IRS issues first penalties against appraisers

The Internal Revenue Service has just assessed its first penalties ever against appraisers, according to Brenda Woolbert, IRS Engineering Team Manager, who spoke at the New York ASA’s “Current Topics in Business Valuation” conference last Friday.

As a result of investigations prior to the enactment of the 2006 Pension Protection Act (see BVWire #54-1), two real estate appraisers have received a total of four penalties for “aiding and abetting” under IRC §6701.   (The pre-PPA version required actual knowledge that their appraisals would be used in a tax return and would result in a material misstatement of value.)  The financial penalty is not huge: The maximum for a corporate-related return is $10,000 and for a personal return, $1000.  More importantly, the cases have been sent to the Office of Professional Responsibility for determination of sanctions, which could bar the appraisers from performing IRS-related services.

More bad news: Woolbert anticipates increasing appraisal investigations—and penalties, especially as the PPA relaxed the “knowledge” requirement of §6701 penalty assertions, and there is no statute of limitations.  (Application of IRC §6695A penalties to transfer tax cases is still “uncertain,” she says.)  The good news: Woolbert, who has become an essential liaison between the BV community and the IRS, doubts that §6701 penalties will be triggered when the Service simply disagrees with a standard BV practice, such as when the appraiser tax-affects an S corporation.   (All of Woolbert’s statements represent her opinions and not those of the IRS.) For a recent summary by the American Bar Association on the PPA and potential IRC §6695A appraisal penalties, click here.

FASB update: final guidance on FIN 48 and FIN 39-1

Last week the Financial Accounting Standards Board (FASB) released its long-awaited final guidance on defining “settlement” in FASB Interpretation No. 48, Accounting For Uncertainty in Income Taxes (FIN 48).   Set forth in Staff Position No. FIN 48-1 (FSP 48-1), the Board provides three conditions a tax position will have to meet to be considered “effectively settled”: a) the taxing authority has completed all required examination procedures; b) the company does not intend to appeal any aspect of the tax position; and c) the chance that the taxing authority would reexamine any aspect of its position is remote.  The guidance is effective upon the initial adoption of FIN 48 (e.g., Jan. 1, 2007 for calendar-year-end financials), and will apply retrospectively if a company did not apply FIN 48 in a manner consistent with the new FSP.

The Board also released its Staff Position No. FIN 39-1, amending FIN 39, Offsetting Amounts Related to Certain Contracts.  In particular, this FSP replaces the terms conditional contracts and exchange contracts with the FASB-defined term derivative instruments (see FAS 133).  It also permits companies to offset fair value amounts recognized for a receivable or payable “against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement that have been offset in accordance with that paragraph.”  FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007.

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New restricted stock data indicate ‘radically higher’ discounts

“The restricted stock illiquidity discounts in the Liquistat™ database are radically higher than those in comparable private placement studies,” says Espen Robak, CFA, President of Pluris Valuation Advisors (New York City).  The average discount in the database is currently 30.7%, with a standard deviation of 16.5%.

Liquistat compiles its database from transactions listed with the Restricted Securities Trading Network (RSTN), with Pluris advisors adding analysis to calculate market-based valuations for restricted stock and warrants.  “With more than 200 transactions, it is believed to be the largest database of restricted securities trades anywhere.”  And it’s the only application of liquidity discounts to warrants and stock options.

For a free copy of Robak’s article, “Introducing Liquistat: A Completely New Way of Determining DLOM,” click here.   And don’t miss Robak along with Ashok Abbot (W. Va. Univ. and Business Valuation, LLC,) and Barry Silbert (Restricted Stock Partners) in today’s telephone conference: “Valuation of Illiquid and Hard-to-Value Securities.”  There’s still time to register; click here.

Of ignorance and irony—one buy-sell ‘war story’

A two-owner company wanted to offer small equity buy-ins to its three employees.  They asked their auditor—who’d never valued a business before—to figure out a price; he found a book on BV and issued his report.  The shareholder agreement was drafted to buy out departing shareholders at fair market value “using the same methods as the original appraisal,” which turned out to be riddled with errors (but ironically arrived at a then-accurate value).

Fast forward eight years: The company has grown tenfold and is being courted by a publicly traded competitor at a price 10 times the original appraisal.  At the same time, an employee/shareholder leaves, and the company offers a buyout using an appraisal by the same CPA—who has since learned solid BV techniques. 

But the employee knows of the M&A discussion price (which is significantly higher than the offer) and hires an attorney, who reads the shareholder agreement and demands a new appraisal.  The same CPA reluctantly prepares a report (based on the same faulty methodology) that concludes a value LESS than the original buy-out price—and a lawsuit ensues.

“Needless to say,” says Bill Quackenbush (Advent Valuation Advisors, LLC), who submitted the story in response to last week’s request, “the fact that there were two attorneys who did not understand valuation, as well as one CPA/appraiser, was the root cause of several years and hundreds of thousands of dollars in litigation expense.”

What’s your buy-sell story?  Email the BVWire editor, and we could feature your story (and its solution) in BVR/Mercer Capital’s three-part special series on buy-sell agreements, which begins May 24, 2007

New CFO study links financial forecasts & strategy

Budgeting and forecasting is no longer just about measuring past performance; it’s now become a critical competency for organizations to plan, manage, and execute on strategy.  How are finance executives responding to the challenge? 

More than half (52%) of respondents to a new study reported that creating closer links between strategy and operations is one of their top two priorities.  Other key findings from the PricewaterhouseCoopers study (at, indicate that the vast majority (65%) of respondents believe the strategic relevance of budgeting and forecasting will increase over time (only 5% expect a decrease).  Three-quarters (75%) depend on spreadsheets for all or a portion of their forecasting activities; and 56% of their efforts are still spent on low-value activities, including data collection and consolidation, reviews and report preparation.   

DOL plans increased oversight of ESOP transactions

At a meeting of the Michigan Bar Tax Section last week, Theresa Gee, Deputy Associate Solicitor with the Department of Labor (Benefit Plan Security) spoke on fiduciary liability in ERISA litigation.  Almost as an aside, Ms. Gee mentioned that the DOL is in the process of creating new disclosure regulations for plans with respect to consultants, including investment banks, financial advisors, and appraisers.

Apparently, the Department plans to issue new regulations to “ramp up” its oversight of ESOP-related transactions (perhaps in the wake of the $8.2 million buy-out of the Chicago Tribune?  See BVWire # 55-3).  There was no word when the regulations would appear or if enforcement of prohibited transactions has already begun—but we’ll keep readers posted on any news from the applicable authorities.

In the mean time, check out the latest (2nd Edition) of The Guide to ESOP Valuation and Financial Advisory Services, by Robert Reilly and Robert Schweihs, which updates current thinking on ESOP employer stock valuation, transaction structure, acquisition financing, independent financial adviser issues, and more.  To pre-order a copy, click here.

Where can you hear from the IRS, Grabowksi, and Hitchner? 

At the New York State Society of CPA’s (NYSSCPA) Business Valuation conference in New York City on May 21-22, 2007, which features a “common errors” overview from Mike Gregory of the IRS; a “hot topics” discussion of discount rates from Roger Grabowski; a FASB 157 update from Jim Hitchner; and best practices in using economic data/industry analysis from Mercer Capital’s Timothy Lee.  For more information and to register, click here.

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