How Marketability Discounts Can Improve Your Estate Plans

If you’re an entrepreneur, you’ve poured time, energy, and money into your business. It’s only natural that you’d want it to outlive you. However, passing on ownership of a privately-owned company can be significantly more complicated than other types of inheritances. If you’re not careful, your estate plan can put your company and beneficiaries at risk of large tax penalties.

That’s where marketability discounts come in. These tax discounts are invaluable for protecting privately-held businesses from excessive inheritance taxes. However, you need to prepare for the discount in advance to achieve the best results. 

Understanding Marketability Discount for Estate Planning 

A marketability discount, or discount for lack of marketability (DLOM), is a reduction of the taxable value of a company compared to its actual worth. It is applied to the non-controlling interest of privately held companies to account for the fact that there is relatively little market for these interests compared to publicly traded companies. 

All businesses have a financial value. For publicly traded companies, the value is usually identified by multiplying the selling price of its stock by the number of shares issued. However, that isn’t possible for privately held companies. Instead, professional appraisers value them based on their revenue, earnings, book value, or liquidation value, depending on the industry and circumstances. 

The problem is that selling off non-controlling interest in a privately held company for its full value isn’t easy or even possible. Without a market, a seller may not be able to find anyone willing to pay “full price” for their interest in the company, especially without offering control over it. Instead, they may need to sell it for significantly less than its worth or wait months or even years to find a buyer. In short, the non-controlling interest lacks marketability.

That’s why the IRS offers DLOMs. These discounts reflect the difficulty of selling non-controlling private business interests for full price. They adjust the taxable value of the business by anywhere from 30-50% based on factors like industry, economic performance, and comparisons with similar companies. 

Benefits of Marketability Discount for Estate Planning 

If you own a business, you should always consider DLOMs in your estate plan. If you are properly prepared, you can:

  • Reduce inheritance taxes by appropriately discounting the business’s value
  • Ensure fair distribution of the assets by accounting for the company’s actual worth
  • Avoid lengthy probate battles with the IRS by providing a clear and well-documented explanation for the DLOM on your estate taxes

In other words, accounting for DLOMs can save your beneficiaries time, money, and legal hassle when executing your will.

How to Predict a Marketability Discount for Estate Planning 

There are two ways you should account for a DLOM in your estate plan. First, you should predict the eventual discount, so you know the total value of what you will pass on to your beneficiaries. Second, you should document how you calculated the estimated DLOM to support your executor if the IRS comes knocking. 

Calculating a marketability discount is a long and complex process. Here’s how to get started: 

  • Consulting an Attorney: When preparing financial documents for your estate plan, consult a skilled attorney to learn how it could affect your beneficiaries.
  • Performing an Accurate Valuation: Your attorney and financial advisors will assist you with choosing the appropriate valuation method and determining your business’s gross value.
  • Calculating the DLOM: Your financial advisors will perform a restricted stock, pre-IPO, or option pricing study to determine how large of a discount to apply to the total value of your company. Their reasoning and associated calculations will become part of your estate plan.

Your attorney will use this information to advise you on the best way to minimize taxes and achieve your goals for your estate after you pass. They will also help you update your plan whenever something affects the value of your business or the DLOM.

Learn More About Estate Planning for Entrepreneurs

Marketability discounts are just the tip of the iceberg when it comes to estate planning as an entrepreneur. If you want to pass your business onto the next generation, consider working with an experienced estate planning attorney like the experts at The Dayton Law Firm P.C. We have spent decades advising California business owners on protecting their assets and their families’ financial futures. Schedule your planning appointment today to learn how we can assist you with your estate.