Business valuation and tax authorities: IRS guidance

As you probably know, the Internal Revenue Service is the tax arm of the US Treasury Department. Unsurprisingly, valuation of businesses and other assets is of interest to the IRS. Through the years, the service has published a number of interpretations that have come to be widely supported in professional business appraisals.

These revenue rules, as they are called, do not have the force of law, representing instead the position the IRS takes toward business valuation best practices. As an example, regulatory guidelines may be used in the context of gift and estate tax laws that require appraisers to use specific valuation approaches or methods when valuing privately owned companies.

Some of the IRS publications are merely pronouncements with administrative authority. Again, they do not have the binding force of the law. Examples of these are the revenue rulings, private letter rulings, technical advice and general counsel memorandums.

As time went by, many of these publications were tested by courts in legal disputes. The case law that emerged lent support to some, but not all, IRS pronouncements. Some of the best known and supported IRS publications that stood the test of time are these:

Revenue Ruling 59-60

This publication is perhaps the best known IRS statement on valuation of private company ownership interests.

68-609

Deals with the fair market valuation of business intangible assets, including goodwill. The exposition of the so-called formula method is part of this paper.

65-193

Updates the Revenue Ruling 59-60 with specifics on intangible asset valuation.

77-287

Introduces the concept of lack of marketability and the restricted stock studies as a method to calculate the discounts for lack of marketability. If you are valuing a privately owned company whose stock is less marketable that shares of public companies, this is a very important point to consider.

93-12

Provides exposition of discounts for lack of control when valuing partial ownership interests in private companies. If you need to figure out the value of a partner’s share of business, the importance of control in business value estimation is something you should review carefully.

The private letter rulings (PLRs) and technical advice memorandums (TAMs) are the usual way the IRS responds to specific taxpayer inquiries. They are widely used for gift and estate tax valuations.

In general, you will find that many professional business valuations in the USA cite the IRS revenue rulings and other publications to enhance the credibility of appraisal. Remember, however, that the IRS guidelines are less compelling when valuation is done for non-tax purposes such as business sale situations.

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