On July 1, 2020 it was my pleasure to be interviewed by Melissa Gragg, CVA, MAFF, CDFA and Managing Partner at Bridge Valuation Partners, LLC. This 84 minute podcast is packed many ideas of how to avoid and what to do if audited by the IRS on an estate or gift tax return. For business valuers this commentary focuses on the most common adjustments by IRS Business Valuers and what you might want to consider to both avoid an audit and what to do if audited. What does this have to do with The Collaboration Effect® you may ask. Read on. Clearly not everything in that podcast can be presented here, but some of the key highlights can be. The purpose of this commentary is to focus on one of the questions from that podcast. That is: What are the most common adjustments by IRS Business Valuers.
What are the most common adjustments by IRS Business Valuers?
The three most common adjustments by IRS Business Valuers historically are the
Discount for Lack of Marketability (DLOM), S-corp tax affecting, and reasonable compensation.
Of course, there are a host of other possible adjustments. These three were common enough that the IRS developed Job Aids of each of these topics. The IRS has now made each of these Job Aids public at this link. I am suggesting that you download each and the appendix associated with reasonable compensation.
The DLOM Job Aid is dated, but still very useful with 32 categories to consider, pros and cons of methods (though some are dated), what the IRS looks for during an audit and other items. The S-corp tax affecting Job Aid is still very much an IRS position. The IRS won 100% on the first six cases starting with the Gross case ((Gross T.C. Memo 1999-254, aff’d. 272 F.3d 333 (6th Circuit) 2001, cert denied 537 US 827 (2002) (Corp)) in 1999. However, the last three cases in 2019 and 2020 have gone the way of the taxpayer. These are the
ESTATE OF AARON U. JONES, T.C. Memo. 2019-101
KRESS VS. U.S., 2019 US Dist. LEXIS 49850 – an article about the case.
PIERSON M. GRIEVE, T.C. Memo. 2020-28
It is suggested as a valuer that you explore all three of these recent cases. Each offers some unique insights.
Reasonable compensation is a more active issue. With the Tax Cut and Jobs Act (TCJA) reasonable compensation has gained additional importance. The IRS has a host of sources that it can explore and it has formed an Issue Practice Network of specialists to assist IRS Business Valuers and agents with reasonable compensation issues. Those using RC Reports according to Paul Hamann, Founder and President, have not seemed to have difficulties with the IRS. If audited this source seems to help in resolving issues too.
What can you do as a business valuer?
Knowing these are the three most significant areas, it behooves a business valuer to
download all three job aids to understand where the IRS is coming from.
The IRS also presents which methods it finds as good sources. The IRS identifies areas where the agency has concerns with each method. If the IRS has concerns with a particular method, this is because the U.S. Tax Court, U.S. District Court, and /or the U.S. Federal Court of Claims has raised significant issues. You may want to emphasize the methods recommended by the IRS reviewers.
It may be that as a business valuer, that you may take exception to feedback from the courts. That is fine too. If this is the case it behooves you as a business valuer to indicate why you have taken the approach you choose and expecting a challenge, clearly articulate why it is especially on point in this case. It is in your best interest to take additional time to further elaborate on your approach when the IRS has put you on notice regarding a particular method. Your goal will be to educate the IRS why an exception should be made, and the method you have chosen makes sense in this instance. Take the time to elaborate and educate. Educate as you would a trier of fact. Keep it simple. Keep it direct. Articulate your three most significant points and include other points if appropriate and needed.
Otherwise seriously consider other alternative approaches that the IRS has found to be acceptable. After all, why irritate the reviewers and regulators. Do your best to anticipate their questions or concerns and provide ample commentary to provide a preventative approach to their questions.
Other areas of concern
In Business Valuations and the IRS: Five Books in One 25 golden nuggets elaborate on additional concerns and each of these three areas are expounded upon with two chapters on each. At my website are four complimentary eBooks that are still available, but likely to be removed soon with my next book coming out.
These four complimentary eBooks address the three areas identified here and how to write a business valuation report for the IRS.
Each of these complementary eBooks is a condensed version of my book with a host of relevant links to help you.
If the IRS conducts an audit of your business valuation return, besides the three areas above, the IRS is likely to explore the discount rate, the adjustments to income or lack thereof, the growth rate, the market approach, and the asset-based approach. The asset-based approach will likely receive further scrutiny in particular if assets are significant such as with real estate or natural resource such as mining or oil and gas assets.
What about the audit?
Apply The Collaboration Effect®. From the very beginning when you receive the written IRS notification letter of an audit,
be positive, professional and calm the fire.
When you know who is working the case at the IRS learn all you can about the person to try and build a connecting relationship. Really listen to the IRS representative. Don’t argue. Determine where they are coming from and why. Summarize what you heard them say better than themselves. Once you have fully listened to the IRS representative, work with the IRS person educate judiciously in a way that makes sense to them. This will help you build bridges to negotiate closure.
Many times, the client is in an elevated state and may very well be oriented towards escalation. If this is the case you may want to help your client with de-escalation techniques. By focusing on listening actively, being empathetic, being positive and working with the other party, you can help your client to understand the process. If you are not familiar with the process you may want to reach out to someone that has a background in valuation having worked at the IRS. Understanding the culture, the administrative processes, and the people can save time, money, mental toil and physical stress. Feel free to contact me. The call is free.
There you have it. These are the three most common adjustment areas on business valuations with some other insights in a nutshell to help you with the IRS.