Discounting the Business Interests To Transfer Wealth

April 13, 2006

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Now that we've discussed the entity form (the family limited liability company) best suited for transferring business interests to the family, it's time to explain how best to make those transfers.

A transfer (in excess of the $12,000 annual exclusion per person) will reduce the $1 million lifetime gift tax exemption allowed under federal estate tax laws. This is where "discounting" becomes an important part of the transfer strategy when planning for estate taxes.

The ability to control the business has value. The interests transferred lack the ability to control the business. Consequently, the value of the transferred interests will be "discounted," or lower in amount. Thus, the transferred interest will use up a smaller portion of the exemption.

Warning

Discounts due to a lack of control and marketability should be documented by an appraisal. Law and accounting firms, as well as banks, provide this type of service. While there is a cost involved in obtaining an appraisal, the cost is usually more than offset by the estate tax savings.

The interests also will be discounted because of a lack of marketability. The interests in a closely held business are not worth as much as similar interests in a publicly traded company, because there is no established market in which the interests can be sold. Discounts typically range from 10 percent to 50 percent (see our case study on transferring LLC interests to the family).