Here's a look, by advanced planning specialists, at valuation planning, a topic of great interest to anyone who wants to start to think about high-net worth market.
"Valuation planning" describes any technique used to affect the valuation of property or business interests for gift, estate, or generation-skipping transfer tax purposes.
Since the basis for valuation of assets for these purposes is fair market value, which is defined in the regulations as what a willing buyer would pay a willing seller – assuming both had knowledge of the relevant facts, it may be possible to undertake planning moves that can actually reduce the marketable value of the property, and thus reduce federal transfer taxes.
Valuing property for federal gift, estate, and generation-skipping transfer tax purposes is a complex and often uncertain process. Frequently, the taxpayer's valuation differs widely from the value established by the Internal Revenue Service. Courts are then asked to resolve the valuation question.
(Related: Legal Arrangements Other than Marriage)
Value is a variable upon which reasonable minds can and will continue to differ. But value is not determined by a mere flip of the coin. The use of careful and thorough appraisals by qualified experts, documentation of sales of similar property recently sold, and well-drawn arm's length restrictive agreements (such as a buy-sell arrangement) are effective tools in substantiating favorable values.
Moreover, an argument for a lower value for estate tax purposes will have a corresponding reduction in the step up in basis and ultimately result in higher income taxes when the property is sold. Valuation discounts are an important factor that must be considered when assets are placed into partnerships and tenancy in common. Eventually, the estate's personal representative will have to grapple with weighing and comparing the costs and benefits of saving estate or gift tax with the possible cost of higher income tax payable on capital gains — and the impact that decision will have on various parties.
Here are five ideas that can help ease you into learning more about valuation planning strategies.
1. The Section 7520 Rate
Annuities, life estates, reversions, remainders, and terms for years are valued according to a discount rate that changes monthly (the Section 7520 rate). The first step in valuing an annuity based on a life (or on the joint lives of two or more people), a life estate, or a reversion or remainder based on a life (or joint lives) is to convert one of the unknowns (the length of the lifetime involved) to a known (life expectancy). This is done by means of a mortality table, which, based on a study of the longevities of a large number of people over a selected period of time, indicates the expectancy of life (in years) for a hypothetical individual who represents the average experience at each age of life.
The second step is to determine a proper discount interest rate (the second unknown that should be attributed to the interest being valued). When that interest rate is determined, a valuation table can be constructed which converts the two factors to be applied, life expectancy and the rate of interest, into one factor to be applied to the amount of the periodic payment, to determine the present worth or value of the property interest.
Valuation must be based on the so called "Section 7520 rate". This is found with a two-step process. Step one is to compute 120% of the Applicable Federal Midterm Rate in effect for the month in which the valuation date falls. Step two is to round the result to the nearest 0.2%.
2. Commercial Annuities
Commercial annuities (annuities under contracts issued by companies regularly engaged in their sale) are valued by reference to the price at which the company issues comparable contracts. A retirement income policy, from the point in time that there is no longer an insurance element, is treated as a contract for the payment of an annuity.
