Estate and Gift Tax Valuation: Three Key Takeaways From IRS Ruling

Estate and Gift Tax Valuation: Three Key Takeaways From IRS Ruling

September 16, 2022

IRS Chief Counsel Advice 202152018 (the “CCA”) provides key insight into approaching post-valuation-date events properly in appraisals.1 As a memorandum, the CCA does not hold precedent in legal cases, but it offers valuable insight into the IRS’s perspective on issues of relevance to the taxpayer. In this case, the IRS offered guidance on whether a post-valuation-date event would need to be considered in the determination of the fair market value of an interest in a company for gift tax purposes.

Background of the CCA: An Outdated and Improperly Used Valuation

The CCA came in response to a highly successful company (the “Company”) utilizing the fair market value determination from an outdated 409A valuation for transferring shares to a Grantor Retained Annuity Trust (GRAT). The Company had hired investment bankers for aid with the potential sale of the Company prior to the funding of the GRAT. Seven months after the 409A appraisal and three days prior to the transfer to the GRAT, the Company had received several arm’s length purchase offers. The Company transferred shares to the GRAT using the fair market value determined by the 409A appraisal; however, it gave no consideration to the potential transaction or the received indications of value in the determination of fair market value. Three months after the formation of the GRAT, a final offer was received that was approximately 10% higher than the offers received pre-GRAT funding. The IRS contested this valuation, stating that “the trustee’s failure is an operational failure because the trustee paid an amount that had no relation to the initial fair market value of the property transferred to the GRAT; instead, it was based on an outdated and misleading appraisal of the company.”2 

Analysis of the CCA: Three Key Takeaways

The Company’s planners made several mistakes in their use of the outdated appraisal, detailed below. These errors highlight key lessons for other companies seeking to capture an accurate valuation for trust and estate purposes.

  • The Company did not account for post-valuation events: During an appraisal, everything reasonably known and knowable as of the valuation date must be considered. In this situation, as of the transfer date to the GRAT, it was known and knowable that the Company was being shopped and that indications of value had been received. A detailed analysis of the indications of value would have been needed to determine if the indications reflected the fair market value of the shares. The terms of the consideration (cash vs. stock vs. debt) as well as whether the buyers are synergistic buyers (and therefore paying a premium), and the potential of the offer not closing or closing at a different price all would need to be analyzed. However, as of the GRAT transfer, it was not reasonably knowable that the final price was going to be another 10% higher, which would negate the necessary consideration of the final price.

    When asked why the first three indications of value were not considered in the valuation, the Company stated that the 409A valuation had been performed close enough to the date of the GRAT funding and that there had been no significant changes regarding Company operations. However, this was clearly not the case: Both the passage of time and the arm’s-length offers could have a significant impact on the fair market value of the shares and therefore would need to be considered.
  • The Company did not remain consistent across tax reporting: The Company made charitable gifts after the GRAT funding but did so with a new appraisal that arrived at a significantly higher value based on the final purchase price. In other words, the appraisal firm appeared selective in their consideration of available information to potentially achieve the best tax benefit for the taxpayer. Although the value arrived at for the charitable contribution might have correctly considered what was known and knowable, consistency in valuations is paramount.

  • The Company did not perform proper valuation: The 409A valuation was originally used for a non-qualified deferred compensation plan. Crucially, a 409A valuation is not acceptable for gift tax purposes, as the 409A’s valuations are used for income tax and have different considerations. In addition, a 409A valuation will not meet adequate disclosure regulations for estate planning and may value a different class of equity. Ultimately, a 409A valuation tends to be very automated and does not appropriately consider the higher standard set for estate and gift tax.

Navigating Trust and Estate Transactions

In the case of the CCA, the Company made a host of errors in using a dated 409A valuation for estate and gift tax purposes. This CCA serves an important role of highlighting the proper treatment of post-valuation-date events, the need for consistency across tax reporting, and the requirement of taking all relevant information into account at the date of valuation. For companies working to navigate an important trust and estate transaction, a trusted advisor can ensure that the valuation is done properly.

Originally published in Practical Tax Strategies.

  1. Chief Counsel Advice 202152018, pg. 8.
  2. Section 2512(a) of the Internal Revenue Code states that “if a gift is made in property, its value at the date of the gift shall be considered the amount of the gift.” The regulations provide that the value of the property is the price at which such 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. Reg. 25.2512-1.