For many estate and gift tax attorneys (and their financial advisors), most of the following "red flags" will not be cause for surprise but should underscore the importance of issues that require continued professional oversight and appraisal expertise.
1. Discounts. The reasonableness of valuation discounts used in estate and gift tax appraisals is still a primary focus for the IRS, which will often flag discount conclusions that are not supported by the data or that apply study averages without sufficient explanation.
2. Standard of Value. Likewise, the IRS continues to receive valuation reports that apply the fair value standard instead of fair market value, or consider the perspective of only one person (either the hypothetical willing buyer or the seller) rather than both. (For a discussion of the difference between "fair value" and "fair market value," see the April 2011 issue of Valuation Perspectives.)
3. Tax-Affecting. Valuation of S corporations is another problematic area, in which the courts, valuation experts and IRS examiners have not always been consistent. Rather than focus on the case law, attorneys and valuation professionals would be well-advised to carefully consider the particular facts and circumstances of any case. Related issues include tax considerations in C to S corporation conversions and the valuation of embedded capital gains tax liability.
4. Factual Errors.
Appraisal inaccuracies will also attract the IRS' attention. More than mere mathematical errors, they include presenting false information or assuming facts related to the appraisal that do not exist.
5. Valuation Errors. Unfortunately, the IRS is still finding appraisals of business interests that purposefully include or exclude valuation approaches, ignore strong market evidence, or disregard professional standards. Many of these mistakes are made by individuals who lack appropriate training or experience and can be avoided by using qualified appraisers.
6. Analytical Errors. The IRS is also finding appraisals that (a) lack a strong, consistent factual development, (b) are based on an income stream that is inadequately or inappropriately matched to any adjustments (discounts), and/or (c) feature an incomplete tax rate analysis. Appraisals that supply a good "analytical fit" to the facts of a case clearly show how the valuation conclusions were reached, what adjustments were made, what data were used, and what law was relied on.
7. Documentation Errors. Finally, the IRS cautioned against (a) using exhibits and computations that fail to follow the analytical narrative or are incomplete and (b) failing to document according to all relevant professional standards.