When you’re dealing with a loved one’s estate, there can be a lot of foreign terms suddenly tossed at you. One of them may be alternate valuation date. This phrase may sound like gibberish and the explanation even more so. Figuring all of it out while dealing with your grief can be overwhelming.

What is the alternate valuation date?

All estates are subject to tax law, and some of them have to pay taxes. Usually, when a person dies, their estate’s value is determined by what the assets within the estate were worth on the date of his or her death. So, if an estate is worth $10 million on the date of death, that’s what the IRS will base its calculations on.

However, the estate can be re-valued six months after the date of death. This is what’s called the alternate valuation date. The IRS tax code allows this new value to be used on estate taxes with no penalty to the estate.

IRS 26 U.S. Code 2032

Getting technical for a moment, the section of the IRS tax code that refers to alternate valuation date is called: Title 26, Subtitle B, Chapter 11, Subchapter A, Part III, Section 2032. You can read it here if you want, but it’s a bit of a slog.

What you really need to know is below.

Why do I want an alternate valuation date?

If the value is big enough, the estate may owe taxes. However, how much it owes could vary depending on when the value of the estate is determined.

Let’s say the estate we talked about before was worth $10 million on the date the person died. Six months later, the market declines, and now the estate is worth $8.5 million. It’s much better to be taxed on the $8.5 million than it is on the $10 million.

What’s the downside?

Before you get too excited, there is a downside to the alternate valuation date.

You can only choose to take the value of the entire estate on the date of death or the value of the entire estate six months after the date of death. There is no in-between.

The IRS will not let you pick and choose which parts of the estate you want to value at the time of death and which ones you want to value six months after death. This is an all or nothing deal.

That means while some of the assets within the estate may be worth less six months later, others may be worth more. You have to do the work to estimate the value at that later date if you think this could be useful.

What’s the other downside?

There’s another wrinkle in choosing the alternative valuation date and that’s future income. Initially taking the lower estate value requires you to pay less in taxes, but remember that the lower value is what’s applied when the asset is distributed to the estate’s beneficiaries. If you choose to take the alternate (lower) value and that asset is later sold, then the alternate value is what’s used to determine how much profit is made (though possibly at a lower rate).

In other words, either way, the IRS is going to get it’s cut.

Are there any exceptions within the alternate valuation date tax code?

The only exception that the IRS allows for is if an asset within the estate is sold, exchanged, distributed, or disposed of in another way within the six months. If that’s the case, then the asset’s value will be determined based on the date that you disposed of the item from the estate.

Is there anything else I need to know about the alternate valuation date?

You have nine months from the date of death to tell the IRS that you want to use the alternate valuation date. You or your CPA will need to make an election when they file IRS Form 706 if you plan to use the alternate valuation date.

Once you make this choice and the form is submitted, there’s no going back. The election to use an alternate valuation date is irrevocable.

Another fun twist is that you have to exclude changes due solely to the passage of time. If you have a loan due to you, you can’t say it’s worth less only because payments have been made in the six months between the date of death and the alternate valuation date.

Is it better to take the alternate valuation date?

So, with everything you’ve learned about the alternate valuation date, is it better to take the value of an estate on the date of death or six months later?

Unfortunately, there’s no easy answer.

You and your CPA should examine several factors when weighing the alternate valuation date option including:

  • Determine if the estate taxable at all;
  • The tax bracket that the estate falls into;
  • Is it on the estate for a married person;
  • The relationship of the deceased to the estate’s beneficiaries;
  • The future tax implications;
  • The future tax benefits on depreciable assets;
  • And whether the estate’s assets will be sold or passed down through inheritance.

For large estates, talk to a professional about whether or not an alternate valuation date is beneficial to you. Make sure you contact your CPA. You can also talk to us here at Towne Advisory Services about any estate valuation questions.

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When it comes to finance, it’s hard to know all the special terms and abbreviations that get tossed out in the middle of a conversation. By the time you Google the meaning of a term, you’ve missed about 30 seconds of the meeting and you’re at a loss.

When consulting, Towne Advisory Services principal Ben Towne likes to include a glossary of terms that he provides to new clients. It helps make sure everyone is on the same page. But not everyone has the benefit of that, so here are some key terms that we at Towne Advisory think you should know anytime you’re working with a business valuation professional.

A quick note before you read further. Many of these definitions can be used differently from person to person, but this is the most common use and the way that Towne Advisory Services uses them.

Comps (comparables)

What does comps (comparables) mean?

Comps, also known as comparables, are other companies or transactions that have some similarity to the company that we’re trying to value.

Why are comps (comparables) important?

Just like in real estate appraisal that compares your house to similar, nearby houses that have sold, looking at business comps gives us pricing info based on actual market evidence relying on real buyers and sellers. By using multiples, we can value the subject company by analogy (see below!)

Discounted Cash Flow (DCF)

What does discounted cash flow (DCF) mean?

Discounted cash flow (DCF) is a method to calculate value using future forecasts of cash flow and a risk rate. DCF estimates the cash flow of a business for a certain period of time. DCF uses the risks associated with the business to convert those future cash flows into today dollars.

Why is discounted cash flow (DCF) important?

DCF specifically shows what the effects of the expected changes in the business are going to have on the value of the business. In other words, it specifically factors in the expectations of the future, not just the past operations of the business in coming up with the business value.

EBITDA (ee-bit-dah)

What does EBITDA mean?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Wow, that’s a mouthful.

In a conversation, EBITDA is sometimes called “operating earnings”.

Why is EBITDA important?

Sometimes EBITDA is used as a proxy for cash flow. It’s useful because it provides comparability between companies that might have very different debt structures, tax positions, and asset ownership.

Enterprise Value

What does enterprise value mean?

This is not the value of your starship. (Cue groans)

Enterprise value is the operating value of a business as a whole. It can be calculated a lot of different ways, but a popular way is to look at the value of the total assets of a business minus the cash.

Why is enterprise value important?

The enterprise value is often similar to what a third-party buyer might consider the value to be.

Equity Value

What does equity value mean?

Equity value is the amount that the owners of the business have a claim on in the value of the business. It’s just equity.

Like a house, you have to consider what the mortgage is before you know how much value the owner has in the house. It is often not the same as the price that a buyer would pay for the house because of that debt.

Why is equity value important?

It’s the amount a business owner would receive if they sold the business after paying off all of the debts of the business.

Multiple

What does multiple mean?

A multiple is a measurement of value in comparison, usually, to a financial metric. It’s a way to compare relative value between companies regardless of size and potentially other factors. Example: value divided by revenue when you are thinking about multiple. If the value is $2 and your revenue is $1 then your multiple is 2x.

Why is multiple important?

A multiple is necessary to compare the values of entities that are similar, but not the same. Ben likes to say, “It’s pricing by analogy or valuation by analogy.”

Example: Company A sold for eight times EBITDA. Company B is similar but is growing faster and therefore should have a higher EBITDA multiple.

Risk Rate

What does risk rate mean?

The risk rate is a percentage that represents the required rate of return that someone would demand to invest in a business. It’s also called the “discount rate” or “rate of return”.

Why is the risk rate important?

Under the financial theory that risk equals return, the risk rate helps us identify what the value of the business should be based on the amount of profit that a company is expected to earn.

Risk rate can be calculated a lot of different ways, but essentially encapsulates the risk inherent in the business’s industry as well as risks that are specific to that particular business.

Seller’s Discretionary Earnings (SDE)

What does seller’s discretionary earnings (SDE) mean?

Seller’s discretionary earnings (SDE) is EBITDA plus the compensation of the business owner. This is the amount that the small business owner has discretion over how to spend or distribute after all the regular operating expenses are paid.

Why are the seller’s discretionary earnings (SDE) important?

SDE is particularly important for small businesses because the owner exercises so much control over the company’s finances. They can pay themselves whatever they want. To provide comparability between companies, the SDE measurement of earnings removes the effects of that decision making.

Trailing Twelve Months (TTM)

What does trailing twelve months (TTM) mean?

TTM stands for trailing twelve months.

It’s usually used in combination with financial statements or a metric. An example of TTM is trailing twelve months of profit and loss through the end of the year, or TTM revenue through June 30.

Why is trailing twelve months (TTM) important?

TTM is important because it shows a whole year’s worth of operations. It factors in whether seasonality has affected revenue or not.

Valuation Date

What does valuation date mean?

The valuation date is the specific date that the value of the business is getting measured. This is drawing a line in the sand about what was known at a certain time and what conditions existed at that point.

Why is the valuation date important?

A valuation project cannot be an ongoing activity; things change in a business all of the time. Therefore, a valuation is a snapshot of a single point in time. We look from the perspective of that date when we do a valuation.

The valuation date is the date that the valuation pertains to, not the date the valuation is issued.