GP is required to make an IRC Section 754 Election 13
Va Valuation Methodol thodology ogy • Asset Approach • Income Approach • Market Approach
• Determination of the FMV of all assets owned by the FLP (less value of the FLP’s liabilities) to arrive at net asset value (NAV) and then application of appropriate discounts for lack of control (DLOC) and marketability (DLOM) • Normally used where the FLP holds passive type assets like real estate, publicly traded securities, etc. • What’s wrong with the NAV method? Ignores income-generating ability Doesn’t quantify future benefits Often relies on overall averages from studies for discounts May be inappropriate for non- controlling interests (A minority owner cannot force the sale of the underlying assets, and although you would apply a DLOC to account for this, does the DLOC truly account for the inability to obtain the value of the underlying assets?) Asset Approach (Net Asset Value)
Income Approach (Net income/cash flow generated by the assets of the FLP) • May consider current earnings and cash flow of the FLP as well as projected future earnings and cash flow over a period of time and application of appropriate discount (DLOM) (No DLOC is necessary since CF capitalized or discounted is the amount available to the minority owner, and result is already a minority value) • Normally used where the FLP activity is an active, operating business • Discount rate developed based upon risk attributes of assets owned in the FLP and the required return on assets relative to comparable investments Income Approach
Issues with Income Approach Often, investment earnings or rental income may be low, but growth in asset values is high • Unless there is a plan to sell the assets at a certain point in future, the return to a minority owner is a low level of income that does not truly reflect the value of the assets Selection of discount/capitalization rate Be careful with number of years you are discounting/capitalizing • Many practitioners look to capitalize dividends, assuming an infinite life • Although many FLPs have 20 ‐ 30 year terms, many FLPs owning only real estate do not make it that long • Perhaps use a 5 ‐ year scenario and a 10 ‐ year scenario 17
Tax Affecting FULL ZERO TAX BLENDED CORPORATE C RATE TAX RATE 18
• Compares attributes of FLP to partnerships with similar attributes – determine appropriate valuation multiple (e.g., price to NAV), adjusted for risks specific to subject company, and apply appropriate discount (DLOM only) (Data is based on trades of minority interest. Therefore the result is a minority value) Market Approach
Determining Discounts Discount – Lack of Control Factors that may influence the discount (where applicable): • Types of assets held in the FLP • Professional management (marketable securities) • Diversification and size • Investment objective • Performance • Maturity of bonds • Amount of FLP’s debt (if any) • History of distributions (affects DLOM also) 20
Sources for DLOC o Closed ‐ end Funds o Partnership Profile Data 21
Determining Discounts A Closer Look at the Databases Closed End Funds A closed ‐ end fund is a publicly traded investment company that invests in a variety of securities, like stocks and bonds. The fund raises capital primarily through an initial public offering (IPO). CEF shares and the proceeds are invested according to the fund's investment objectives. "Closed" refers to the fact that, once the capital is raised, there are typically no more shares available from the fund sponsor and the issuance of new shares is closed to investors. 22
Closed End Funds Table Determining Discounts
Determining Discounts A Closer Look at the Databases Partnership Profiles Data • Data available at www.partnershipprofiles.com and PPI Annual Executive Summary Report • Partnership Profiles keeps track of resale transactions involving non ‐ controlling interests in non ‐ traded publicly held limited partnerships and REITS • Price ‐ to ‐ NAV discounts ranged from around 18% to 56% • Discount depends most on type of assets owned by partnership, on degree of cash distributions, and on amount of debt financing utilized by the partnership • According to PPI, most of this discount is due to lack of control • 10% discount is due to lack of marketability 24
Determining Discounts Limited Partnership Discounts (PPI Annual Studies):
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