Valuation discounting techniques can be effective tools to transfer wealth between generations and minimize estate taxes.
The Valuation Process
To utilize any discounting strategy properly, you should first obtain an appraisal of the assets to be transferred from a valuation specialist. This professional appraiser will
determine the value of the business, stock portfolio, real estate, or other assets subject to the proposed transaction based on such factors as closing stock prices, anticipated
future earnings, marketability, and the value of underlying tangible assets.
The Discount Process
The appraiser will then determine a specific discount percentage based on factors such as lack of control (minority discounts) or lack of a market for the transferred assets (marketability
discounts). The rationale for a minority discount is that a willing buyer would pay less for an asset in which he or she would not control management, the right to receive income,
or the right to sell the underlying assets. Marketability discounts apply when there is a limited market of potential buyers for the transferred interest, as compared to the underlying
Implementing Valuation Discounts
There are several estate planning strategies that utilize valuation discount planning. Two of the most popular and recognized techniques are the family limited partnership (FLP)
and the grantor retained annuity trust (GRAT).
Family Limited Partnership (FLP): This strategy reduces gift taxes on outright gifts, be it private investments or family
businesses. A FLP is frequently used to shift future appreciation to the family's next generation. Typically, the parents either sell or gift limited partner interests in the FLP
to the children (or grandchildren) while retaining general partner interests. As the general partner(s), the parents retain the power to control the underlying assets and all partnership
distributions. However, the value of the limited partnership interest is no longer considered part of the parents' estate and, thus, avoids estate taxes when the parents die.
Grantor Retained Annuity Trust (GRAT): The GRAT is another type of transfer that is best utilized for the sale of a business or investment assets. The GRAT provides a fixed
annual payment for a term of years in exchange for transferring property to an irrevocable trust. The gift is taxed at the time of the original transfer, determined by subtracting
the present value of the retained annuity payments from the fair market value of assets contributed. Most planners design the annuity payments on a present value basis to equal
the value of the assets contributed. At the end of the trust term, the remaining assets in the trust, if any, pass to the trust beneficiaries with no estate or gift tax. However,
if the transferor dies during the term of the trust, all trust assets will be included in his or her estate for estate tax purposes.
Planning in a Down Market
In addition to potential discount-repeal legislation, the recent decline in the stock market has created another reason to take advantage of valuation discount estate planning
sooner rather than later. The decline in value may have created an inherent discount from the stock's long-term value.
For example, assume you have stock that has significantly declined in value in the past year. By using the stock with a depressed value as part of an estate planning strategy that
also involves valuation discounts, you could leverage the amount of future appreciation transferred to your children, and at the same time significantly reduce the estate and gift
tax cost of the transfer.
With estate tax reform legislation a hot topic of discussion in Congress and the Bush Administration, it is possible that opportunities to take advantage of the tremendous benefits
of valuation discount planning may substantially diminish over the next several months. Concerned investors may want to take advantage of this special estate planning technique
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Charles M. Bloom, Registered Principal offers securities
and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.
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