Fair market value.
Property included in a decedent's gross estate is valued at its fair market value on the date of the decedent's death or, if the executor elects, its fair market value 6 months after death (i.e., the "alternate valuation date"). Fair market value is defined in Treasury regulations as the price at which an item of property, or a business interest, would change hands between a willing buyer and a willing seller, neither of whom is under any compulsion to buy or sell, and both of whom have a reasonable knowledge of all the relevant facts.
When it comes to valuing an interest in a closely held business, the above definition of fair market value is often of little practical assistance. In Revenue Ruling 59-60, the Internal Revenue Service set forth the following eight factors that are considered essential in valuing a closely held corporation:
1. The nature of the business and the history of the enterprise from its inception.
2. The economic outlook in general and the condition and outlook of the specific industry in particular.
3. The book value of the stock and the financial condition of the business.
4. The earning capacity of the company.
5. The dividend-paying capacity.
6. Whether the enterprise has goodwill or other intangible value.
7. Sales of stock and the size of the block to be valued.
8. The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over the counter.
It is interesting to note that factor number 6 is goodwill, and that four of the other factors play a part in the capitalization of earnings formula demonstrated in the chart on page 139.
In determining fair market value, discounts are allowed for minority interests and lack of marketability. For publicly traded stock, it is also possible to obtain discounts using the "blockage" theory, which recognizes that placing a large block of stock on the market would likely have a depressing effect on its price. However, a "control premium" might increase the stock value of a person owning more than 50 percent of the business.