By Tom Marks
There is a common theme for business owners doing estate planning: They almost never understand what their business is worth. Few have ever had a formal appraisal done. Business owners rarely view their business as an asset like a home or a savings account. As a small business owner myself, I can appreciate why. Day to day, we generally focus on serving our clients, paying our bills and increasing revenue. Unless we are preparing to sell or retire, we rarely consider what our business is worth. We are blind to its market value. Unfortunately, if we die ignorant, at least two unintended consequences may result.
Equal treatment of family
Valuation is critical when figuring out “who gets what” in your family. If you have kids, you likely want to treat them equally. Often, however, only one will take over the business. If so, identifying the business’s value is necessary to achieving your goals. For instance, assume you have other assets worth $500,000 and a business worth $250,000. You have four kids, one of whom will get the business. If you split your $500,000 evenly, each kid gets $125,000, but the one inheriting the business gets a $250,000 bump. He ends up with $375,000 worth of assets - three times that of the others. Clearly, equal treatment is impossible when you don’t know your business’s value.
There is no one formula for determining value. Value is always a function of revenue averages, expenses, client stability and goodwill (name recognition), among other factors. I advise my clients to hire a certified business appraiser with experience marketing similar businesses. The cost depends, in part, on the purpose of the valuation and the requested detail. An appraisal done for purposes of a sale requires the most detail. In Massachusetts, I am accustomed to seeing such valuations cost $10,000 and up. However, appraisals for purposes of estate planning are often far less detailed. Generally, I see appraisers charge around $5,000.
Ah, yes, the “death tax.” Many jurisdictions literally tax you for owning “too much” when you die. Although Canada has no federal estate tax, the United States taxes estates valued at $5.5 million for an individual and $11 million for a couple. Not worried? Consider that 15 states have their own estate tax, usually with far lower thresholds. Massachusetts has one of the lowest thresholds ($1 million) whereas Maine and Delaware have the highest (about $5.5 million). The percentage tax escalates to 16% in most states.
Still not worried? Know that when calculating the value of your estate, all assets that you own or control are generally counted. This includes your property equity and even life insurance death proceeds (yes, the money you didn’t even have when you were living). Then, there is the value of your business. If a recent appraisal was not performed, one will be needed before filing your estate tax return. Not surprisingly, tax authorities don’t appreciate educated guesses.
As an illustration, let’s say you have $250,000 in savings, $150,000 in property equity and a $500,000 insurance policy. With a $900,000 estate, you would have no death tax liability wherever you lived. However, if your business appraises at $300,000, your estate could now be taxed. The liability in Massachusetts, for example, (with a $1 million threshold) would be about $56,000. Other states have similar rates. So, particularly in a state that has its own estate tax, it’s critical to know your business’s value.
Taking action and advantage
Thankfully, federal and state tax laws provide multiple planning opportunities. If your estate is “eligible” for death taxation, you can take advantage of these techniques to reduce and even eliminate the liability. An estate planning attorney can help you understand and leverage these options. Effective tax planning will require a proper business valuation. In addition to aiding your tax planning, the valuation will help ensure that any equal treatment plan for heirs yields the intended result. In my experience, the most effective plans for business owners result from a team approach quarterbacked by an estate planning attorney and flanked by an appraiser and CPA.
When it comes to your business’s value, ignorance is not bliss. Understanding valuation is critical for effective family planning and avoiding unintended tax consequences. We should all pay attention now so our family does not pay later.
Attorney Tom Marks specializes in business law and estate planning. Contact him at email@example.com.