Make sure your business is valued accurately

It seems only natural to claim the right to transfer our wealth and possessions to those whom we choose. In the event of our death, we expect that our legacy will be passed on to those we have named, whether a spouse, children, family, trusted friend or a favorite charity.

In this country, however, the right to transfer wealth is not without consequences. Wealth transfer is a taxable event on the federal level and in Michigan and most other states. This should be of particular concern for a business owner, especially if the business represents the majority asset in the owner' s personal estate.

If you own all or part of a business, you should be aware of how your interests have been valued. Have they been valued on a "best guess" basis and, if so, do you believe that "guess" represents a fair value should you decide to sell?

Or has the business worth been determined based on accepted accounting principles that use a prescribed formula to assess value? " Best guess" scenarios often invite IRS scrutiny and could result in the value of a business being disputed, which can lead to higher estate taxes.

Concern over the proper valuation of a business can be eased by using the accepted method of establishing a buy-sell arrangement to transfer the business to the desired party—usually a partner, family member, employee or competitor. Within this contractual agreement the value of the business assets will be fixed based on recognized accounting methods.

Typically, credible value assessments are developed using a formula or by applying accepted methods provided by a reputable accounting firm.

Reliable assessments, reviewed at least every other year and finalized at the time of transfer, are generally acceptable to governmental tax authorities. This also tends to smooth transfer of ownership and minimize delay in receiving payments equal to the true value of the assets at a time when it is often most in need.

Unfortunately, far too many owners and partners still have faith in an "arm' s length" agreement on the value of their business assets, which is essentially nothing more than belief in an unsupported guess. The consequences of unsubstantiated value can be severe.

Suppose, for example, you establish a buy-sell agreement but calculate the value of the business assets using the "arm' s length" method. Later, the IRS re-evaluates the assets and imposes higher estate taxes. As a result, you find the proceeds of the sale based on the " arm' s length" value are not sufficient to pay the increased taxes.

In many cases, costs of settling the estate require liquidating assets or borrowing against them. The fact that businesses tend to be illiquid (that is, not easily turned into cash) makes a strong case for pre-arranged agreements designed to provide sufficient funds to settle the estate without liquidation.

The business world is rife with stories that describe an estate transfer of significantly less value than anticipated or, in worst-case scenarios, no value at all.

Furthermore, just as it seems only natural to want to pass on your estate, you also want to maximize the amount your estate receives from the sale of your business while minimizing expenses and emotions involved.

A properly designed buy-sell agreement and an appropriate estate plan will work effectively to ensure a smooth process, but the value of the business in question should be as true and as accurate as possible.

No business owner plans to fail, but too many fail to plan. Don' t put off planning. Consult your financial planner, attorney, tax consultant or life insurance agent for more information on buy-sell agreements, estate plans or business valuation methods.

This article was written by Ron Gronevelt and Mike McDonald of AAA Michigan. AAA Michigan and its agents do not provide legal or tax advice.