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October 7, 2019

Why Care About Value vs. Price?

As professionals, we generally see entrepreneurs and closely held business owners do a great job of managing their business growth. What they sometimes don’t do a great job of is planning for what happens to the business after their death. Where does the business interest go upon the death of the owner? For what price? And at what value?

Why should we care about value vs. price? We should care because there is “price,”  which is the cost of purchasing shares from a decedent’s estate, and then there is “value,” which is the dollar value imputed to those same shares for estate-tax purposes. As you may have guessed, price and  value are not always the same. When they are, it’s great. When they’re not, it can spell trouble.

In many businesses, the owners have an agreement that upon the death of one shareholder, the surviving shareholder(s) or the business will purchase the deceased shareholder’s shares for an agreed-upon price. The agreement usually calls for the shareholders to agree upon a price—for instance, once a year—and record that price in the minute book or business records. That is the price the surviving shareholder(s) or the business will pay to the decedent’s estate for the shares.

For estate-tax purposes, however, tax authorities are not necessarily interested in the price. They care about the value of the shares and, in particular, the fair market value (FMV) of the shares as of the date of death. This FMV is the amount that will be taxed in the decedent’s estate despite the price paid to the decedent’s estate for the shares. When the FMV is above the price, the estate is taxed on a larger amount than it receives. In some extreme instances, the tax incurred can be even greater than the price paid. This outcome can be minimized or even avoided by engaging in some proactive planning prior to death.

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