According to a memo from IRS Commissioner John Koskinen, the IRS will hire 600 to 700 new employees to focus on tax enforcement in the near future. This represents the IRS’s first large-scale hiring in recent memory. The IRS views this as a prudent investment, as Mr. Koskinen noted that each employee returns “almost $10” to the U.S. Treasury for every dollar spent. Assuming 700 employees are hired at a cost of $50,000 per employee, the move would yield a potential profit of over $300 million dollars.i
With increased staffing levels comes increased scrutiny of gift and estate tax returns. It is likely that additional employees will allow more of these returns to be reviewed, resulting in more audits and challenges. It’s interesting to note that formal business valuations are not always specifically required for gifting or estate tax return preparation; they are often required to meet the IRS’s adequate disclosure regulations. In addition, a quality valuation can proactively reduce the likelihood of future disputes.
Proper Business Valuations Now Even More Critical
Aside from the general credibility provided by an appraiser with the requisite amount of valuation training, a valuation report that supports the value on the return should mitigate the risk arising from challenges from the IRS. Further, should a matter escalate and advance to the Tax Court, a credible valuation report (and possible expert testimony) is critical. In Estate of Edgar A. Berg v. Commissioner, T.C. Memo. 1991-279, the opinion “thought it significant” that the “estate had not commissioned a formal appraisal of the fair market value” of the stock. This indicates that the Tax Court encourages the inclusion of a third-party appraisal to support the values placed on the tax return.
Retaining an appraiser with proper training and expertise is critical. In Shannon Pratt’s Valuing a Businessii, the author notes that, “The instances and factors contributing to inadequate valuations for tax purposes by both taxpayer and IRS experts could easily fill an entire book of this size.” (That book’s text is over 1,000 pages, excluding the glossary and index.) Dr. Pratt further cites the following as some of the most common issues contributing to such inadequacies:
- The valuation being out of date
- Lack of site visits and/or management interviews
- Inadequate selection and/or analysis/explanation of selected guideline company comparability
- Inadequate empirical support for the valuation variables selected
- Successful Daubert challenges
Each of these items can and should be avoided so long as an accredited appraiser is selected, is granted the time to perform a thorough analysis, and documents the results in a report that includes substantial detail supporting the conclusion of value.
When choosing accredited appraisers, look for designations that provide industry acknowledgement of proper valuation procedures and knowledge. Several organizations offer credentials, including the American Society of Appraisers, the National Association of Certified Valuation Analysts, the American Institute of Certified Public Accountants (ABV designation), and the CFA Institute, among others.
Expense of Getting It Right vs. the Cost of Getting It Wrong
As pricing pressure continues to mount for valuation engagements, there has been a shift toward a lowest-cost mentality. In order to meet the guidelines detailed in Revenue Ruling 59-60, this low-cost mentality may end up being more costly for the taxpayer and the appraiser alike, with the IRS’s ability to assess separate penalties to each of these parties. Further, lower-fee engagements often result in an inadequate work product or may arise from practitioners who lack the requisite industry experience.
Given the IRS’s recommendation for adequate disclosure for gift and estate tax purposes, we recommend that CPAs, tax attorneys, and other consultants encourage clients to avoid the lowest-cost-possible approach. Instead, engage a qualified appraisal firm to perform a proper valuation, one that supports gift and estate tax returns and will withstand the increased scrutiny that can be expected with these new federal employees and their tax-enforcement focus.
i (700 employees x $50,000 x $10) - (700 employees x $50,000) = $315 million.
iiValuing a Business: The Analysis and Appraisal of Closely Held Companies, Shannon P. Pratt with Alina V. Niculita; Fifth Edition; The McGraw Hill Companies, Inc.; 2008.