Estate & Gift Tax Valuation: When Do I Need to Hire an Appraiser?

By Keith Meyers, CPA, ABV, CFF

Executive Summary
The valuation misstatement penalty provisions under IRC section 6662 require that assets included in estate and gift tax returns be priced accurately. An understated value can expose the taxpayer to a 20% penalty or more. These penalties are imposed if a tax return understates the value of any property by 35% or more.

In today's economic environment, clients have never been more cost conscious, especially when it comes to professional fees. There is a constant struggle to provide the best in professional services while keeping costs at a minimum. When executing an estate plan that includes estimating the value of a hard-to-value asset, what are the risks to a taxpayer if the reported value is incorrect?

Section 6662(a) imposes a 20% taxpayer accuracy-related penalty on the underpayment of tax if the underpayment is attributable to a "substantial valuation understatement." Under this section a "substantial" understatement is when the reported value is 65% or less than the amount ultimately determined to be correct value (IRC sec. 6662(g)(1)). A disallowed discount of 35% will be enough to expose a taxpayer to this penalty. The penalty can double to 40% if the understatement is considered a "gross valuation understatement." A gross valuation understatement is when the reported value is 40% or less than the "correct" amount.

What can the professionals do to reduce the risk that these penalties will be imposed?

You always have the option to be conservative, estimating hard-to-value assets with little or no discounts. The risk of exposure to the accuracy-related penalty will be lower, but the taxpayer will probably pay too much in taxes. Even this strategy has its limits. There will be times where neither the advisor nor the taxpayer has a reasonable way of estimating the value without the advice of a professional appraiser. In these cases, a value based on an expert opinion and supported by adequate evidence is the most prudent course of action.

The accuracy-related penalty is not "conduct based" but will be imposed in all cases where the gap between the reported value and the "correct" value is large enough. There a two exceptions. It will not be imposed if the amount of understatement is a) less than $5,000 or b) if the taxpayer had reasonable cause for taking the position on the return and acted in good faith. So assets with estimated values under $10,000 or so are probably too small to create a problem. For larger assets, the taxpayer must rely upon the reasonable cause/"good faith" defense. This rule is applied on a case-by-case basis, so there is no "iron-clad" safe harbor that can be relied upon for total protection against the imposition of this penalty.

The reliance on a qualified valuation professional is the best way for the taxpayer to show that they acted reasonably and in good faith. A valuation that is based on a qualified appraiser's opinion is normally enough to establish reasonable cause. However, the Second Circuit has ruled that the taxpayer should have a reasonable belief that the expert possesses the necessary expertise and experience to properly value the asset. In these cases, an experienced and qualified valuation professional is the best way to show a reasonable cause/"good faith" defense and protect the taxpayer from the understatement penalties under section 6662.

The Perkins & Co valuation team is willing to discuss with you situations where a valuation might be appropriate, as well as cost-effective ways to establish a reasonable, supportable value for hard-to-value assets.

This bulletin is a summary and is not intended as tax or legal advice. You should consult with your tax advisor to obtain specific advice with respect to your fact pattern.

Based on the most recent "best practice" standards for tax advisors issued by the Treasury Department, commonly referred to as Circular 230, we wish to advise you that this bulletin has not been prepared to be used, and cannot be used, to provide assurance that penalties which may be assessed by the IRS or other taxing authority (including specifically section 6662 understatement penalties) will not be upheld.