Estate and gift tax valuations are a critical component of tax planning, determining the fair market value of transferred assets. Inaccurate valuations can lead to costly disputes with the Internal Revenue Service (IRS) and potentially result in penalties and interest. The recent CCA 202152018 provides essential guidance on how to address post-valuation-date events in appraisals accurately, specifically within the context of estate and gift tax planning.
Post-valuation-date events are occurrences that happen after the valuation date but can impact the fair market value of an asset. Examples include a potential sale of the asset, changes in the company’s financial performance, or new industry developments.
Internal Revenue Service (IRS) Chief Counsel Advice 202152018 (the “CCA”) involved a successful company (the “Company”) that utilized a dated 409A valuation to transfer shares to a Grantor Retained Annuity Trust (GRAT). In anticipation of a potential sale, the Company engaged investment bankers to assist with the process before funding the GRAT. During this period, the Company received several arm’s length purchase offers for its shares. However, when transferring shares to the GRAT, the Company relied solely on the 409A appraisal’s fair market value, without considering the potential transaction or the value indications from the received offers.
The IRS contested the Company’s valuation approach, arguing that the transfer amount bore no relation to the initial property’s fair market value. The IRS contended that the Company should have taken into account the post-valuation-date events (i.e., the potential sale and received purchase offers) when determining the fair market value for gift tax purposes. By not incorporating these events into the valuation, the Company potentially underpaid gift taxes, which subsequently drew the IRS’s attention and scrutiny.
The CCA is a significant development in the field of estate and gift tax valuation. It clarifies that taxpayers must consider all relevant information, including post-valuation-date events, when valuing assets for gift tax purposes. The CCA also emphasizes the importance of engaging a qualified valuation expert to perform estate and gift tax valuations.
The CCA analysis highlights three essential takeaways for companies aiming to accurately value assets for trust and estate purposes:
Estate and gift tax valuation appraisals must consider all reasonably known and knowable information as of the valuation date. In this case, the company was aware that it was being shopped and had received value indications. A thorough analysis of these indications would have been required to determine if they reflected the shares’ fair market value.
Consistency in valuations is crucial. The company’s post-GRAT charitable gifts used a new appraisal that incorporated buyout terms, resulting in a significantly higher value. This inconsistency suggests that the appraisal firm selectively considered information to maximize tax benefits for the taxpayer.
409A valuations are designed for income tax purposes, specifically for determining the fair market value of a company’s common stock in connection with stock option grants under IRC Section 409A. Because of this, 409A valuations may not be suitable for gift tax purposes due to two main reasons:
409A valuations are used for income tax purposes, while gift tax valuations are used for estate and gift tax purposes. This difference in purpose can lead to different valuation results.
For example, a 409A valuation may consider factors such as restrictions on the stock and the company’s financial condition, which may not typically be considered in a gift tax valuation. As a result, a 409A valuation may result in a lower value for the stock than a gift tax valuation. Another key difference is the standards that apply to the valuation. 409A valuations do not have to meet the same rigorous standards as gift tax valuations.
In addition, the use of certain discounts might be different depending on the purpose of the valuation. For example, the lack of marketability discount is a discount that is applied to the fair market value of an asset to account for the fact that the asset is difficult to sell quickly. This discount is typically applied in both 409A valuations and gift tax valuations, but at differing rates.
Another example is the minority interest discount. This discount is applied to the fair market value of an asset to account for the fact that a minority shareholder does not have the same control over the company as a majority shareholder. This discount is typically applied to a minority interest in gift tax valuations, but is less common in 409A valuations.
Many 409A valuations are produced by firms employing “automated valuation methods” or algorithmic methods. These methods may not adhere to the Uniform Standards of Professional Appraisal Practice (USPAP) and might fall short of the higher standards required for estate and gift tax valuations. USPAP is a set of ethical and professional standards that govern the valuation profession.
The CCA offers valuable insights on properly handling post-valuation-date events, maintaining consistency in tax reporting, and considering all relevant information during valuation.
Improperly accounting for post-valuation-date events can lead to inaccurate valuations, which can have significant implications for taxpayers. For example, if a taxpayer undervalues a transferred asset, they may underpay gift taxes. In this case, the IRS could assess additional gift taxes, plus interest and penalties.
Inconsistency in valuations can also raise red flags with the IRS. For example, if a taxpayer uses a lower valuation for gift tax purposes and a higher valuation for income tax purposes, the IRS may scrutinize the valuations more closely.
Taxpayers should disclose all relevant information about their valuations on their tax returns. If a taxpayer does not sufficiently disclose a valuation, the statute of limitations for assessing additional taxes may extend.
Taxpayers should generally avoid using 409A valuations for gift tax purposes. As noted above, 409A valuations are designed for income tax purposes and may not be suitable for gift tax purposes. Taxpayers should instead engage a third-party expert to perform an independent valuation for gift tax purposes.
Properly calculated and documented independent valuations are essential for initiating the three-year statute of limitations on gift taxes. After this period, the IRS cannot assess additional gift taxes unless an exception applies. Adequate disclosure on gift tax returns is critical; if a gift is not sufficiently disclosed, the statute of limitations extends to six years. Conducting proper, specific-purpose, independent valuations help avoid IRS disputes, interest, penalties, or even litigation.
The CCA offers valuable insights on properly handling post-valuation-date events, maintaining consistency in tax reporting, and considering all relevant information during valuation. A trusted advisor can ensure accurate valuation, prevent IRS disputes, and provide peace of mind. Estate and gift tax planning can be intricate, but collaborating with experienced professionals guarantees proper valuation and compliance with tax laws. The consequences of inaccuracies can be severe, so consult a trusted advisor to ensure your valuations are correct, efficient, and compliant with tax regulations.
At Eton Venture Services, we are dedicated to assisting you in accurately valuing your assets for estate and gift tax planning, following the invaluable lessons from CCA 202152018. Avoid potential disputes, penalties, and complications with the IRS by relying on our team of seasoned professionals for precise, compliant, and independent valuations tailored to your needs.
Eton’s exceptional client service and valuation expertise are trusted by countless businesses and individuals navigating the complexities of estate and gift tax planning. Don’t leave your financial future in the hands of inexperienced teams or automated software; trust Eton Venture Services to provide accurate and compliant valuations that safeguard your interests and ensure compliance with tax regulations.
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Chris co-founded Eton Venture Services in 2010 to provide mission-critical valuations to venture-based companies. He works closely with each client’s leadership team, board of directors, internal / external counsel, and independent auditor to develop detailed financial models and create accurate, audit-proof valuations.
