Lewis, executive director of the Institute of Business Appraisers, once served as national program director for valuation services at the IRS; joins other appraisal stakeholders to offer feedback on IRS section 6695A penalties

New Carrolton, MD

February 18, 2010

My name is Howard A. Lewis. I’m the Executive Director of the Institute of Business Appraisers, located in Plantation, Florida. I’m also the former National Program Manager of the IRS Engineering and Valuation Program. I held that position from June 2000 to August 2008, when I retired from the Service. The Institute of Business Appraisers, or, the “IBA,” is the nation’s first and oldest appraisal membership association. Mr. Raymond Miles, who continues to serve as a consultant, founded IBA in 1978. The IBA is the only association specializing in business appraisal. It’s nearly 2,000 members come from all parts of the United States and many foreign countries, and typically hold accreditations from IBA and or one or more of the other appraisal organizations, including those represented here today.

While at the Internal Revenue Service, I was the first to identify the problem with the Circular 230 regulations linking Code section 6701 to the professional responsibility rules governing appraiser practice. I strongly advocated for breaking that link and such was accomplished in the Pension Protection Act of 2006. The purpose was to enable more effective administration of the professional responsibility rules affecting appraisers and the intended result was accomplished with the enactment of section 6695A and subsequent announcements by the Internal Revenue Service.  However, some important issues regarding administration of that section have arisen and I am pleased to discuss some of these with you today, representing the members of the Institute of Business Appraisers.

The IBA, and I am certain we are joined by our colleagues here today representing other professional associations, strongly supports the efforts of the Internal Revenue Service to improve and enhance it’s oversight and administration of appraisers of all disciplines, including business appraisers. The IBA appreciates this opportunity to address several issues of importance as the Service continues to develop its approaches and procedures involving penalties under section 6695A.

I’d like to focus this afternoon on three areas I believe are important to the Service and the professional appraisal community. First, I’d like to discuss the importance of appraisal credentials, both in the private and public sector and make a recommendation that would improve the Service’s ability to administer section 6695A. Second, I will point out a few elements of the Service’s current penalty implementation procedures, reflected in the Commissioner’s memorandum of August 18, 2009 and in the statute itself that IBA believes may be improved to better serve both the interests of appraisers and of federal tax administration. Third, I’d like to share with you a few recommendations from the field, having spoken to and heard from a representative sample of members of the IBA, who have spent decades in the profession and have a lot of experience with tax examinations involving appraisal issues. Finally, if time permits, I will make a brief comment on my perspective as a former national program manager, now serving as the leader of the nation’s pioneer business appraisal membership association.

First, my advice. To better understand my recommendation, it is important to reflect on the context of the penalties under section 6695A from the perspective of who can assert the penalty. IRS notes, in the referenced memorandum of August 2009, Revenue Agents, E & G Attorneys and Tax Compliance Officers have responsibility for asserting IRC section 6695A penalties. Examiners are encouraged to submit referrals to LMSB’s Field Specialists Engineers for assistance or consultation. Depending on the facts and circumstances of the related tax case, additional Engineer support may be warranted to fully develop the penalty case particularly if the Engineers were not involved during the related tax examination. Clearly, the procedure allows IRS staff who are not certified appraisers, and even who are not appraisers at all, to assert a penalty under section 6695A. At the same time that the Service has aggressively and, I add, smartly, elevated the appraiser qualifications and appraisal standards for certain tax-related appraisals, the Service has failed to upgrade its own appraisal staff’s credentials to ensure equity and fairness in administering over this section. I am fully aware that the Service strives to hire only certified appraisers. I implemented that change during my leadership of the program. No argument there. However, there remains no requirement or incentive, other than a personal one, for IRS appraisal staff to maintain and or improve their credentials once on board. Further, we all know the workload is enormous and resources are limited. Thus, IRS has no choice but to assign valuation issues to non-certified staff and even to non-appraisal staff. Management does this carefully and with the utmost regard for customer service. I know that personally. However, penalty administration must be dealt with separately and differently. Penalties involve not only monetary amounts but also the real risk of suspension from practice, which could well mean the end of a professional’s career. The appraiser and his or her family has a lot at stake and the Service must ensure that only the most qualified staff are authorized to investigate, evaluate, and assert penalties under section 6695A, even if that means creating a special team, hiring more staff, or foregoing penalty examinations if properly credentialed staff are not available. IBA and its affiliates, would be pleased to assist the IRS with training, continuing education and a fast-track accreditation process, to help accomplish these goals.

Second, as to another element of the August memorandum and the statute itself. It is no surprise to anyone in this room that the “more likely than not” exception to the 6695A penalty has caused, and understandably and appropriately so, a great deal of confusion and concern among tax and appraisal professionals. With rare exceptions, it may be extremely difficult for an appraiser to demonstrate that his or her opinion falls within the boundaries of this exception. Most IRS staff would agree, and I have no doubt that, an appraiser would rarely make an adjustment to a value claimed by a taxpayer if the IRS appraiser believed the taxpayer’s appraiser was more likely than not correct as to their opinion of value. Surely a criminal or other sensitive investigation may provide an exception but, normally, if I believed the taxpayer’s appraiser was more likely than not correct, I wouldn’t propose an adjustment in the first place. Without an adjustment, there’s obviously no 6695A penalty. Long term, I believe statutory change may be necessary. Short term, I believe the Internal Revenue Service should consider developing a standard by which, for the purpose of asserting the penalty, the appraiser’s opinion would be judged under the more likely than not exception. The standard would, in my opinion, include an analysis of the compliance by the appraiser with generally accepted appraisal standards, whether the appraiser’s work was reviewed by a qualified third party, such as one holding the appraisal review designation from the Institute of Business Appraisers or its equivalent, whether the appraiser had sufficient experience in appraising the particular type of property under consideration, and similar objective standards of professional appraisal practice. Another element of the penalty administration process I would like to comment on involves the not atypical situation of a taxpayer who, for any number of reasons, including strategic, nuisance value, or otherwise, decides to agree to an appraisal adjustment in exchange for the Service’s concession of one or several unrelated issues. Having over 32 years of experience in the field as an IRS valuation engineer and as a management team member from first level through national program manager, I assure you that this common, every day process will result in inadvertent and apparent valuation misstatements unless recognized and dealt with. A compromised value is not necessarily the correct value and appraisers must be assured that their professional opinions will not be misinterpreted due to a decision made by their client that has nothing to do with value.

Third, some interesting and relevant field observations. Several members suggested the creation of an appraisal review board, perhaps similar to the Commissioner’s Art Advisory Panel. This board could be formed with representatives of the major membership associations, together with certified IRS appraisers. The board could serve as an independent group to assist the IRS in evaluating penalty applications. Many members suggested the development and use of a checklist, similar to the one I described earlier. The checklist could assist the Service in determining the credibility of appraisal reports in instances where the more likely than not exception should apply. Another group of members suggested that the Service compile, redact and summarize actions taken involving assertion of 6695A penalties against appraisers, pointing out the salient facts and circumstances and trends, if any, identified by the IRS in its penalty administration process. I think these suggestions are very good ones and IBA hopes the IRS will consider them.

Finally, a personal note. After 32-1/2 productive, enjoyable and successful years at the IRS, I’ve spent the last year and a half working with some of the finest appraisers and leaders in our profession. One observation rings home again and again. The vast majority of appraisers in our profession are competent, knowledgeable, ethical and truly focused on performing their work on the highest quality basis. They strive for excellence, resent incompetence and are continually looking for ways to become better at their jobs and to help others improve their skills as well.

It is an honor to be here today to speak with you.

In business valuation, our fundamental assumptions are the parameters of our engagement: identifying the client, the purpose and use of the appraisal, the size and type of interest to be valued, the date, standard, level, and premise of value, extraordinary assumptions (such as reliance on a fixed asset appraisal), and the scope, type, and restrictions on use of the report.

Engagement parameters form the foundation of our work: they govern our research, analysis, methodology, and conclusion.  If we mess up any of them, we risk being way off base. 

Most engagement parameters are established without confusion.  If we are doing a gift tax valuation, the standard is fair market value; the valuation is as of the gift date; and so forth.  We don’t have to think a great deal about them, and our clients and their advisors are on the same page with us.

But there’s a big trap there!  Some engagement parameters may be undefined.  We have all seen buy-sell agreements that fail to stipulate the standard or level of value.  In divorce, the valuation date is often an issue.  Even worse, clients and advisors may not understand that business interests can have legitimately (and dramatically) different values depending on the chosen parameters.  (How many times has an estate valuation client wanted to know “what their business is REALLY worth” – i.e., what they could sell it for to a strategic buyer?  You and I can think of dozens of examples of clients / advisors trying to infer values using different engagement parameters. 

The lessons are obvious:

Always check your premises.  Clearly understand each engagement parameter before you start work. Explain them in your engagement letter and report.

1. Do NOT let yourself get boxed into assuming an undefined engagement parameter because nobody else can establish it.  If the valuation date is at issue, reserve the right to update your report (at additional cost and with adequate time to do so) if it changes, or issue a report with conclusions for multiple dates.           

Who is right, why, and how would you explain your position to the shareholders? 

I think – in fact, I know – that the retiring shareholder (the seller) is right!  The confusion arises because Alpha Company is buying the shares.  If one or more of the other shareholders (or anybody else, for that matter) were PERSONALLY buying them, there would be no effect on Alpha Company (except for a change of share ownership). This is because no COMPANY dollars would be involved in the buyout.  Its financial position would be unaffected.  THAT is the proper way to think about the buyout.

The fact that Alpha is buying the shares certainly reduces the value of the remaining equity (debit equity, credit cash), but the remaining shareholders will each have larger ownership interests after the buyout.  These effects offset each other. The buyout price is not so high that it will change the Company’s business or financial risks and returns. (The agreed pre-buyout price was approximately $100,000, the Company had cash of $600,000 of which at least $200,000 was unequivocally in excess of its needs, it had no debt, and so forth.)

If the buyout price were to be reduced to reflect the Company’s purchase of the shares, then the selling shareholder would be paying for part of his own redemption, which is not correct or fair.

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The magnificent Fontainebleau Miami Beach hotel will host the NACVA/IBA 2010 Annual Consultants’ Conference—the year’s first and foremost gathering of the business valuation/financial forensics/consulting industry’s brightest visionaries, June 2−5, 2010. Stay abreast of the latest developments in your discipline. And leap ahead of the curve on theory that will have a major impact on the future of your practice.

This always highly anticipated superconference will feature 12 tracks, including: Business Valuation, Financial Forensics, IBA Symposium, Academic Research, International Valuation, Practice Management, Industry Standards, ValuSource Software, and NACVA Recertification. And new this year: Mergers and Acquisitions, Matrimonial Litigation, and Healthcare Consulting.

Choose from 70 presentations. Earn up to 30 hours of CPE. Check out state-of-the art products and services designed to enhance your practice and facilitate your workflow. And network with friends, acquaintances, and speakers for your own personal development and pleasure.

Click here to view the 2010 conference agenda.

Register and pay by January 31, 2010 for:

Registration
To register, click the appropriate button below for the Registration Form, print, complete, and mail or fax it to either NACVA: 801-486-7500 (or complete the form, scan, then e-mail to nacva1@nacva.com, or call NACVA Member Services: 800-677-2009) or for IBA registrations—fax: 954-827-0131, e-mail registration@go-iba.org, or call 800-299-4130.

Register with NACVA National Association of Certified Valuation Analysts 1111 Brickyard Road, Suite 200 Salt Lake City, Utah 84106-5401 Telephone: (801) 486-0600� Fax: (801) 486-7500 Internet: www.nacva.com

Register with IBA Institute of Business Appraisers P.O. Box 17410 Plantation, FL 33318 Telephone: (954) 584-1144 Fax: (954) 827-0131 Internet: www.go-iba.org

The first thing I do when this issue comes up is to check the RMA data for the industry. It reports the number and type of statements (unqualified, reviewed, compiled, tax returns, and other) in the sample.  If most of the statements are tax returns, then I feel comfortable using the subject’s tax returns not only to do a comparative analysis but also for the Market Approach, Direct Data Method using IBA or similar data.  If not, I am going to want accrual basis statements. I check with the company’s CPA to get a qualitative idea as to how different accrual based statements would be from the tax returns, and how much it would cost to prepare them.  (I am not qualified to do this work, not being a CPA.)  I then discuss the alternatives with my client.

The answer also depends on the valuation approaches and methods to be used.  If we are going to use the Asset Approach with a liquidation premise of value (the Asset Approach under a going concern premise would be hugely expensive: I rule that out immediately), then I am going to have to know the receivables, payables, and other major accruals to use it. 

If I am going to use the Market Approach, I also need to know those things to make packaging adjustments to convert operating asset values to equity values.  An exception might be if the valuation is for sale, only operating assets will be sold, and the seller will retain the receivables, payables, and other accruals.

If I am going to use the Income Approach, with net cash flow to equity as the ownership benefit metric, I need to know how different net cash flow to equity will be on an accrual versus cash basis.  The company’s accountant can help me here (see above).  In the long run, they should be very similar, but there could be short-term differences that I need to be aware of.

A more global issue is whether the willing buyer of such a business would require accrual based statements or work off the tax returns.  That is also suggested by the RMA data, which is why I check it out first.

 Contact: Paul Halverson, CEO, CBA
 612-230-3100
paul.halverson@chartwellcapitalsolutions.com

MINNEAPOLIS, MN, January 21, 2010 — In a move to further its West Coast presence, Chartwell Capital Solutions is excited to announce the addition of Pamela Steverango who will lead the firm’s new San Francisco office.   Pamela is the former President and owner of Valuation Analysts, Inc. and will expand Chartwell’s investment banking, ownership transition consulting and business valuation services to the west coast region, effective January 1, 2010. 

Based in San Francisco, Pamela is a leading authority and speaker on business valuation and ownership transition strategies, particularly on Employee Stock Ownership Plans (ESOPs) and other qualified ERISA plans.  Pamela is a Chartered Financial Analyst and holds an MBA in Finance.  She has developed an excellent reputation by serving the business valuation and financial advisory needs of privately held businesses for over 25 years. 

Joining Pamela in Chartwell’s California office is Laura Cashion.  Laura is also a Chartered Financial Analyst and CPA.  She has provided financial advisory and valuation services to privately held companies since 1999.  Laura has significant experience working with high-tech and financial services companies.  Previously, she served five years at Ernst & Young LLP. 

“As we looked to expand our presence in the western states, we sought a partner who exemplified Chartwell’s dedication to serving its clients.  Pamela’s work philosophy and commitment to her clients aligned with Chartwell’s culture,” said Paul Halverson, Chartwell Capital Solutions CEO.  “She will lend critical leadership to our continued mission at Chartwell as a premiere advisor for ownership transition.” 

“My clients and professional business associates will immediately benefit from Chartwell’s expertise and depth of talent in ownership transition alternatives,” Pamela said. “They will have access to a broader range of services including valuation for equity compensation and financial reporting purposes, plus buy and sell side advisory services.  Business owners are searching for advisors who can provide a strategic approach to the next stage of their companies so I am pleased to work with this talented and credible team.”

Chartwell Capital Solutions is a financial consulting firm providing business valuation and investment banking services to private business owners.  The firm specializes in assisting owners of privately held companies with the evaluation of their ownership transition alternatives and executing upon their chosen strategy.  The partners in the firm are recognized leaders in their respective markets who have successfully guided hundreds of business owners through their ownership transition experience.

For more information about Chartwell Capital Solutions, visit www.chartwellcapitalsolutions.com or call Christine Powell at 612-230-3100.

What might this mean for business appraisers?  At first blush, discount limitations threaten our revenue streams, but I think there is some good news, too!

Right off the bat, there will be questions as to whether a business is a holding or an operating company.  Like many others, these will be resolved by attorneys and accountants, not appraisers.  I can foresee controversies as to whether real estate acquisition and development companies are deemed holding or operating entities.

Other things being equal – thinking only about valuation discounts – it would be desirable for discountable (operating) companies to have higher assets, earnings, cash flows, and lower liabilities. These would increase their values (that could be discounted).  The opposite would be true for non-discountable (holding) companies.

Here is an example of what might transpire. A client owns two entities: an operating company and a real estate holding company.  The operating company leases the real estate from the holding company. To maximize valuation discounts, this client should consider things like:

1. Lowering the rent.  This raises the operating company’s earnings and cash balance, and lowers those of the holding company.
2. Increasing holding company debt and distributing the proceeds.  This lowers its value.
3. Investing the proceeds in the operating company. This raises its value.
4. Raising owner compensation from the operating business and lowering it from the holding company.
5. Merging the entities (if the merged company would be an operating company subject to discounting).
6. Whether “S” or “C” corporation status makes more sense for each entity.

Of course, all of these options have to be considered in the context of what makes good business and prudent financial sense and what is feasible.  That is where we come in: rather than doing appraisals, we can offer planning services (i.e. limited calculation engagements) to help such clients explore the financial ramifications of different scenarios.

Those dying in 2009 had $3.5 million exemptions above which values were taxed at 45%. Asset values were fully stepped up. That meant that if an estate’s assets were valued at $5 million, the heirs’ basis was $5 million.  This affects capital gains tax liabilities should those assets are sold.

Under the current system (IRC Section 1022) people dying in 2010 pay no federal estate tax. Step-up is limited to $1.3 million ($3.0 million for assets passing to surviving spouses).  Taxpayers choose how to allocate step-up to specific assets’ basis. (That complex issue is not one business appraisers have to worry about.) Heirs’ basis becomes the lower of stepped-up basis or fair market value.

People dying after 2010 have $1.0 million exemptions above which values are taxed at up to 55%. Asset values are fully stepped up.

For all years, taxpayers have $1.0 million lifetime gift tax exclusions and pay 35% taxes on gifts above that. The annual gift exclusion is $13,000 in 2010. There is no change in the definition of fair market value (hurrah).

The 2010 rules will change, but nobody can say when, how, to what, whether changes will be retroactive to January 1, 2010, or even if such a retroactive tax (increase) is constitutional.  If a hugely wealthy person dies (I can think of one living in Omaha) while current rules prevail and their estate is retroactively taxed, there could be a Supreme Court case in the offing, and it might take years to resolve. 

As long as current 2010 rules stand, there may even be a reversal of traditional incentives. Historically, taxpayers wanted low taxable values and the IRS wanted high ones.  Right now, taxpayers may want high (fair market) values to increase their heirs’ basis and reduce capital gains taxes while the IRS may want low values (to reduce basis and increase capital gains taxes). I use the word “may” because of the inherent flexibility of the limited basis step-up allocation to individual assets. Case-specific circumstances such as expected appreciation rates and planned asset sales will make each situation unique and potentially very complicated.  Although appraisers in estate tax matters have to be independent and objective, it certainly helps to understand and empathize with our clients’ and advisors motives and dilemmas.

Despite these dilemmas, I hope that you have a happy, healthy and prosperous 2010!

Tuesday, January 07, 2010

Seattle University’s Albers School of Business and Economics has announced a partnership with the Institute of Business Appraisers (IBA) to offer a fast track to the IBA’s Certified Business Appraiser (CBA) designation. The IBA has approved Seattle University’s Business Valuation Specialization for Master of Professional Accounting, Master of Science in Finance and the Post Graduate Certificate of Business Valuation certificate for this fast track program. Students who attain either degree or certificate will qualify for 66 of the 90 business valuation education hours required for the IBA’s CBA designation.

The Certified Business Appraiser designation is awarded by the oldest business appraisal society in the nation: the Institute of Business Appraisers. CBAs are recognized by business leaders, educators and the judiciary as a sign of excellence.

Becoming a Certified Business Appraiser is not easy.  Rigorous standards, a challenging examination and extensive peer review are part of the process which applicants undergo to obtain the designation.  The process can take six months to one year to complete.

About IBA: The Institute of Business Appraisers is the oldest professional society devoted solely to the appraisal of closely held businesses.  Established in 1978, the Institute was the original pioneer in business appraisal education and professional accreditation, which include: the Certified Business Appraiser (CBA), Accredited in Business Appraisal Review (ABAR), Business Valuator Accredited in Litigation (BVAL) and Master Certified Business Appraiser (MCBA).    IBA’s goal is to provide a supportive and nurturing environment for each member through IBA’s business appraisal resources. In fulfilling this mission, the Institute offers members free technical support and FREE access to IBA’s Market Database, the industry’s largest database of closely-held comparable business sales. To learn more about the benefits of an IBA membership, visit www.go-iba.org or call 800-299-4130.

About Albers: The Albers School of Business and Economics at Seattle University is home to over 1,900 undergraduate and graduate business students. Established in 1947, Albers offers students undergraduate degrees in business and economics.   In addition to our MBA for working professionals, we also offer graduate degrees in finance, international business, and accounting, as well as the Leadership Executive MBA.  Our undergraduate, MBA, and LEMBA programs are all nationally ranked by U.S. News & World Report. The MBA program is also nationally ranked by BusinessWeek. Albers is accredited by AACSB International, a distinction earned by only 5% of business schools world-wide. For more information, go to www.seattleu.edu/albers.

Members of the media: For interview arrangements or photo requests, please contact IBA  Marketing Analyst, Grace Clarke, at gclarke@go-iba.org  or (954) 584-1144.