Valuation plays an essential role in any well-crafted estate plan. After all, the value of your assets at the time of transfer has a major effect on the tax implications of different estate planning strategies.
Many business interests and other assets have had their value impacted by the COVID-19 pandemic, and this may create some attractive opportunities for estate planning. However, these pandemic disruptions can also present a challenge for valuation professionals, and involving an experienced valuation expert in the estate planning process is now more important than ever.
New opportunities
The COVID-19 pandemic has depressed the value of many assets (oftentimes only temporarily), which makes it an ideal time to consider gifting them, either directly to family members or by placing them into other estate planning vehicles such as irrevocable trusts.
Since values are currently low, gifting these assets now will also allow you to minimize the use of your gift and estate tax exemption, keeping more of that amount available for future gifts or bequests. If your asset values fully rebound as the economy recovers, the beneficiaries of these gifts will enjoy significant growth outside your taxable estate.
Pandemic challenges
Unfortunately, COVID-19 has also created some unique challenges for those in the valuation profession. The pandemic differs from other recent economic crises in that most of the damage to the economy has been caused by business closures, travel restrictions, and other measures for stopping the spread of the virus.
This can present a number of challenges for business valuation, including:
Is pandemic fallout “known or knowable”? Generally, fair market valuations don’t consider “subsequent events,” meaning events that occur after the valuation date and weren’t “known or knowable” at that time. Although experts are generally in agreement that the pandemic wasn’t known or knowable as of December 31, 2019, the picture is less clear for valuation dates that come after that. Because of this, it can be difficult to determine whether the pandemic was known or knowable and whether this should be considered when valuing a business or other asset.
Impacts on valuation methods. Valuators usually consider all three of the major approaches to valuation: the income, market, and asset approaches. However, the pandemic may affect how appropriate each approach is and how much weight each approach should be assigned.
Market-based methods, for instance, may be less relevant in cases where the underlying transactions predate COVID-19, since these methods rely on data about actual transactions involving comparable businesses (however, it may still be possible to adjust to reflect the impact of the pandemic).
By contrast, income-based methods such as the discounted cash flow (DCF) method are now being emphasized by many valuators. Using the DCF method involves making a projection of a business’s future cash flows over a defined period (for example, over the next five years), then discounting these projections to present value. The DCF method is particularly useful at the moment because it allows for a good deal of flexibility: a business’s expected financial performance can be modeled based on current conditions while also incorporating assumptions about its eventual return to “normal” over the next few years.
It’s also important for valuators to make an assessment of a business’s available and expected cash needs and its future viability, regardless of the valuation methods they use. These considerations allow valuators to assess a business’s risk, which may have a significant impact on its value.
Need help with valuation?
Although the depressed value of certain assets during the COVID-19 pandemic has created some attractive opportunities for estate planning, other assets have remained unaffected or even increased in value. If you have questions about the valuation of your assets, contact us.