Valuation and estate planning go hand in hand. After all, the tax implications of various estate planning strategies depend on the value of your assets at the time they’re transferred.
The COVID-19 pandemic has had a significant impact on the value of many business interests and other assets, which may create some attractive estate planning opportunities. It also presents unique challenges for valuation professionals. As a result, it’s more important than ever to involve experienced valuation experts in the estate planning process.
What are the opportunities?
With the value of many assets depressed (in many or most cases temporarily), now may be an ideal time to gift them, either directly to family members or to irrevocable trusts and other estate planning vehicles. Transferring assets while values are low also allows you to use as little of your gift and estate tax exemption as possible, maximizing the amount available for future gifts or bequests. As the economy fully recovers and assuming your asset values rebound, your beneficiaries should enjoy substantial growth outside your taxable estate.
What are the challenges?
The pandemic has created a situation that’s truly uncharted territory for the valuation profession. Unlike other economic crises in recent years, most of the damage to the economy resulted from business closures and restrictions and other measures designed to help contain the virus.
For business valuations, the current environment presents several challenges, including:
Known or knowable. A fair market valuation generally doesn’t consider “subsequent events” — that is, events that occur after, and weren’t “known or knowable” on the valuation date. Experts generally agree that the COVID-19 pandemic wasn’t known or knowable as of December 31, 2019. Yet for valuation dates after that, determining whether the pandemic was known or knowable and should be considered in valuing a business or other asset can be a formidable task.
Valuation approaches. Generally, valuators consider all three of the major valuation approaches: the income, market and asset approaches. The pandemic may affect the relative appropriateness of each approach and the amount of weight they should be assigned.
For example, market-based methods, which rely on data about actual transactions involving comparable businesses, may be less relevant today if the underlying transactions predate COVID-19 (although it may be possible to adjust to reflect the pandemic’s impact).
Many valuators are emphasizing income-based methods, such as the discounted cash flow (DCF) method, which involves projecting a business’s future cash flows over a defined period (such as five years) and discounting them to present value. The advantage of DCF is that it provides a great deal of flexibility to model a business’s expected financial performance based on current conditions as well as assumptions about its eventual return to “normal” over the next several years.
Regardless of the method or methods used, it’s important for valuators to consider a business’s available cash and expected cash needs to assess its viability as a going concern. These considerations will be critical in evaluating a business’s risk and the impact of that risk on value.
What’s it worth?
Depressed asset values can create attractive estate planning opportunities. While the pandemic has dropped the value of some assets, others haven’t been affected or have even increased in value. Contact us with questions regarding the valuation of your assets.