Valuing Private Company Interests for Gifting and Estate Planning

Why this matters

Transferring ownership in a private company—by gift, trust, or at death—often triggers gift or estate tax reporting and can affect heirs’ financial control. The IRS requires fair market value (FMV) to be reported on gift tax returns (Form 709) and estate tax returns (Form 706). A defensible valuation reduces audit risk, supports tax positions, and helps families avoid disputes over perceived unfairness. (See IRS guidance on reporting gifts and valuation: https://www.irs.gov/forms-pubs/about-form-709 and general business valuation information: https://www.irs.gov/businesses/small-businesses-self-employed/business-valuation.)

Background in practice

In my practice working with privately held business owners and estate planners, I’ve seen valuations saved or cost estates tens to hundreds of thousands of dollars when properly documented and prepared in advance. Historically, valuators relied on rules of thumb (multiples of revenue or earnings). Modern practice requires multiple approaches and careful adjustments for ownership restrictions, lack of marketability, minority interest discounts, and unique company facts. Professional appraisals should follow industry standards (USPAP) and commonly accepted tax precedents, including Revenue Ruling 59-60 for valuation principles. For standards and professional credentials see the Appraisal Foundation (USPAP) and American Society of Appraisers (ASA) (https://appraisalfoundation.org/; https://www.appraisers.org/).

Core valuation methods

A defensible valuation typically considers at least two of the three primary approaches:

• Income approach (Discounted Cash Flow, DCF): Project company cash flows and discount them to present value using an appropriate discount rate that reflects business and owner-specific risk. DCF is preferred when reliable forecasts exist.

• Market approach: Use guideline public company multiples (adjusted for private-company differences) or recent transactions in the industry. For small, local businesses, comparable private transactions are most useful when available.

• Cost approach: Reconstructive or adjusted net asset method. Best for asset-heavy or early-stage businesses with limited earnings history.

Each method produces a value range. The final FMV is a weight-of-evidence conclusion grounded in facts, not a single formula.

Adjustments unique to gifting and estate situations

Two adjustments frequently affect the per-share value in transfers between family members or to trusts:

• Control vs. minority interest: Minority ownership interests generally carry a discount because they lack the ability to direct operations or distributions. Conversely, a controlling interest may command a premium.

• Lack of marketability discount (LMR): Shares in private companies are harder to sell than public company stock. LMRs quantify the value reduction for restricted liquidity. Empirical studies and transaction data inform reasonable ranges.

• Other specific reductions or premiums: Restrictive buy-sell agreements, voting provisions, and transferable rights all affect value.

A classic estate planning technique is to combine discounts with lifetime gifts to move future appreciation out of the taxable estate. For more on discount strategies for family gifting see our guide on Valuation Discounts for Family Business Gifting: https://finhelp.io/glossary/valuation-discounts-for-family-business-gifting/.

Practical step-by-step process

1. Clarify the purpose and valuation date. The FMV date for gifts is typically the date of transfer. For estate tax, it is generally the date of death, though alternate valuation can apply in narrow circumstances (see IRS Form 706 guidance).
2. Gather data: financial statements (3–5 years), tax returns, projections, cap table, shareholder agreements, recent transactions, and market/comparable data.
3. Select appropriate methods: choose the income, market, or cost approaches based on company facts.
4. Perform analysis: DCF modeling, comparable multiples, and asset reconciliations. Document assumptions and sources for discount rates and multiples.
5. Apply ownership adjustments: control/minority and marketability adjustments backed by precedent or empirical studies.
6. Compile a written appraisal report: include methodology, calculations, supporting exhibits, and a clear statement of the concluded FMV with the valuation date and scope.
7. File tax forms and retain documentation: attach supporting appraisals or include appraiser details when required (large noncash gifts, charitable gifts, or other situations). Retain backup for audits.

Example calculations (simplified)

• DCF example: expected free cash flow $500,000 annually, long-term growth 2%, discount rate 10%. Present value of perpetuity ≈ 500,000 / (0.10 – 0.02) = $6.25M before adjustments. If ownership is a 20% minority interest with a 25% combination discount (minority + lack of marketability), the minority interest value ≈ $6.25M * 20% * (1 – 25%) = $937,500.

• Market approach example: comparable company EBITDA multiple of 6x. Company EBITDA = $600,000 → enterprise value $3.6M. Subtract net debt and then apply minority/LMR discounts to derive FMV for the transferred interest.

These simplified examples illustrate how method choice and discounts materially change reported values.

Documentation that strengthens defensibility

• Workpapers: spreadsheets, projections, and sensitivity analyses.
• Third-party support: market data subscriptions, database extracts for comparables, and studies on discount ranges.
• Qualified appraiser’s report: include the appraiser’s credentials, scope limitations, and reliance on professional standards (USPAP). The IRS often gives more weight to valuations prepared by credentialed business appraisers.

When to use a professional appraiser

Engage a qualified business valuation professional when:

• The transfer involves significant value or complex ownership terms.
• You plan discounts that will materially lower taxable value.
• The gift or estate is likely to be audited or challenged.
• The recipient is a charity and substantiation rules (Form 8283) may apply.

Qualified experts hold credentials such as ASA (Accredited Senior Appraiser) or ABV (AICPA Accredited in Business Valuation). Appraisers should follow USPAP and be familiar with tax-court precedent.

Common mistakes and audit triggers

• Relying on uninformed rules of thumb (e.g., arbitrary revenue multiples).
• Failing to document assumptions and data sources.
• Misapplying discounts without supporting empirical evidence.
• Using inconsistent dates (valuation date vs. tax reporting date).

Audit risk can be reduced when the valuation is conservative, well-documented, and prepared by a recognized professional.

Coordination with estate planning strategies

Valuations should be coordinated with estate plans and gifting strategies (GRATs, FLPs, trusts). Proper valuation timing and documentation support strategic moves—such as making lifetime gifts in years with lower asset values or using valuation discounts to amplify transfers. For broader gifting and liquidity context, see Lifetime Gifting Strategies with Valuation and Liquidity Considerations: https://finhelp.io/glossary/lifetime-gifting-strategies-with-valuation-and-liquidity-considerations/ and review your estate-planning checklist for business owners: https://finhelp.io/glossary/estate-planning-checklist-for-business-owners/.

Best-practice checklist before a transfer

• Obtain 3–5 years of financials and current projections.
• Engage a credentialed business appraiser early—don’t wait until closing.
• Review and, if needed, update shareholder agreements and buy-sell provisions.
• Keep contemporaneous records of discussions, valuations, and tax filings.
• Reassess valuation periodically (every 3–5 years or after material events).

Audit defense and post-transfer tips

If the IRS questions a valuation, a robust defense includes the original appraisal, workpapers, and the appraiser’s qualifications. Consider obtaining a preemptive valuation review or second opinion for high-value transfers. For charitable gifts, follow IRS substantiation rules and include qualified appraisal details when required (see IRS rules on appraisals and charitable contributions).

Final recommendations

Valuing private company interests for gifting and estate planning is both an art and a discipline: it requires rigorous analysis, careful documentation, and experienced judgment. I recommend partnering early with a qualified valuation professional and your estate tax counsel to design transfers that meet your legacy goals while minimizing tax surprises.

Disclaimer: This article is educational and not individualized tax, legal, or investment advice. Consult a qualified tax advisor, estate planning attorney, or accredited business appraiser before making gifting or estate decisions. Authoritative resources: IRS Form 709 and Form 706 instructions (https://www.irs.gov/forms-pubs), Revenue Ruling 59-60 (valuation principles), the Appraisal Foundation (USPAP) and the American Society of Appraisers (https://appraisalfoundation.org/; https://www.appraisers.org/).