United States: Valuation Challenges In Estate And Gift Tax Planning Situations: Practical Dos And Don'ts Of Obtaining, Relying Upon, And Defending A Valuation Report

Last Updated: July 13 2015
Article by Michael G. Goller

Michael Goller examines the duties owed by the practitioner and the risks faced by the client when wealth transfer issues involve valuation issues.


In spite of significant budget cuts, certain audit issues remain a priority for the IRS. High-income individuals continue to be a popular IRS audit target.

In 2009, the IRS created its Global High-Wealth Industry Group (part of LB&I). This group conducts "package audits" of taxpayers and their related businesses and entities. These audits often involve very detailed information requests and focus on a broad range of issues.

The IRS also continues to audit the estates of and gifts made by high-net-worth individuals. This is due, in large part, to the fact that in 2012 many wealthy individuals made significant year-end gifts. Due to the uncertainty that surrounded the estate and gift tax law and whether the Unified Credit would be reduced in subsequent years, these gifts were often made in a hurried manner.

A common issue in many estate and gift tax audits is valuation. The IRS and taxpayers often disagree over issues such as valuation methodology, what valuation discounts are applicable and the extent of those discounts. Thus, obtaining a sound valuation report is of the greatest importance.

Should the IRS dispute the value of a gift or bequest, a solid, contemporaneous valuation report is a valuable audit defense tool. A contemporaneous report is something that the IRS can never obtain ( i.e., the IRS's appraisal is always prepared well after the fact). Thus, taxpayers who obtain a well-written, upfront appraisal may benefit greatly if there is an IRS audit.

It is important, however, for the practitioner to understand the pitfalls that he or she may face when obtaining and defending a valuation report. Often, success at trial will depend on work that was performed years before when the appraiser prepared the original report. These pitfalls include potential Circular 230 violations, penalties faced by the taxpayer, appraiser and practitioner and other traps for the unwary.

Circular 230 Issues That Arise When Obtaining a Valuation Report1

While tax practitioners are subject to Circular 230 in its entirety, there are certain provisions that have a direct and significant impact on the practitioner when planning and implementing a transaction designed to reduce value for tax purposes.

Circular 230 Section 10.37(a). Requirements for Written Advice

In June 2014, the IRS did away with the Covered Opinion Rules2 for written tax advice. These rules contained very objective (albeit somewhat unreasonable) standards for written tax advice. The Covered Opinion Rules were replaced with a new Section 10.37, Requirements for Written Advice .

It is critical that practitioners explain to their clients tax strategies and planning techniques in a clear and understandable manner. Thus, the rules that govern written communications are of great importance to the practitioner. This is especially true in light of the fact that valuation strategies and techniques are frequently very complicated and are often best explained in writing.

The revised rules replace the objective standards of the Covered Opinion rules with more subjective standards. These standards stress the theme that a practitioner must be "reasonable."

Specifically, written advice may only be based upon reasonable factual and legal assumptions, including assumptions as to future events.3 When giving advice the practitioner must reasonably consider all relevant facts and circumstances the practitioner knows or reasonably should know about.4 Further, the practitioner has an obligation to be proactive in that he or she must use reasonable eff orts to identify and ascertain the facts relevant to the written federal tax advice.5 Finally, the practitioner must explain the possible application of penalties faced by the client and how to avoid those penalties ( see discussion of Code Sec. 6662 , below).6

The practitioner may not rely upon representations, statements, findings or agreements (including projections, financial forecasts, or appraisals) of the taxpayer or any other person if reliance upon them would be unreasonable.7 Additionally, the practitioner must relate the applicable law and authorities to the facts. When evaluating a federal tax matter, the practitioner may not take into account the possibility that a tax return will not be audited or that a matter will not be raised on audit.8

Finally, when providing written advice, the practitioner cannot blindly rely upon third-party representations or agreements ( e.g., blindly rely on a value set in a buy/sell agreement). Reliance upon a representation, statement, finding or agreement is specifically unreasonable if the practitioner knows or reasonably should know that one or more representations or assumptions on which the representation is based is incorrect, incomplete or inconsistent.9

Accordingly, when describing a valuation strategy in writing, one must spend the time and eff ort to make sure the strategy is reasonable and that it is clearly explained to the client.

Circular 230 Section 10.37(b). Reliance on Others

When providing written tax advice, some practitioners assume that so long as they obtain a valuation report, they can simply rely upon the report and look no further. This is, however, a dangerous assumption. The practitioner may rely upon third parties; however, "blind" reliance is not permitted. The reliance must be reasonable.

Specifically, the practitioner may only rely on the advice of another person if the advice was reasonable and the reliance is in good faith, considering all the facts and circumstances.10

Further, reliance is specifically unreasonable when:

  • the practitioner knows or reasonably should know that the opinion of the other person should not be relied upon;
  • the practitioner knows or reasonably should know that the other person is not competent or lacks the necessary qualifications to provide the advice; or
  • the practitioner knows or reasonably should know that the other person has a conflict of interest in violation with Circular 230 ( e.g. , the conflict has not been properly waived).11

Accordingly, it is often a good idea to provide a client with a written summary of a tax planning strategy. However, when giving written tax advice to a client, the practitioner must act in a reasonable manner, in light of the facts and circumstances. The scope of the engagement and the type and specificity of the advice sought by the client will be considered when determining whether the practitioner's conduct was reasonable.12

Circular 230, Section 10.22. Due Diligence

The Circular's due diligence requirement is perhaps the broadest section in the Circular. Almost any "bad act" can be characterized as a lack of diligence.

Section 10.22 mandates that every practitioner exercise due diligence when practicing before the IRS. This includes exercising diligence in preparing documents relating to IRS matters and verifying the correctness of oral and written presentations made to both the IRS and one's client with regard to any matter administered by the IRS.13

Thus, even if a practitioner does not advise a client in writing, the practitioner cannot blindly rely on a valuation report. A practitioner will be presumed to have exercised due care if the practitioner relies on the work product of another person. However, this presumption is limited to cases where the practitioner used reasonable care in engaging, supervising, training and evaluating the person, taking into account the nature of the relationship between the practitioner and the other person.14

Thus, in the context of an appraisal report, a practitioner's due diligence obligation would seem to require the practitioner to review and understand the valuation reflected in the report and conclude that the value is reasonable, before making a recommendation to a client.

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1 Circular 230, containing the ethical rules that govern practice before the IRS. It is authorized under 31 USC §330 and can be found at www.IRS.gov.

2 See former Circular 230 Section 10.35.

3 Circular 230 Section 10.37(a)(2)(i).

4 Circular 230 Section 10.37(a)(2)(ii).

5 Circular 230 Section 10.37(a)(2)(iii).

6 See Circular 230 Section 10.34(c) which requires a practitioner to inform a client of any penalties reasonably likely to apply and how to avoid those penalties through disclosure.

7 Circular 230 Section 10.37(a)(2)(iv).

8 Circular 230 Section 10.37(a)(2)(v) and ( vi).

9 Circular 230 Section 10.37(a)(3).

10 Circular 230 Section 10.37(b).

11 Circular 230 Section 10.37(b)(1)–(3).

12 Circular 230 Section 10.37(c).

13 Circular 230 Section 10.22(a).

14 Circular 230 Section 10.22(b).

Previously published in CCH Journal of Tax Practice & Procedure

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Michael G. Goller
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