IRS tightens the reins on business valuations

The IRS has cracked down on abusive tax reporting and upgraded its Business Valuation Guidelines. Understanding IRS preferences can minimize taxpayer liabilities and expedite settlement.

Revised guidelines - In an ongoing effort to improve the quality of tax-related valuations, the IRS recently added more than 300 in-house appraisers and revised its Business Valuation Guidelines. The eight-page IRS valuation guide incorporates comments from appraisers and business valuation organizations.

Despite many obvious similarities, the IRS decided against formally adopting the Uniform Standards of Professional Appraisal Practice (USPAP). This allows it to retain authority over future modifications of its guidelines, rather than relinquish control to the Appraisal Foundation, which governs USPAP. In addition, the IRS wanted to keep the option of attaching less structured valuation reports with tax filings.

The Business Valuation Guidelines - apply exclusively to in-house valuation personnel. Although the IRS encourages taxpayers’ valuators to continue following the standards of affiliated professional organizations, a valuation report organized in accordance with the IRS guidelines may be easier for an IRS appraiser to follow and generate fewer questions.

Furthermore, compliance with the IRS guidelines may demonstrate that the taxpayer has provided “credible evidence” of its valuation claims, thereby shifting the burden of proof to the IRS under Internal Revenue Code (IRC) Section 7491.

IRC Section 6701 - The IRS also plans to penalize valuators who aid and abet taxpayer efforts to understate tax liabilities, under Internal Revenue Code (IRC) Sec. 6701. If found guilty of abusive valuation practices, appraisers may be fined or disqualified from preparing tax-related valuations in the future.

These penalties underscore the importance of maintaining both actual and perceived independence and credibility. There is a fine line between independent expert and taxpayer advocate. Once valuators cross the line, they usually cannot turn back.

Tips for surviving IRS inquiry - Recently, Howard Lewis, the National Program Manager for the Valuation Program at the IRS, offered the following suggestions to improve the outcome of IRS valuation challenges:

Be thorough - A written report generally serves as a valuator’s only form of direct testimony in tax court. As such, valuation reports should stand on their own, detailing all relevant information, data sources and analyses underlying the appraiser’s conclusion.

Play IRS advocate - Valuators should put themselves in the shoes of IRS auditors. Is the report organized and technically sound? Does the conclusion consider the point of view of both hypothetical buyers and sellers?

Be responsive. Taxpayers and their valuators should promptly respond to IRS inquiry with full disclosure of all relevant information. Delayed response may imply that the taxpayer and valuator are uncooperative, unprepared or hiding damaging information.

Work toward settlement - Finally, keep in mind that the revised Business Valuation Guidelines advises IRS personnel to resolve any issues or disagreements “as early in the examination as possible.” The guide encourages valuators, taxpayers and IRS personnel to cooperate and collaborate, rather than taking an adversarial position. Litigation is reserved as a measure of last resort.

Bottom line - Today’s IRS personnel possess the requisite financial literacy to delve into the technical analyses underlying a value conclusion. The best defense against an IRS valuation challenge is a comprehensive written report that complies with the IRS Business Valuation Guidelines, as well as the appraiser’s own professional standards.

Tax-related issues can pose problems post deal if not watched carefully. If a valuation report contains shortcomings or aggressive discounts, the new and improved IRS valuation department is geared up to expose them.