Why Every Estate Plan Needs a Qualified Appraisal

Chief Counsel Advice (“CCA”) 202152018 was released on December 30, 2021 and includes analysis by the Office of the Chief Counsel surrounding a taxpayer gift to a grantor retained annuity trust (“GRAT”) and subsequently in the same year, a gift to a charitable remainder trust (“CRT”). It is important to note that CCAs cannot be used or cited as legal precedent, however they offer insight into how the IRS concluded given the specific facts of the situation and how the IRS may conclude given similar facts in the future. This article endeavors to provide background for this CCA and the relevant valuation considerations for gift and estate tax planning. All dollar amounts and dates are hypothetical for discussion purposes.

KEY FACTS[1]^, [2]

On December 31, 2015, the Company obtained a valuation for 409A purposes, which concluded on a value of $1,000 per share. A 409A valuation is used to issue stock options and not for gift and estate tax planning purposes. Around the same time, at the end of 2015, the taxpayer began to market the Company for sale, using investment bankers and seeking strategic buyers. Between June 15, 2016 and June 30, 2016, the Company received offers from five potential buyers. Three days later, the taxpayer funded a two-year GRAT with 100,000 shares of stock in the Company at the value of $1,000 per share, as determined in the December 31, 2015 409A valuation. The GRAT specified that the annuity payments were calculated on a fixed percentage based upon the initial fair market value of the shares in the Company.

On September 30, 2016, four of the five initial bidders increased their offers on the Company such that the per share value of the Company could have been as high as $2,850.

On November 15, 2016, the taxpayer created a CRT and funded it with 100,000 shares based on the $2,850 value per share. In December 2016, the Company accepted the tender offer of $2,850 per share from the highest bidder.

On December 31, 2016, the Company obtained a new 409A valuation that concluded on a value of $2,000 per share. This valuation included a statement “according to management, there have been no other recent offers or closed transactions in Company shares as of the valuation date.”

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[1] https://www.irs.gov/pub/irs-wd/202152018.pdf

[2] https://www.naepcjournal.org/wp-content/uploads/issue39d.pdf

CCA CONCLUSION

For purposes of valuing the transfer of shares to the GRAT, the taxpayer relied on the December 31, 2015 appraisal which did not contemplate the search for buyers, the ongoing merger negotiations, or the offers that had been actually received in the days before the GRAT was funded. The CCA concluded that the per share value would have been higher than 409A value, but likely not as high as $2,850 if the offers had been considered in an updated valuation.

The CCA suggested that the value determined by the December 31, 2015 409A was not valid to use for the gift to the GRAT because it did not consider the pending offers for the Company and other current market data at the time of the GRAT funding. Further the CCA suggested that the taxpayer likely knew of potential offers that would impact the Company’s value such that the value at the time of the transfer to the GRAT was potentially higher than the value determined by the December 31, 2015 409A. Therefore, the CCA held that the taxpayer used a misleading and outdated valuation to fund the GRAT and called into question the good faith motives of the taxpayer.

Ultimately, the CCA concluded that the GRAT transfer in July 2016 was made to a trust that did not qualify as a GRAT as a matter of law. The CCA’s reasoning was that the trustee paid an amount that had no relation to the initial fair market value of the property transferred to the trust, disqualifying the trust as a GRAT.

VALUATION CONSIDERATIONS

This CCA memo highlights the risks of failing to take seriously the valuation of assets specifically for gift and estate planning. In this case, the taxpayer attempted to use a seven-month-old 409A appraisal for the transfer to the GRAT that did not consider the offers the Company had received that would affect the value of the shares.

Further, 409A appraisals are used by a company to set the strike price of options for employee equity compensation and are prepared pursuant to Internal Revenue Code Section 409A. The IRS has stated that for purposes of Section 409A, an independent appraisal will be presumed to reflect the fair market value of the stock if the appraiser is independent, and the appraisal is dated within the last twelve months. Importantly, this presumption is only rebuttable if the IRS can show that the valuation is grossly unreasonable. Additionally, a 409A is not governed by Revenue Ruling 59-60 but rather is presumed to be per se valid and sufficient when submitted for 409A purposes.

In contrast, a qualified appraisal, which is submitted to support gift and estate tax values, requires the appraiser to be independent, as well as to disclose and consider the transaction in question, the assets being valued, and the valuation methodologies. Specifically, a qualified appraisal must consider the factors laid out in Revenue Ruling 59-60:

1. The nature of the business and the history of the enterprise from its inception.
2. The economic outlook in general and the condition and outlook of the specific industry in particular.
3. The book value of the stock and the financial condition of the business.
4. The earning capacity of the company.
5. The dividend-paying capacity.
6. Whether or not the enterprise has goodwill or other intangible value.
7. Sales of the stock and the size of the block of stock to be valued.
8. The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter.

A 409A valuation does not necessarily require an appraiser to consider all of the above factors and therefore it is not appropriate to use such a valuation for gift and estate planning purposes.

COLLABORATION BETWEEN ADVISORS IS KEY FOR SUCCESS

Frequently, advisors can be siloed by their client, intentionally or not, which can create blind spots or errors in the planning process. Planning teams often consist of valuation professionals, investment bankers, corporate counsel, estate planning counsel, and CPAs. Allowing these professionals to communicate and collaborate during the planning process can result in a more polished and substantial plan. For valuation advisors, some of the most important collaborative actions are as follows:

• Review prior valuations and comminate with past appraisers to ensure consistent work.
• Communicate with investment bankers regarding projections and market transaction data.
• Speak with corporate counsel to understand any restrictions on company stock or shareholder agreements that may impact the valuation.
• Discuss the contemplated gift or estate transaction with the estate planning counsel to ensure the valuation meets the needs of the plan.

CONCLUSION

The CCA guidance clearly shows the potentially costly mistake of not using a qualified appraisal in the planning process. In the case of the taxpayer discussed above, a significant portion of the estate plan was put in jeopardy because the taxpayer did not use a qualified appraisal, which ultimately caused the taxpayer’s trust to be disqualified as a GRAT. In addition, the CCA guidance shows the pitfalls of lack of collaboration between advisors. Had the valuation advisors been in contact with the investment banks, corporate counsel, or estate planning counsel, it is likely that the valuation would have been updated to consider the recent offers and the transfer to the GRAT would have been successful.