Estate and Gift Valuation Planning in the 2020 Election Year
Executive Summary
Recent estate planning articles are full of speculation about potential tax changes related to the upcoming 2020 US election. Here is the one consensus piece of advice observed from numerous articles by reputable tax planners and professional advisors:
Use your lifetime gift tax exclusion now if you can afford it.
Making gifts of appreciating property, such as privately held stock and business interests, is a popular choice for tax and succession planning reasons.
Introduction
The results of this year’s national elections could have a big impact on tax planning depending which party wins the White House, the Senate, and the House of Representatives. We surveyed tax planning articles considering the 2020 election by The American College of Trust and Estate Counsel, private banks, law firms, CPA firms, and others. All generally agree that planning for the possibility of increased tax rates, whether income, capital gains, or estate and gift taxes, is prudent.
Proactive planning does not necessarily require immediate or major changes to existing estate plans. According to several sources, election day marks the beginning of in-depth planning, not the deadline. However, all agree that using the lifetime gift tax exclusion, especially in the current low interest rate environment, is worth serious thought before the end of 2020.
Estate and Gift Tax Exclusion
The lifetime gift tax exclusion is currently $11.58 million – double the “permanent” estate tax gift exemption – and it is scheduled to sunset back to the inflation indexed permanent level in 2026. Fortunately, “the IRS clarified that individuals taking advantage of the increased gift tax exclusion amount in effect from 2018 to 2025 will not be adversely impacted after 2025 when the exclusion amount is scheduled to drop to pre-2018 levels.”[1] The concern voiced by advisors to high-net-worth individuals and families is that certain election outcomes, plus budgetary pressures from the COVID-19 pandemic, could lead to the gift tax exclusion sunset being moved earlier – perhaps as early as 2021.
For people who can benefit from the increased exemption, advisors often recommend gifting appreciating assets such as privately held stock, carried interests in private investment funds, and other high-growth investments. The use of trusts, including the charitable lead annuity trust (CLAT) and the grantor retained annuity trust (GRAT), are frequently used in estate planning to further minimize taxes on large gifts to family members. GRATs are especially attractive and work best when interest rates are low (like now) as we discussed in our post “Why You Should Think About a GRAT Today.”[2] Of course, we always recommend consulting with your legal and tax advisory team about the best strategy for your circumstances.
Importance of Qualified Appraisals
When gifting privately held business interests, timely and high-quality valuations are critical. Valuation misstatements can lead to the application of substantial tax penalties by the IRS, which may be mitigated by a qualified appraisal. The IRS spells out the repercussions on its website as follows:
If a misstatement results in an underpayment of tax of more than $5,000, an addition to tax of 20% of the underpayment can apply. The penalty increases to 40% if the value or adjusted basis reported is a gross valuation misstatement.
The IRS may waive all or part of the 20% addition to tax (for substantial valuation overstatement) if the following apply.
The claimed value of the property was based on a qualified appraisal made by a qualified appraiser.
In addition to obtaining such appraisal, the taxpayer made a good faith investigation of the value of the contributed property.
No waiver is available for the 40% addition to tax (for gross valuation overstatement).[3]
In relation to the 20% tax exemption circumstances discussed above, here is further guidance from the IRS on what defines a qualified appraiser follows (emphasis added).
Section 170(f)(11)(E)(ii) provides that the term “qualified appraiser” means an individual who (1) has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements set forth in regulations prescribed by the Secretary, (2) regularly performs appraisals for which the individual receives compensation, and (3) meets such other requirements as may be prescribed by the Secretary in regulations or other guidance. Section 170(f)(11)(E)(iii) further provides that an individual will not be treated as a qualified appraiser unless that individual (1) demonstrates verifiable education and experience in valuing the type of property subject to the appraisal, and (2) has not been prohibited from practicing before the Internal Revenue Service by the Secretary under § 330(c) of Title 31 of the United States Code at any time during the 3-year period ending on the date of the appraisal.[4]
Summary
In a year already full of seismic changes, the 2020 national elections ensure the fourth quarter will not allow the year to slip quietly into the past. Regardless of the election’s outcome, this is a good time to revisit estate plans and tax mitigation strategies. Advisors agree now is a good time to take advantage of the increased lifetime gift tax exclusion. Quality business valuations are key components of successful estate planning, incentive stock programs, succession planning, and tax compliance.
About the Author: Brian M. Alwine, CPA, ASA has 20 years of experience in business valuation. He has worked with hundreds of clients across the USA, ranging from small privately held companies to large public companies in many industries. Brian is a Director with Redwood Valuation, a boutique business valuation firm with a focus on serving venture capital and private equity clients nationally.