If you plan to pass on your wealth to your children, grandchildren, or other beneficiaries, now is the time to act. The current gift and estate tax exemptions are set to sunset, or expire, at the end of 2025. It is important to understand the exemptions and how to properly value your gifted assets so you can maximize your wealth transfers before time runs out.
Gift and Estate Tax Exemptions for 2025
Gift and estate taxes are federal taxes imposed when money or property is transferred to another person. They apply to large gifts made by a person or a married couple while they are alive, or large inheritances passed on when they die. However, most people are not required to pay these taxes due to generous annual and lifetime exemption limits. Since the 2017 Tax Cuts and Jobs Act (TCJA), the gift and estate tax exemption amounts have increased significantly.
The annual gift tax exclusion for 2025 is $19,000, which means a person can give up to this amount to as many people as desired without reporting it to the IRS. Married couples can double this amount, giving up to $36,000 annually.
If gifts exceed this limit, the gifting individual or couple must disclose it to the IRS by filing a gift tax return in addition to their federal tax return. However, exceeding the annual gift tax limit doesn’t necessarily trigger taxes—it simply counts against the lifetime exemption. The lifetime gift and estate tax exemption for 2025 is $13.99 million per person and $27.90 million for married couples. Any gifts exceeding the annual limit are deducted from this lifetime exemption. No taxes are due unless you exceed the lifetime exemption.
Estate taxes, which are applied to assets passed on after death, are subject to rates ranging from 18% to 40% depending on the value of the assets, but only the portion of an estate that exceeds the lifetime exemption is taxed.
Avoiding Penalties in Gift and Estate Tax Planning
Accurately determining the value of gift or estate transfers is necessary to ensure correct tax liability and avoid any undervaluation penalties. If assets are significantly undervalued, the IRS may impose a penalty equal to 20% of the tax due resulting from the substantial valuation understatement.
For example, if an asset with a fair market value of $30 million is gifted and taxed at 40%, the tax due would be $12 million. However, if a conclusion of value report erroneously states the asset’s value as $15 million, the calculated tax liability would be only $6 million, resulting in a tax underpayment of $6 million. The IRS would then impose a 20% penalty for the $6 million underpayment, which amounts to $1.2 million.
Understanding Valuation Discounts
Certain adjustments are necessary to reflect real-world market conditions when valuing a business interest for gift or estate tax purposes. Two key discounts often applied are the Discount for Lack of Marketability (DLOM) and the Discount for Lack of Control (DLOC).
DLOM reflects the reduced value of an asset in a private business due to the difficulty of selling it compared to publicly traded stock. For example, consider how quickly Apple stock can be sold on an open market, whereas selling interest in a local CPA firm may take months or years. Private companies typically do not have an open market to sell their shares, often requiring more time and resulting in higher transaction costs. Legal and contractual restrictions on the transfer of stock can further limit the pool of potential buyers, increasing the discount. While large private companies like Wegmans may experience smaller discounts, generally, transferring any interest in a private business results in a reduction in value because private businesses are not as marketable as public companies.
DLOM is typically calculated using restricted stock studies, which compare the prices of publicly traded shares to similar shares with transfer restrictions; market studies, which analyze transactions of private businesses to determine typical discounts; or option pricing models, which estimate the cost of liquidity constraints based on financial theory.
In addition to marketability limitations, ownership structure also plays an important role in valuation discounts. DLOC captures the reduction in value when a shareholder lacks control over the entire company and key decisions, such as acquisitions, financing, or dividend policies. For example, in a company with two shareholders—one owning 90% and the other 10%—the minority owner has no decision-making power unless the majority owner agrees. Therefore, the shareholder’s 10% interest is worth less than 10% of the total company. Even in a highly profitable business generating $5 million annually, if the majority owner decides to retain all earnings rather than distribute dividends to shareholders, the 10% interest becomes significantly less valuable. While these scenarios are generalizations, they convey how the lack of control in a company results in a lower value of that interest, as minority shareholders cannot control these financial and operational matters, making their stake worth less than a proportionate share of the total company.
To determine the value reduction for a minority shareholder, DLOC is typically calculated through empirical studies, which examine real-world transactions between minority and controlling interests in companies, or control premium studies, which analyze price differences between controlling and non-controlling stakes in similar businesses to quantify the value reduction.
Incorporating these discounts will enable valuations to more accurately reflect the true economic value of private business interests by considering both marketability constraints and the effects of minority ownership. This leads to fair and defensible assessments, particularly in the context of estate and gift tax planning.
Upcoming Changes to Gift and Estate Tax Exclusions
The higher gift and estate tax exclusions introduced by the TCJA will expire at the end of 2025 unless Congress takes further action. Once they sunset, these exclusions will revert to their pre-2017 levels, adjusted for inflation. This makes 2025 a prime opportunity to review your plans and take advantage of the higher exemptions before they decrease.
If you need assistance in maximizing your gift-giving, call 1RDG at 585-673-2600. We can help you determine the fair market value of your gifts and avoid costly penalties.