A perfect storm for gifting…

Over the past few months, we have suffered gut-wrenching declines in the economy. Stock market volatility has been at all time highs, and we are in a recession. During stormy economic times like these, it is a natural reaction to want to hoard assets.

However, if you have a significant estate, now may be a great time to take advantage of gifting.

Under these volatile economic conditions, the fair market values of real estate, asset holding companies and operating companies have likely fallen. For estate planning purposes, business owners can benefit from this decline in value. When company values are low, owners can gift a larger percentage of their company and maximize the impact of estate planning.

Asset holding companies often hold investments in real estate or marketable securities. It is no surprise that asset holding company values are based on their net asset values, or the market value of assets less liabilities. The values of assets held by these entities have generally declined in the current economic environment. So, while values are depressed, it is a good time to gift interests in these entities.

Operating companies are companies that are engaged in a business other than holding assets for sale or rent. Two common methods of valuing an operating company are the market approach and the income approach. The market approach utilizes valuation multiples derived from market transactions to arrive at a company’s value.

The valuation multiples from most public companies and merger and acquisition transactions have also declined in the current market, causing closely held company values to fall. Under the income approach, estimated future cash flows are discounted to a present value. Due to the economic downturn, the amount of future cash flows has declined for many companies. In addition, there is additional risk associated with such cash flows. As a result, most operating company values are down, making this a good time to gift.

The discount for lack of marketability is applied in a valuation context because no market exists for minority interests in closely held companies. During periods of high volatility, investors prefer to hold liquid investments in lieu of illiquid investments. In other words, the discount applicable to illiquid investments typically increases.

Therefore, larger discounts for lack of marketability are applied to minority interests in closely held companies. These discounts cause minority interest values to be lower than they would be in a less volatile market environment and increase the estate benefits associated with gifting.

Today, it is not clear if the estate tax will go to zero in 2010 and resume at higher rates thereafter. Under President Barack Obama’s “Comprehensive Tax Plan,” estates over $3.5 million per person will be taxed at the 2009 level of 45 percent. In addition, Congress is considering proposals that could limit or even eliminate valuation discounts. These valuation discounts have a very positive impact on estate planning. With uncertainty surrounding the future applicability of minority and marketability discounts, once again, now is the time to gift.

Every storm eventually comes to an end – the economy and the market will inevitably rebound. Now is the time for business owners with significant estates to take advantage of the current volatile economic conditions and gift. When the economy strengthens and valuations begin to increase, you will be glad that you made the right decisions for your estate and for your heirs.

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