CORPORATE VALUATION SERVICES
ESTATE GIFT TAX VALUATION
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.
For Estate 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 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. The sources for specific guidelines for estate valuations include the following:
- Internal Revenue Code (IRC)
- Treasury Regulations
- Revenue Rulings
- IRS Positions (Technical Advice Memorandums and Private Letter Rulings)
Certain valuation related estate tax provisions are described in summary fashion below, but a more detailed treatment of these issues, and other relevant issues, is beyond the scope of this review course. The valuation analyst preparing valuations for estate tax purposes must develop and maintain a basic working knowledge of the valuation related laws, regulations and court decisions and, ideally, work with the client estate's attorney or other professional advisors.
The valuation date for a business interest for estate tax purposes can be either the date of death, or an alternative valuation date six months after the date of death ("Alternate Valuation Date"-IRC Section 2032 (a)). The Alternate Valuation Date can be selected by the estate ofthe 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 complex valuation guidelines were introduced with the passage of Chapter 14 of the IRC in 1990. The primary provisions under Chapter 14 relating to the valuation of closely held business interests include the following:
- Section 2701 - Addresses classic preferred estate freezes and other situations
- Section 2703 - Addresses buy-sell agreement and other issues
- Section 2704 - Addresses lapsing voting and liquidation rights and other issues
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. Under IRC Section 6701, valuation analysts could be subject to civil penalties for aiding and abetting a tax understatement, and, in the some cases, the valuation analyst could be barred from working on future IRS tax proceedings.
In addition, the IRS Restructuring and Reform Act of 1998 added IRC Section 7491, which enables a taxpayer in certain circumstances to shift the burden of proof for a determined value or valuation issue to the IRS. This relief is generally available if a taxpayer provides credible evidence (as defined by the IRS) supporting his tax position or treatment.
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 final regulations giving the specific requirements to start the statute running were issued in December of 1999. The final regulations describe the attributes necessary for the both the appraiser and the appraisal to enable the statute of limitations to start.
The primary appraiser and appraisal requirements to start the statute of limitations running on a gift tax return include the following:
- Appraiser Requirements
- Regularly performs appraisals and represents himself or herself to public as an appraiser
- Qualified to make appraisals of type of property being valued
- Appraiser unrelated to donor, donee, or other related parties
- Appraisal Disclosure Requirements
- Date of appraisal
- Date of transfer
- Purpose of appraisal
- Description of property
- Description of appraisal process employed, including valuation methods
- Description of assumptions
- Description of any hypothetical conditions
- Descriptions of any restrictions or limiting conditions
- Identification of information utilized in sufficient detail to allow reader to replicate
- the appraisal analysis and valuation
- Description of reasoning supporting the analysis, opinions, and conclusions
- Identification of specific comparative transactions utilized
- If relevant, undiscounted value of 100% of entity
- Certain additional items if Chapter 14 applies
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.
Revenue Ruling 93-12
This ruling marked the end of the IRS's attempts to aggregate family attribution in determining minority and control issues and revoked its position on this matter as outlined in Revenue Ruling 81-253. At the same time, it opened up the use of discounts in the valuation of family businesses and interests. Higher discounts, of course, mean lower estate and/or gift taxes for minority interests. Revenue Ruling 93-12 involved the case of a father, the 100% shareholder of a corporation, who gifted 20% 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% 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.
IRS Valuation Guide for Income, Estate, and Gift Taxes
In January 1998 the IRS issued an updated version of its Valuation Guide.
Houlihan applies valuation methodologies of closely held business. These characteristics include:
- Lack of marketability.
- Concentration of management and voting in a family group.
- Influence of shareholder's 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.