Adequate Disclosure Requirements for Tax Valuations

Although Tax Season may be over for this year, we should start talking about or at least considering issues for the future.  Gifting strategies are an effective and popular way to manage estate tax issues.  Gifting not only removes an asset from the estate – but it also removes any future appreciation in the value of that asset.   It’s the latter part that’s perhaps most interesting.  For assets that are not rapidly appreciating it’s less of a consideration.  But for many businesses – especially high growth companies- appreciation is a paramount concern.

In many cases this quickly appreciating asset is a privately held business with no readily available market value.  As such reporting that value can be troublesome as the part of the filing includes meeting adequate disclosure requirements.   We routinely appraise these assets to provide safe harbor, and frequently field questions as to what constitutes adequate disclosure.

Critical to transferring the assets in a trust or estate is providing the necessary information, not only to receive an accurate valuation, but also to follow IRS rules.  Those rules usually require the filing of a tax return, in the case of a gift, and a valuation that meets all the adequate disclosure requirements.  That will begin the three-year statute of limitations that the IRS has to audit the transfer.  Without this valuation and adequate disclosure, the statute of limitations does not begin to toll.

Information Requirements

In order to meet those adequate disclosure requirements, the following information must be included in the valuation:

Transfers are conducted at Fair Market Value, which is traditionally defined as: “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” (Treasury Regulation Section 20.2031-1(b)).  In many cases gifts will be effected as non-controlling or non-marketable, thus triggering discounts for marketability (DLOM) or lack of control (DLOC).  As such disclosure also requires:

These items are, principally, the same that we take into account in determining any discounts or premiums applied to a valuation.   Support often comes in a variety of formats, ranging from reliance on academic studies, application of market data supporting such discounts, as well as more quantitative methods.

In furtherance of mitigating risk, it’s imperative to have the appraisal completed by a qualified appraiser. Ensure that you choose a qualified appraiser that satisfies all these requirements as stated in the Treasury Regulations (Treasury Regulation Section 301.6501(c)-1(f)(3)):

A certified valuation firm that is familiar with these types of transactions is your best option.  Getting this valuation done as soon as possible and have it included with any filings will begin the three-year timeline.

You should consult your tax and legal advisors prior to implementing any estate planning transactions.