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Down and out Featured

6:01am EDT May 30, 2003
Business owners thinking about passing their company on to the next generation may find a silver lining in this down economy -- lower sales and revenue often mean that a business' stock or value is also lower.

Lower value, albeit usually not a good thing, can work in favor of family owned businesses looking to transfer ownership to the next generation.

"Now is a good time to be thinking about succession, in part because the economy is down," says Cindy Johnson, an accountant at Bober, Markey, Fedorovich & Co.

The benefits are apparent when drafting a succession plan and gifting stock.

"There is a big opportunity in term of gifting," Johnson says. "We are looking at the historical income stream to see the value of the business, and the last few years for many haven't been so good. Because of these poor results, parents can gift more shares of the business to their children."

And if planned correctly, gifted shares of stock may also be discounted to less than the fair market value.

"It's a great tool ... it helps keep the value down and is recognized by the IRS," says Johnson.

Valuation discounting requires an analysis of the fair market value of the assets, then discounts on those assets can be applied elsewhere.

One discount applies to family limited partnerships, in which senior family members contribute assets (shares or stock) to the partnership but retain control.

And while a parent can transfer the entire value of a business into a limited family partnership, the benefit is greater if only a minority, noncontrolling share is transferred, allowing the assets to be discounted according to minority interest rule.

"It is one of the big things in wealth preservation," Johnson says. "What kind of position is (the business owner) in, and what is the value of the assets and the liquidity of those assets?"

The discounts correspond with the degree of influence the shareholder has in the company and normally will not exceed 25 percent to 30 percent.

There is also a discount for the lack of marketability derived by comparing the value of publicly-traded stock with privately-held stock.

"Smaller, closely-held businesses don't have the same access to the marketplace," Johnson says. "If I own shares in IBM and I want to sell them, I just call my broker and sell ... If I'm invested in a smaller company, the market is different."

Discounting done properly and within IRS guidelines can save a succession plan almost 50 percent of its value.

Johnson cautions, however, that navigating the legal, tax and financial challenges of succession planning is just part of the story. Succession and valuation are as much emotional as quantitative for those who spent their lives building a business.

"It's not just preparing the younger generation for taking over the company, but preparing the founder to step aside," she says.

And devaluing someone's life work can be emotionally charged.

"It is a very big deal," Johnson says. "In many cases, it is the scorecard of someone's life." How to reach: Bober, Markey, Fedorovich & Co., (330) 762-9785 or www.bobermarkey.com

Good value

In recent years, the IRS has increased its audit activity for gifts of limited partnership interests in an effort to attack perceived abuses of the use of discounts.

Also, the IRS has disallowed a discount when a family limited partnership was formed shortly before the death of an individual, ruling in those cases that the partnership was an artificial attempt to depress the value of the individual's assets.

To keep the IRS from disqualifying your valuation, it's a good idea to follow some basic guidelines, especially when valuating a business.

According to the IRS, a qualified appraisal:

* Is not done earlier than 60 days before the transfer date.

* Is prepared, signed and dated by a qualified appraiser.

* Includes a description of tangible assets transferred, with any terms of conditions, and the appraiser's full name.

* Lists the appraiser's qualifications.

* States that the appraisal was performed for income tax purposes.

* Provides a date and method of valuation.

* Reveals the fee arrangement between donor and appraiser.