With a new executive team in the White House, the Biden administration has proposed changes to the federal estate tax rate and exemption. Significant changes to estate tax laws are part of proposed legislation for individuals and families. These changes, combined with the current low-interest-rate environment, create an urgent opportunity to plan now for issues such as a reduction in the lifetime estate and gift tax exemption.
As of 2021, the exemption is $11.7 million per person, which is scheduled to return to $5 million in 2026. The Biden administration has proposed reducing the estate tax exemption to $3.5 million and increasing the estate tax rates. Many individuals, particularly small business owners, are interested in preparing their estates under the current provisions before the Biden proposals are enacted.
In addition to the timing of reducing exemptions, business owners can benefit from uncertainty in the economy caused by the global pandemic. The economic impact resulting from the pandemic has affected us all -- but not all of us equally. While the public markets have done well during the pandemic, many privately-held businesses were adversely impacted. The return to normalcy is much more uncertain for these businesses, increasing their risk and possibly decreasing the value of their companies.
Several current economic issues impact business valuations. The existing economic environment may benefit owners of privately held businesses and their estate planning since lower valuations may increase current estate opportunities, and perhaps even more so if the Biden administration's proposals are enacted.
Typically, estate planning for a privately held business involves transferring only a portion of the equity in the company. The interest in the business being transferred is usually a minority, non-marketable interest, meaning it does not have ultimate control over the direction of the business, nor is it readily marketable to another party. Both factors may increase the risk for whoever is transferring the interest in the company, therefore lowering the pro-rata valuation. Under the current estate tax exemptions, the lower valuation allows for a more significant percentage of the business to be included as part of the estate planning.
High-net-worth individuals who own privately held businesses and looking to maximize their estate tax exemptions may have a smaller window of opportunity due to recent proposals to change the level of exemptions.
They say nothing is certain in life but death and taxes. And while you cannot prevent either one, you can certainly plan for both.
Valuations are likely to increase as economies emerge from the current conditions caused by the global pandemic. So now, more than ever, you need to review your estate plan and how the current economic environment has affected your business's value.
To discuss business valuation services with Brinker Simpson, please contact Michael Simpson, CPA, CVA, Partner, at msimpson@brinkersimpson.com.