Valuation Discounts

Incorporated businesses often encounter the need to determine the fair market value (“FMV”) of the company’s stock, for example where there is a sale or gift of the stock. Unlike publicly traded stock, the value of which can be determined easily on the Internet or in a newspaper, stock in a closely held business has a value that is more difficult to nail down. By definition, the shares are held by a much smaller number of people and are not widely traded.

Fair market value means the price at which property would change hands between a willing buyer and a willing seller when neither party is under any compulsion to buy or sell and both parties have a reasonable knowledge of relevant facts. Calculating the FMV of closely held stock generally starts with an estimate of the total value of the closely held company itself. Application of discounts (or premiums) to account for the specific circumstances of the company then reduces (or increases) the FMV of the stock.

The process is highly focused on the particulars of each business. For example, in a recent decision by the United States Tax Court, the starting point in valuation of a decedent’s minority interest in a closely held family corporation was easier to figure, because the corporation was a holding company with a portfolio of widely traded securities that had readily ascertainable values. But that market value was discounted by 10% to take into account a buyer’s lack of control over the company and by another 15% for lack of marketability of the shares.

The Internal Revenue Service likes to keep an eye on valuation discounts, since they lead directly to a reduction in tax liability. Federal statutes, regulations, and Revenue Rulings have shed light on the use of valuation discounts. IRS Revenue Rulings have identified the following list of some primary criteria for determining the valuation discounts for closely held stock:

nature and history of the business;
outlook for the economy and the specific industry;
book value of the stock and financial condition of the business;
earning and dividend paying capacities of the company;
goodwill or other intangible value of the enterprise;
sales of the stock and size of the block of stock to be valued; and
market price of publicly traded stocks of corporations in the same or similar line of business.

Although we are not experts in business valuation, we can provide you with advice and resources concerning valuation decisions. Contact us and give us an opportunity to assist you in building your enterprise.

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Valuation Discounts