The year started with a proverbial “BANG” from an estate planning perspective with the passage of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 late last year. The Act, as some have named TRUJCA, could almost just as easily been titled “Estate Tax Repeal.” Regardless of the name, the new rules certainly have people talking about the numerous planning opportunities it affords, although those may be temporary.
The new law raises the estate and gift tax exemption to $5 million and sets the top tax rate at 35%. In addition, the Act provides a new portability element for married couples. Under the new guidelines, the death of one spouse enables the surviving spouse to use the deceased spouse’s unused estate tax exemption upon the remaining spouse’s death. There are several steps the surviving spouse must take in order to claim the benefit but the availability of portability is certainly a significant change.
Impact on Estate Tax Planning
During a recent conference on estate tax planning, there were numerous discussions about how to use these changes to implement certain estate tax planning techniques. The use of entities such as limited partnerships (LPs) and limited liability companies (LLCs) was central to many of the discussions and a key concern was valuation. In several of the conference sessions, valuation was mentioned multiple times as a critical component of any planning in which these sophisticated techniques are applied. We agree, but don’t believe that the change in the tax law impacts the necessity of obtaining a well-reasoned, independent valuation. An independent valuation, in our estimation, has always been important.
Valuation of these types of entities has evolved significantly over the last decade (the same period during which the estate tax laws have been “temporary”). Valuation of holding-type entities like LPs and LLCs is no longer simply an application of discounts based upon observed transactions of similar entities, as was common in 2001 when the last big tax act was passed. Valuation now revolves around required rates of return more explicitly than ever before. That is, rates of return were always the drivers of the “right answer,” but rarely was the analysis expressed that way. Today, the analysis of interests in these entities is much more clearly tied to market rates of return that reflect the risks of investing in such interests.
When experts state that a strong valuation is vital to successfully implementing an estate plan utilizing these planning techniques, we can only assume that strong means well-reasoned, independent and applying current financial theory. Just as the changes in the estate tax has many more features than those mentioned here, the valuation of the entities commonly used in effectuating sophisticated estate plans has many more facets. However, unlike the new estate tax rules, which are set to expire in two years, the financial theory behind the valuation principles is long-lasting.