Estate and Gift Tax ValuationFor Estate Tax Purposes
Perhaps the most common tax purpose for a business valuation is to determine the value of a business interest for federal estate and/or gift tax purposes.
Valuation for estate tax purposes is critical because the estate tax value determines, in some instances, whether and the extent to which, the estate owes federal estate taxes. The value of the business interest determined for the estate adds to the values of the other assets in the estate to determine the total estate value for federal estate tax purposes. The value of the business as determined for the estate also determines the tax basis of the business interest for the beneficiaries of the estate, because the beneficiaries usually receive a stepped-up basis equal to the business interest’s fair market value on the valuation date.
In addition to general valuation principles, approaches, and methods, valuations for estate tax purposes are subject to a constantly shifting body of laws, regulations, and court decisions.
Guideline sources
In addition to general valuation principles, approaches, and methods, valuations for estate tax purposes are subject to a constantly shifting body of laws, regulations, and court decisions. The sources for specific guidelines for estate valuations include the following:
Valuation date choice
The valuation date for a business interest for estate tax purposes can be either:
- The date of death
- Six months after the date of death [“Alternate Valuation Date” – IRC Section 2032 (a)]
The alternate valuation date can be selected by the estate of the decedent under certain circumstances, one of which being that the total estate tax due will be less than if the date of death were used.
Certain of these guidelines are intended to override the result otherwise obtained from applying general valuation principles, approaches, and methods. Taxpayers are potentially subject to IRS penalties for the under-valuation of estate assets. The penalties under IRC Section 6662 result from asset under-valuation and are calculated as a percentage of the resulting tax underpayment. The IRS may waive these penalties if the taxpayer had a reasonable basis for the claimed value. A competent appraisal prepared by a qualified appraiser may help the taxpayer demonstrate that a reasonable basis existed, thereby offsetting any penalty.
For Gift Tax Purposes
Valuations are also necessary when making certain gifts. Valuations for gift tax purposes fall under most of the same regulations and requirements for estate tax purposes that were listed above. As a practical matter, an independent valuation should usually be done contemporaneously with the gift.
The Taxpayer Relief Act of 1997 amended IRC Section 6501 (c) (9) to provide for a three-year statute of limitations that can bar the IRS from challenging certain gift tax valuations. The ability to start the statute of limitations running is dependent upon the taxpayer adequately disclosing the gift on a gift tax return. Absent the statute of limitations starting, gifts made by the taxpayer many years earlier are potentially subject to IRS adjustment as late as the filing of that taxpayer’s estate tax return.
The primary appraiser and appraisal requirements to start the statute of limitations running on a gift tax return include the following:
Regularly performs appraisals and represents himself or herself to public as an appraiser.
The appraiser is qualified to make appraisals of type of property being valued.
The appraiser is unrelated to donor, donee, or other related parties.
Appraisal disclosure requirements
While the statute does not specifically require a complete, formal appraisal report prepared by an independent appraiser to start the statute running, the statute does recognize that the presence of such an appraisal report can satisfy the taxpayer’s disclosure requirements. Below is a list of appraisal disclosure requirements:
- Date of appraisal
- Date of transfer
- Purpose of appraisal
- Description of the property
- Description of appraisal process employed, including valuation methods
- Description of assumptions
- Descriptions of any restrictions or limiting conditions
- Identification of information utilized in sufficient detail to allow reader to replicate the appraisal analysis and valuation
- The valuation method used, the rationale for the valuation method, and the procedure used in determining the fair market value of the asset transferred
- Description of reasoning supporting the analysis, opinions, and conclusions
- Identification of specific comparative transactions utilized
- If relevant, undiscounted value of 100 percent of entity
- Certain additional items if Chapter 14 applies
IRS Valuation Guide for Income, Estate, and Gift Taxes
In January 1998, the IRS issued an updated version of its Valuation Guide. This Guide is currently out of print.
Chapter seven of the Guide introduces the practitioner to the general concepts of valuation of the closely held business. These characteristics include:
- Lack of marketability.
- Concentration of management and voting in a family group. Influence of shareholders’ personal circumstances on dividend policy.
- Lack of access to public markets for capital funds.
- Greater possibility of asset realization through merger, sale, or liquidation of the company.
The Guide states that the standard of value for the closely held business is fair market value. This is in keeping with the regulations, cases, and Revenue Ruling 59-60 and its progeny. The guide maintains the long-standing IRS position that the beginning point for any business valuation is Revenue Ruling 59-60 and its progeny.
In July 2006, the IRS issued a document entitled IRS Business Valuation Guidelines for use by all IRS employees who provide valuation services or review the valuations and appraisals prepared by others. It provided guidelines for tangible property appraisers, real property appraisers, intangible asset appraisers and business valuation appraisers.
Relevant Revenue Rullings
Outlines the approaches, methods, and factors to be considered in valuing shares of closely held corporations. The Ruling applies to valuations performed for estate and gift tax purposes and to the valuation of stock on which market quotations are either unavailable or not reflective of fair market value.
Modifies Rev. Rul. 59-60 by recognizing the possibility of valuing the tangible and intangible assets of a business separately.
Discusses a formula approach (excess earnings method) for valuing the fair market value of intangible assets of a business.
Addresses the discount for lack of marketability inherent in the valuation of shares of stock that have not been registered for public trading when the issuing company has stock of the same class that is actively traded on one or more securities markets.
Further amplifies Rev. Rul. 59-60, as modified by Rev. Rul. 65-193 and as amplified by Rev. Rul. 77-287, by discussing the valuation of stock of a subsidiary corporation that is distributed to the shareholders of the former parent and can be sold only with the stock of the distributing corporation.
Specifies additional factors to be considered in valuing common and preferred stock of a closely held corporation in a recapitalization.
This ruling marked the end of the IRS’s attempts to aggregate family ownership in determining minority and control issues and revoked its position on this matter as previously outlined in Revenue Ruling 81-253. After this Rev. Rul. was promulgated, attorneys started drafting FLP agreements. Revenue Ruling 93-12 involved the case of a father, the 100 percent shareholder of a corporation, who gifted 20 percent of the shares of the corporation to each of his five children. The ruling concluded that the family relationship was not to be taken into account in the determination of the value of the gifts and that the gifts were to be valued as five separate 20 percent minority interests. As such, the implication was that appropriate discounts for lack of marketability and minority interest, if consistent with the valuation methodology used, could be taken in arriving at the value of the gifts.
Indicates that the IRS continues to fight discounts relating to family businesses.
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