The fair market value of stock (FMV) is the amount of money a stock is determined to be worth if it is freely traded on the open market. In order for the determination to be valid, both the buyer and the seller must be interested parties, but not desperate. The transaction must also take place over a reasonable period of time.
Why FMV Matters
The FMV of stock is important because it can be considered income by the IRS, or it may be claimed as a charitable donation and used as a deduction, depending on the circumstances. This includes employees who receive stock through their employment and people who receive stock as a gift. For those who donate stock to charities, the IRS looks at the FMV of the stock on the date is was given to a qualified charity in order to determine the value of the stock for tax purposes.
It is relatively easy to determine the fair market value for stock that is publicly traded, especially if it is traded on a regular basis. On the day that the fair market value is to be determined, the high and the low price for the day are added together. The average of those two numbers is the fair market value. If there is no trading that day, averages from just before and just after the target day are used instead.
Private stock is much more difficult to value. There is no simple method for determining FMV on private stock, but there are some rules that can help. Recent sales can be used to compute the value, but there can’t be any relationship between the parties that might contribute to the stock being either under- or over-priced, such as a discount given to a family member. If there are no recent sales, then it may be necessary to determine the value of the company and divide that by the total number of shares of stock in order to come up with the FMV.
There are some conditions that can affect the fair market value of stock. Among these, a discount for a stock that is not readily marketable can reduce its FMV. This normally applies if trading for this stock is very slow and there are few transactions. Another situation that can cause a discount of the FMV is when the holder owns a large block of stock, which is likely to make it difficult to sell all at once. This degree of difficulty is what causes the value of the stock to drop.
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