Business Valuation After Death

Why a Formal Valuation Is Required

When a business owner dies, the IRS requires a fair market value determination of the business interest for estate tax purposes. This isn't optional — if the estate exceeds the federal exemption threshold, Form 706 must include a defensible appraisal of every business interest the deceased owned.

Even if the estate falls below the threshold, a formal valuation is often necessary for buy-sell agreement execution, equitable distribution among heirs, and establishing the stepped-up cost basis that heirs receive on inherited assets.

Fair market value, under the IRS definition, is the price at which the business interest would change hands between a willing buyer and a willing seller — neither under compulsion, both with reasonable knowledge of all relevant facts. That standard comes from Revenue Ruling 59-60, and it governs every closely held business valuation for tax purposes.

The Three Valuation Methods

Certified business appraisers use one or more of three recognized approaches:

The income approach converts expected future cash flows into present value using a risk-adjusted discount rate. This is the most common method for active operating businesses — service companies, manufacturing firms, professional practices — because their value lies in their earning capacity, not their physical assets. Variations include the discounted cash flow (DCF) method and the capitalized earnings method.

The market approach estimates value by comparing the business to similar companies that have recently sold. The appraiser looks at pricing multiples — revenue multiples, EBITDA multiples, or earnings multiples — from completed transactions involving comparable businesses. This approach works best when good comparable data exists, which is often limited for very small or niche businesses.

The asset approach calculates value by subtracting total liabilities from the fair market value of all assets (tangible and intangible). This method is most appropriate for holding companies, real estate-heavy businesses, or companies being valued for liquidation rather than as going concerns.

Most appraisals use a weighted blend of two or more methods, with the appraiser explaining why certain approaches received more weight based on the nature of the business.

Revenue Ruling 59-60: The Eight Factors

The IRS expects the appraiser to analyze and document eight specific factors:

1. The nature of the business and its history
2. The general economic outlook and specific industry conditions
3. The book value and financial condition of the business
4. The earning capacity based on historical performance
5. The dividend-paying capacity (not just actual dividends paid)
6. Whether the business possesses goodwill or intangible value
7. Recent sales of company stock and the size of the block being valued
8. The market prices of comparable publicly traded companies

An appraisal that skips any of these factors is vulnerable to IRS challenge. The appraiser should explicitly address each one in the written report, even if certain factors (like prior stock sales) don't apply.

Valuation Discounts That Lower the Number

For minority interests and closely held shares, two categories of discounts can significantly reduce the appraised value:

Discount for Lack of Marketability (DLOM): Private company shares can't be sold on a stock exchange. Finding a buyer takes time, costs money, and involves negotiation. An appraiser may reflect this illiquidity in a discount, with the amount supported by the facts of the company and interest being valued.

Discount for Lack of Control (DLOC): A minority shareholder can't set corporate strategy, declare dividends, hire or fire management, or force a sale. An appraiser may reflect this lack of control in a discount, with the amount supported by the facts of the company and interest being valued.

These discounts can compound when supported by the facts. For illustration only, a 50% interest in a company worth $2 million has a pro-rata value of $1 million; applying a supported 25% DLOM and 20% DLOC would reduce that value to $600,000 for estate tax purposes.

Timing Matters

The default valuation date is the date of death. But if the business has declined in value since the owner died — lost customers, lost key employees, revenue dropped — the executor may elect the alternate valuation date (exactly six months after death) under IRC Section 2032. This election must reduce both the gross estate value and the estate tax liability.

For many family businesses, the owner's death triggers a real decline in enterprise value. The alternate date captures that decline and can save substantial estate tax, though it also lowers the stepped-up basis heirs receive.

How to Find a Qualified Appraiser

Look for designations from the American Society of Appraisers (ASA), the American Institute of Certified Public Accountants (AICPA), or the National Association of Certified Valuators and Analysts (NACVA). For estate tax purposes, ask the appraiser to analyze the applicable Revenue Ruling 59-60 factors and document the valuation in a written report.

Expect the appraisal to cost $5,000 to $25,000 for a small business, depending on complexity. The fee may qualify as an estate administrative expense deductible on Form 706; ask the estate's tax adviser to confirm.

The Small Business Owner Dies toolkit includes a valuation preparation worksheet that helps you organize the financial records and documentation the appraiser will need.