Two ways to get the IRS to close the file
“When I look at your appraisal, I pull up the report writing guidelines and BV standards from your society, and see if you've complied,” says Patrick McKay, ASA, AVA—a Senior Valuation Specialist with the IRS, who spoke last week at the Second Annual IRS National Symposium on Valuation Issues in Los Angeles. If there’s no compliance, “that’s the first warning that due diligence levels were not met.”
His next step: “Find the five to ten key assumptions [in the report]. Did the appraiser clearly lay these out for me—or put them in a footnote?” Why is this important? “You’d do the same in reviewing an IRS report,” McKay says. “It’s worth your while to flesh out the assumptions in your narrative; don’t imbed them in the spreadsheets. If you can do this up front, it will save you and your client a lot of trouble.” In fact, if these BV standards are met and assumptions are clearly laid out and supported, “I usually tell the examiner: ‘Looks good to me,’ and close the file.”
McKay was also recently promoted to National Business Valuation Issue Coordinator, one of two such positions in the IRS Engineering Program; his duties include internal education as well as professional outreach, to make sure “valuation issues are being worked consistently across the country.” For an overview of the Engineering Program, which now boasts 340 professionals—including their training and examination of expert reports, click here.
IRS to appraisers: ‘Just walk away’ from bad deals
As expected, the new appraiser/appraisal penalties were all the “buzz” at the IRS Symposium. With the enactment of the Pension Protection Act (PPA) last summer—and the issuance of interim guidance in Notice 2006-96 (see BVWire # 49-4), most business appraisers are now clearly aware that the Service is “enhancing practitioner oversight,” as Brenda K. Woolbert, Team Manager (Engineers & Appraisers) puts it, and they are all working “as fast and as furious” as they can. “We need clear, robust, and meaningful standards of conduct.”
The Service also needs business appraisers to help “support the IRS and your profession,” and to this end, the ASA has been a “treasured partner.” Will Frazier (HFBE, Houston), who sat in on Woolbert’s session, adds, “We are all concerned with having good appraisers and appraisals. We recognize there is a problem out there—and that’s the reason we [the ASA] backed the PPA.” Visit the ASA website for more on what constitutes a qualified appraiser/appraisal, including IRS Guidance and ASA interpretation. Or perhaps just heed Commissioner Steven Miller, who provided this pointed advice to appraisers at a recent public land conference:
A donor’s aggressive acts bring discredit to all involved, and the IRS and the Congress to the door. Here is where I will ask for your help. Please exercise prudence. If you perceive that there is something out of whack with a transaction, if it does not pass the smell test—if it is not fairly valued, walk away. Do not accept it, and let us know about it.
Do the appraiser/appraisal penalties apply to E & G?
Taxpayer penalties are nearly automatic under IRC §6662, when the valuation claimed exceeds the “correct” valuation by 150% or more in income tax cases, and when the value is 65% or 40% less than the “correct” valuation in transfer tax cases. But in the latter context, does IRC §6695A make these same penalties applicable to the appraiser? The question came up in several sessions at the L.A. Symposium. Apparently, the Service first took the position that the penalties do apply, then reviewed several authorities and changed its opinion, according to Woolbert. But now “we’ll pursue penalties on a §6695 basis and see what happens.”
“It’s on the table,” agrees Chuck Morris, Esq., Western States Territory Manager for the IRS Estate and Gift Tax program. “Our instructions from on high are to pursue and utilize this penalty.” Compared to the “aiding and abetting” penalties of §6701, generally limited to $1,000, these new penalties have some “teeth” to them, Woolbert adds, as they are based on the economic benefit to the appraiser. Changes to §6701 also reduce the applicable standard from “actual knowledge” to whether the appraiser “knew or should have known” the appraisal would be used in connection with a substantial or gross misstatement of valuation on a tax return.
For a comprehensive overview of the PPA and related penalties, click here for a recent ABA article by Steve R. Akers of Bessamer Trust Co., also a panelist on BVR’s recent telephone conference on the McCord Reversal and the Future of Marketability Discounts.
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Will the IRS amend Circular 230 to include appraisers?
For now, the IRS appraiser penalties are retrospective, “applying sanctions based on the past behavior and its impact on the taxpayer case,” says Carolyn Gray, Technical Advisor to the Director Office of Professional Responsibility. “The IRS will have to amend Circular 230 in light of the PPA provisions, both to eliminate reference to the threshold requirement [definition of qualified practitioners] and to provide a framework for determining the types of appraiser behavior that may warrant the prospective sanction of disqualification.”
In the meantime, Gray reminds appraisers who are also CPAs that they may very well fall within the threshold requirements of Circular 230, and qualify as a “practitioner.” Her advice: Read Regulation 10.22, concerning a practitioner’s due diligence requirements, which is on page 16 of the official publication of Treasury Department Circular No. 230; the current definition of a qualified “practitioner” is on page 4. For a copy, click here.
Do’s and don’ts of FLP valuations
Anyone who believes the IRS lacks a sense of humor should have attended the session by Harry J. Furhman, a financial analyst with the Service, on FLP valuations. In the context of multi-tiered entities, “we’ve seen discounts out the yin yang,” Furhman says, using what must be a technical term. The IRS is still seeing full marketability discounts applied on top of Real Estate Limited Partnership (RELP) net asset value discounts. “That’s just not good,” he says.
Also not good: In calculating net asset value, don’t deduct selling expense from a non-liquidating premise of value “unless you have a darned good argument.” The same goes for using the inverse of control premiums to estimate discounts for lack of control (DLOC) for FLPs holding cash, marketable securities, and real estate. “Courts prefer closed-end funds, REITs, and RELP data for asset-holding entities,” Furhman says. If you still decide to use the inverse control premiums, either adjust them downward or include an explanation why you didn’t adjust. But in the end, “just don’t use them for FLP DLOCs.”
For an excellent, related article from the November 2006 BVU on “Why NAV May Not Be the Best Method for Valuing Multi-Tiered Entities,” by Lari Masten and Dennis Webb (Webb is also the “mastermind” who put together the IRS Symposium), click here.
The essential IRS disclaimer
Keep in mind that all of the statements quoted in this issue are the opinions of the specific person, and not the IRS.
The IRS, its faculty and presenters, together with Dennis Webb and the L.A. Chapter of the ASA, have done a tremendous “service” to the valuation community by putting on this year’s National Symposium. Webb hopes to make the Symposium a regular if not annual occurrence; he also recommends that local chapters of the ASA and other BV societies consider putting on similar gatherings in their regions. The chapters can bring their membership and other groups together, hopefully make a little money and the IRS can continue to make efforts toward sustained outreach with the BV profession. For more information, contact Webb at firstname.lastname@example.org
More on ESOARS: New article from Mercer Capital
In response to last week’s item on the ESOARS pricing model for public company employee stock options (see BVWire #53-1), we heard from Mercer Capital (Memphis, TN) and received a new article—written in the past couple of weeks—by B. Patrick Lynch and Travis W. Harms. For a free copy of “ESOARS to Offer Market Pricing of Employee Stock Options?” click here.
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