Business appraisals are serious business. Whether considering a business appraisal from the viewpoint of the Internal Revenue Service (IRS), business owner(s) or any combination of associated parties, a thorough valuation and supportable value conclusion serve everyone’s best interest.

All too often, business owners rely on appraisers who lack necessary training and education. Evolving changes in the industry make it difficult to remain current with standards and best practices — especially for those not affiliated with a certifying appraisal association. Therefore, employing a professional who has been certified in the trade and who keeps abreast of this ever-changing field should be seen as a best practice.

Reasons for a Business Appraisal
Many events could necessitate a business appraisal. A business might be valued, for example, during a change of ownership. Understandably, both buyer and seller would want to know the value of the business in as accurate terms as possible.

Business appraisals also commonly are required during litigation. Whether a legal action is family-oriented (e.g. divorce), or professional (e.g. contract dispute), businesses often are drawn into courtroom dramas and a well-reasoned valuation typically wins the day.

Among the most common reasons for a business appraisal is estate planning. People, regardless of how successfully they have operated a business, simply cannot live forever. Some create family businesses that are passed from generation to generation while others dissolve a business in favor of a financial legacy. Regardless, planning is always ideal and should incorporate any relevant business and its worth into the estate calculations. Having a deficient valuation could undermine efforts to build and manage personal wealth as well as lead to tax implications in the future.

Thorough Appraisal Process, Supportable Value Conclusion are Important
Definitive tax implications related to the accuracy of appraisals exist. The IRS penalty for a substantial valuation misstatement is 20 percent of the tax due, while the penalty for a gross valuation misstatement is 40 percent. Therefore, one benefit of a supportable value conclusion is being able to withstand an IRS challenge and minimize the potential for penalties.

An Evolving Industry
While real estate appraisers have functioned for decades under licensing requirements, business appraising was historically reminiscent of the Wild West. Certifications existed but still are not required even today.

The Uniform Standards of Professional Appraisal Practice (USPAP) apply to all forms of appraisals. They were adopted in 1987 and are considered the minimum standard for any appraisal. The majority of accrediting societies also have adopted additional standards that include stricter requirements of the appraiser.

One recent development was the IRS published regulations related to the Adequate Disclosure of Gifts in 1999. The new regulations essentially marked the beginning of the increased level of risk associated with having appraisals conducted by other than a certified professional.

Additionally, these regulations mandated that the basis for valuing a business included on a gift or estate tax return be “adequately disclosed” for the statute of limitations to begin. In addition to the risk of an IRS challenge, gifts of business interests without a thorough appraisal by a competent appraiser leaves the gift open indefinitely to such a challenge.

Unfortunately, the qualifications of a competent appraiser were not addressed in the legislation. It was not until the Pension Protection Act of 2006 that the term “qualified appraiser” was defined as an individual that has “earned an appraisal designation from a recognized professional appraiser organization.”¹

Concluding Comments
Business appraisals should be taken seriously and entrusted only to trained professionals. When considering an appraiser, it is important to ensure the individual possesses the knowledge and skills necessary and inquire whether he/she possesses a professional certification.

After devoting a lifetime creating a legacy for future generations, it would be devastating to undermine those efforts with a faulty appraisal and regulatory nightmares. Remember that business appraisals add value only when the value they assign is accurate. Choose your appraiser carefully.

Robert Morrison is a Managing Director with RSM McGladrey, one of the nation’s leading providers of accounting, tax and consulting services. Robert has more than 27 years experience working with financial and accounting matters, including an extensive background in business valuations and litigation support. He has served as a court-appointed Independent Appraiser and Special Master on several occasions. Robert is a certified Accredited Senior Appraiser and serves regularly as a national instructor for the American Society of Appraisers. Robert can be reached at robert.morrison@rsmi.com.

Article originally appeared in FirstMonday Magazine.

¹H.R. 4, “The Pension Protection Act of 2006”, Section 1219(c)(1)(E)(i)(II),(www.dol.gov/ebsa/pdf/ppa.2006.pdf)