The Most Important IRS Document as it Relates to Estate & Gift Tax Valuation: Revenue Ruling 59-60

Undoubtedly the single most important document from the IRS as it relates to estate and gift tax valuations is Revenue Ruling 59-60.  Revenue Ruling 59-60 provides the roadmap for valuations performed for tax purposes to be deemed acceptable by the IRS.  59-60 is the reason that valuation experts need to write full length reports that examine and analyze a number of factors in order to conclude on the value of a business interest.

fair market

The first and potentially most significant aspect of 59-60 provides a definition of fair market value.  Fair market value is defined as:

“The price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.”

The key in this definition is that the buyer is hypothetical as opposed to specific.  A specific buyer may be willing to pay more for a particular business based on the buyer’s ability to realize synergies from the combined companies.  59-60 tells us that we cannot consider a strategic/synergistic buyer.  In this context, fair market value pertains to a strictly financial buyer.  This is one of the many reasons why the standard of value is extremely important in all valuation engagements.  Many business owners may see an estate/gift tax valuation and compare that to an offer they received to by the business from a competitor in their industry.  These two valuations are not based on the same standard of value, so it is not an apple to apples comparison.

Another key aspect of 59-60 is the factors that valuation analysts need to consider in order to develop a conclusion of value.  These factors are included in a detailed narrative report.  The factors that must be considered include:

  1. The nature of the business and history from inception

    Written narrative of the company and its operations historically, and as of the valuation date.

  1. The economic outlook in general and the condition and outlook of the specific industry in which it operates.

    Written narrative on the general economy (GDP, unemployment statistics, etc.) and the industry (growth rates, risks/opportunities, etc.) are often included.

  1. The book value and the financial condition of the business.

    An analysis of the balance sheet of the company, including the book value of assets, liabilities, and equity.

  1. The earning capacity of the business.

    An analysis of the company’s historical and potentially an examination of projected/budgeted income statements.

  1. The dividend-paying capacity of the business.

    An analysis of the company’s earnings/cash flows and the cash available to provide a return to the company’s shareholders.

  1. Whether the enterprise had goodwill or intangible value.

    An asset approach to valuation that looks at the balance sheet and examines if the company is worth more than the fair market value of its net assets.

  1. The market prices of the stocks of corporations engaged in the same or similar line of business having their stocks traded on an exchange or over-the-counter.

    A market approach to valuation, where the analyst will examine publicly traded companies in similar industries and determine trading multiples to apply to the subject company.

  1. The marketability, or lack thereof, the securities.

    This factor examines whether the subject company’s shares are traded in an active market, and if not, potentially applies a discount to account for the lack of liquidity.

Based on the above factors, it is no surprise that the reports that accompany estate/gift tax valuations can get lengthy.  However, it is important that all of these factors are analyzed and addressed in order to arrive at a conclusion of value that is logical and supportable.

Given the current tax climate and the potential changes on the horizon, it may be advisable to transfer assets to the next generation through a gifting strategy.  The gifts of business interests need to be accompanied by a report that is compliant with Revenue Ruling 59-60 to avoid trouble with the IRS upon examination.  Contact one of DKB’s valuation experts today to find out how we can help!