Business Valuation for Estate Planning: What Owners Need to Know

For many business owners, the company represents the largest asset in their estate. A $10 million business can trigger federal estate taxes of $4 million or more if not planned properly. Yet the same business, valued and transferred strategically, might pass to the next generation with minimal tax burden.

As discussed in our Complete Guide to Business Valuation for Owners, valuation is both art and science. For estate planning, the stakes are high because the IRS actively scrutinizes these valuations, and getting them wrong can result in penalties and litigation.

Fair Market Value vs. Fair Value

Estate and gift tax valuations use the "fair market value" (FMV) standard. The IRS defines this as the price property would change hands between a willing buyer and seller, neither under compulsion, both with reasonable knowledge of relevant facts.

• Hypothetical transaction: FMV assumes an arm's-length transaction between unrelated parties
• Specific date: FMV is determined as of a specific valuation date
• Discounts applicable: FMV allows minority and marketability discounts

"Fair value"—used in shareholder disputes and financial reporting—is different. Fair value typically does not apply discounts, resulting in higher values. For estate planning, you want fair market value with appropriate discounts applied.

Valuation Discounts: DLOM and DLOC

Two discounts can significantly reduce fair market value for estate and gift tax purposes.

Discount for Lack of Marketability (DLOM)

Private company shares cannot be easily sold on a public market. This illiquidity reduces value. Typical range: 15-35%. Factors include transfer restrictions, holding period, and dividend policy.

Discount for Lack of Control (DLOC)

Minority interests cannot declare dividends, hire management, or sell the company. This lack of control reduces value. Typical range: 10-30%.

Gifting Strategies

Annual Exclusion Gifts

Gift up to $18,000 per year per recipient (2024) without using lifetime exemption. A married couple can gift $36,000 annually to each child. With valuation discounts, you transfer more proportional value than the gift tax amount.

Lifetime Exemption Gifts

The federal lifetime exemption is $13.61 million per person (2024). Larger gifts use this exemption. Critically, all appreciation after the gift passes outside your estate tax-free.

Estate Freeze Techniques

Freeze techniques lock the value in your estate while transferring future appreciation to heirs.

Grantor Retained Annuity Trust (GRAT)

Transfer assets to a trust while receiving fixed annuity payments. Growth exceeding the IRS assumed rate passes to beneficiaries tax-free. Can be structured with minimal gift tax value. Risk: if you die during the term, assets return to estate.

Intentionally Defective Grantor Trust (IDGT)

Sell business interests to a trust for a promissory note. No capital gains on the sale. You receive note payments; appreciation goes to beneficiaries. You pay income tax on trust earnings, further reducing your estate.

Family Limited Partnership (FLP)

Parents retain general partner interest (control) while gifting limited partner interests (economic value) to children. Limited interests qualify for DLOM and DLOC discounts.

For more on succession and estate planning integration, see our guide on Family Business Finance.

Documentation Requirements

Without adequate documentation, the IRS can challenge your valuations, resulting in additional taxes and penalties.

Qualified Appraisal Requirements

• Qualified appraiser: Must meet IRS education and experience requirements
• Written report: Detailed analysis supporting valuation conclusion
• Methodology disclosure: Clear explanation of approaches used
• Discount support: Specific justification for DLOM and DLOC

Timing

• Gift tax: Valued as of transfer date
• Estate tax: Valued as of date of death
• Ongoing gifting: Update valuations annually

When You Need a 409A-Style Appraisal

Section 409A applies to stock option grants, not estate planning directly. However, understanding the differences matters:

• 409A: Stock option strike prices, typically DLOM only, valid 12 months
• Estate valuation: Gift/estate tax compliance, DLOM and DLOC, point-in-time

You may need separate valuations for different purposes. Don't assume one serves all. Discuss with your valuation professional and tax advisors to ensure appropriate support for each transaction.

Choosing an Appraiser

• Credentials: ASA, ABV, or CVA designation
• Experience: Specific estate and gift tax valuation experience
• Independence: Must be objective and defensible