We are noticing a decided uptick in gifting before the end of the year as many are anticipating an end to the crushing weight on the economy caused by the pandemic lockdown and a reduction in the unified exemption from 2020’s record-high $11.58 million ($23.16 per couple). The timing might be right for a number of reasons, however, when the time for making gifts arrives it is always prudent to have a qualified appraisal to support the value of the gift upon challenge by the IRS. Why is a qualified appraisal a smart investment? Look at just a few recent developments in this area:
Relying upon the proper methodology and then applying that methodology correctly are the keys to a defensible qualified valuation. In Estate of Jones T.C. Memo. 2019-101, the IRS expert used the net asset value method for determining the value for the subject interests while the taxpayers’ expert used a tax-effected discounted cash flow method (DCF) to value the interests in an S Corporation and a limited partnership. The IRS has long taken the position that tax-effecting (i.e., applying an assumed corporate-level income tax) the earnings of a pass-through entity is inappropriate when using a DCF to value an entity. In a number of cases, the Tax Court has famously rejected tax-effecting for pass-throughs. In Jones, however, the Court clarified that its earlier rulings did not condemn tax-effecting per se but that it was dependent upon the facts and circumstances of the case and that in the current case “ [the Estate’s] tax-effecting may not be exact, but it is more complete and convincing than [the IRS’s] zero tax rate.”
Discounts for lack of control or lack of marketability are often at issue when the IRS reviews gift and estate tax returns. In Grieve v. Commissioner T.C. Memo. 2020-28 the taxpayer was successful in defending combined discounts from net asset value of 34.97% and 35.68%, respectively, for two gifts of 99.8% nonvoting member interests in family LLCs. The IRS contended that a hypothetical willing seller would seek to maximize their return and would purchase the remaining 0.2% interests in the holding companies, and thus avoid the discounts, before offering the entire enterprise for sale. The Tax Court rejected that notion stating that “[w]e do not engage in imaginary scenarios…”
Understanding the facts and circumstances surrounding a particular gift and being able to apply a variety of methodologies and techniques that fit those circumstances are critical to a qualified appraisal. Those who believe that the casual use of a rule of thumb or formulas and the application of “reasonable” discounts are good enough may wish to think again. In a memorandum dated January 22, 2020, the IRS eliminated the multi-tier review process for appraiser penalty cases. Now if an IRS appraiser or valuation specialist determines a valuation misstatement has occurred that specialist can open a potential penalty case by notifying an immediate supervisor.
There are both opportunities and pitfalls to making and documenting gifts in 2020. Aronson’s dedicated team of valuation specialists can help you navigate these issues safely. For more information contact Sal Ambrosino.