Understanding the Role of Valuations in Gift Tax
When an individual gifts money or property to someone else in excess of the annual exclusion (other than their spouse), they must report it to the IRS by filing a Form 709, also known as the United States Gift (and Generation-Skipping Transfer) Tax Return, and may be required to pay gift tax.
For gifts of closely held and family-owned entities, business valuations are critical. These analyses and their related reports provide a detailed narrative of the assumptions and methodologies used to substantiate the value of the asset gifted. In this context, considering the business valuation from all angles is highly important, as any valuation report for gift tax filing is subject to IRS audit.
Key Elements of a Gift Valuation
Standard of Value
Business interests transferred for gift tax purposes are valued based on fair market value. This standard of value considers the price to be what a willing buyer and seller would agree on to transfer the business interest.
Regulatory Compliance Considerations
Valuations adhere to IRS revenue rulings, the Internal Revenue Code and precedents set by Tax Court decisions. IRS Revenue Ruling 59-60 outlines the approach, methods and factors that business appraisers must consider in valuations for estate and gift tax purposes, particularly stock or an equity interest in a closely-held private company. These factors include:
- The nature of the business and the history of the enterprise from its inception.
- The economic outlook in general and the condition and outlook of the specific industry.
- The book value of the stock and the financial condition of the business.
- The earning capacity of the company.
- The dividend-paying capacity.
- Whether or not the enterprise has goodwill or other intangible value.
- Historical sales of the stock and the size of the block of stock to be valued.
- The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over the counter.
Closely Held and Family-owned Entity Considerations
The gifting of business interests in closely held and family-owned entities often involves the transfer of assets that are illiquid and on a minority basis (i.e., the business interest holder doesn’t have the ability to control the business’s operations). In these cases, valuation discounts for lack of marketability and lack of control can reduce the taxable value of the gift.
IRS Audit Risk and Adequate Disclosure
Filing a Form 709 starts a three-year statute of limitations in which the IRS can conduct an audit of that return. While there are exceptions, generally the three-year statute of limitations will not start to run until a detailed list of conditions is met by the donor as reflected on the Form 709, also referred to as “adequate disclosure.” These requirements are listed in Regulation Section 301.6501(c)-1(f)(3) which include the following:
- A description of the transactions, including a description of transferred and retained interests and the method(s) used to value each.
- The identity of, and relationship between, the transferor, transferee, all other persons participating in the transactions, and all parties related to the transferor holding an equity interest in any entity involved in the transaction.
- A detailed description (including all actuarial factors and discount rates used) of the method used to determine the amount of the gift arising from the transfer (or taxable event), including, in the case of an equity interest that is not actively traded, the financial and other data used in determining value.
- Financial data should generally include balance sheets and statements of net earnings, operating results, and dividends paid for each of the five years immediately before the valuation date.
If a transfer of property is not adequately disclosed on IRS Form 709, then any gift tax imposed by the IRS on the transfer may be assessed at any time indefinitely. Further, valuation reports written for other purposes (e.g., 409A valuation reports) do not meet the definition of adequate disclosure under the IRS guidelines.
Advantages of a Valuation for Gift Tax Purposes
The IRS will read any report attached to a gift tax return, but assessing the value of the transferred business interest through an adequately disclosed valuation offers several benefits. These include:
- Establishing a statute of limitations for an IRS audit: After filing Form 709, the IRS only has three years to audit the valuation.
- Allowing appreciated assets to be excluded from a decedent’s taxable estate: Making lifetime gifts of assets today allows for post-gift appreciation to escape the taxable estate at death, which reduces estate tax liability for beneficiaries.
- Opportunity to minimize gift tax: Planning the gift strategy with your estate tax attorney and structuring the gift to involve minority equity interests will minimize the potential gift tax and maximize the amount of the gift by taking advantage of valuation discounts. A comprehensive business valuation will accurately determine the value of a gifted business interest and provide appropriate support to meet the adequate disclosure requirements. Giving at this amount allows you to pay the minimum amount of gift tax.
Gift Tax Rates and Exemptions for 2025 and Beyond
The federal gift tax starts at 18% but can reach 40% depending on certain gift amounts. In 2025, the annual exclusion from gift tax and the obligation to disclose the gift on Form 709 is for gifts in excess of $19,000 per donee, but only if the gift is a present interest. The IRS defines present interest as “the donee has all immediate rights to the use, possession, and enjoyment of the property or income from the property.” Because gifts to trusts are often viewed as future interests (where a beneficiary has access to the property at a future point in time), gifts to trusts generally do not qualify for the annual gift tax exclusion. Accordingly, a Form 709 must be filed if a gift exceeds the annual exclusion amount or if the gift does not satisfy the present interest requirement.
In 2025, the federal lifetime gift and estate tax exemption is $13.99 million per individual and $27.98 million for married couples. After P.L. 119-21, also called the “One Big Beautiful Bill Act,” these amounts for 2026 are $15 million per individual and $30 million for married couples. Once an individual’s cumulative lifetime taxable gifts exceed their lifetime exclusion, a 40% gift tax rate is assessed on each dollar value exceeding the exclusion.
Your Guide Forward
Navigating the complexities of gift and estate tax for family-owned and closely held businesses requires careful attention to strategic gift and estate tax planning strategies, including valuations as well as awareness of evolving changes in tax rates and exemptions. Engaging with experienced valuation professionals and legal advisors can help tailor those strategies not only to ensure compliance with IRS regulations but also to help individuals minimize their tax liabilities and plan effectively. When you need proof of valuation, our Valuation practice is ready to assist.
