How to List and Value a Decedent’s Small Businesses
If a decedent owned a small business, in full or in part, the estate’s executor needs to value that small business and decide whether to continue the business or sell it. Use the decedent’s tax return (Form 1040) to determine what businesses the deceased had an ownership in. Check the business’ tax returns and/or any formal partnership agreement for special provisions or stipulations before deciding what to do with it.
You need to know how the business is set up before it can be properly valued and administered. Businesses may be set up in the following ways:
Sole proprietorship: A sole proprietorship is an unincorporated organization that is accounted for entirely on Schedule C of the decedent’s tax Form 1040. The company may be organized as a Limited Liability Company (LLC). It may even have its own Employer Identification Number.
If the decedent’s business is reported on Schedule C of tax Form 1040, you’re dealing with a sole proprietorship or an LLC where the decedent owned the entire business. Value this business as such.
Partnership: If the decedent held a partial interest in a business, it may have been formed as a partnership. Locate the decedent’s tax returns and look for the partnership entry on Schedule E to verify this.
If the deceased had a partnership interest, get a copy of the most recent partnership tax return (Form 1065). This tells you what percentage of the partnership the decedent owned and how the decedent held title in that property. A formal partnership agreement may include a provision for the surviving partner(s) to buy out the decedent’s interest and a formula for the buyout price. Or a separate buy-sell agreement could exist.
In the case of a sale, try to obtain the best price possible. This price sets the value for estate tax purposes if it reflects the fair market value of the partnership interest. The partnership may dissolve upon a partner’s death unless the agreement contains a provision to the contrary.
Subchapter S corporation: In these businesses only the shareholders pay income taxes on profits instead of paying tax first at the corporate level and then again when the profits are paid out as dividends. Your decedent’s most recent income tax returns should tell you whether he or she was an S corporation shareholder. You can also review the corporation’s income tax return (Form 1120S).
Be careful when dealing with S corporation shares which can only be transferred to an individual or to a qualifying trust. Selling or transferring shares to a nonqualified shareholder can cause the corporation to lose its S status.
Subchapter S corporation shares require valuation by an expert unless a buy-sell agreement is in place that fixes the formula or purchase price of the decedent’s stock by the remaining stockholders on his or her death. For the estate’s purposes, that price or formula is fair market value.
Closely held C corporation: If the decedent owned stock in a non-publicly traded company that’s not an S corporation, you’re dealing with a closely (or privately) held C corporation. With a C corporation, there are no income tax concerns about who may inherit the stock.
The corporation may have a buy-sell agreement that sets the price at which the other stockholders may buy the C corporation stock. This agreement sets the stock’s value for estate tax purposes, if the IRS considers the price fair market value.