Official and Unofficial Rules of Engagement with the IRS
Mike Gregory Discusses the Newly Released Five in One Book on Business Valuations and the IRS
In this article, Michael Gregory provides some thoughts of how the official IRS rules of engagement are different from the unofficial rules of engagement and introduces how to work with the IRS. The 38 examples in the book provides additional insight. Mike Gregory recommends the book to all business valuation firms that have a library and those that prepare reports for federal tax purposes. Parts One and Two of the book discuss the IRS structure, process, and how to resolve conflicts with the IRS; and Parts Three to Five address the most common and troublesome adjustment areas by the IRS: Valuing non-controlling interests in S corps, Reasonable Compensation, and Discounts for Lack of Marketability.
I recently published a new 852-page book that I am calling the Business Valuations and the IRS: Five Books in One.¬† It provides detailed discussion with real-world examples of the most commonly audited valuation issues.¬† What follows is a brief overview of some of the main topics covered in the book.
IRS Official Documentation
The IRS has 13 divisions, 11 of which interface with the public and two that interface internally.¬† Business valuers interface most frequently with these three: the Small Business Self Employed (SBSE) division where the Estate and Gift (E&G) program is located; the Large Business and International (LB&I) division; and the Tax Exempt and Governmental Entities (TEGE) division.
Each division has been operating in its own silo since 2000.¬† This effectively means that each has developed its own culture.¬† In the case of SBSE an actual policy memorandum exists on how the division requests assistance from the business valuers in the LB&I Engineering Program where the IRS houses its engineers and business valuers.¬† This policy asks LB&I to supply a calculation with no tax affecting on non-controlling interests in S corps and requires the IRS business valuers to consider Revenue Ruling 59-60 and the job aid.¬† There is no like policy in any other division of the IRS.¬† The full text of that memorandum is included in the book.
An overview of the IRS Engineering Program including areas of expertise, management, the referral process, pre-exam analysis, contact with taxpayers, the information document request process,[i] factual development, workpapers, issue resolution, types of reports, issue narratives, expert reports, and training are all found in the Internal Revenue Manual (IRM) at 4.48.1.
The IRS has four levels of involvement by business valuers with an agent on cases.¬† An informal consultation is up to two hours and requires no administrative record.¬† A formal consultation is up to eight hours, has an administrative record, but there is no report for the taxpayer, only for the agent.¬† An examination over eight hours but may be limited in scope with a review with an opinion of value report provided to the taxpayer through the agent by the business valuer and, in general, will have contact with the taxpayer and taxpayer‚Äôs valuer.¬† A full examination will result in an appraisal by an IRS business valuer or an outside fee appraiser (contracted business valuer will have dialogue with the IRS valuer or outside fee appraiser and the taxpayer).
Regarding business valuation training, the IRS partners with NACVA and encourages employees to become certified as a CVA, but with significant reductions in training funds, this is a continual concern.¬† All new employees to the IRS engineering program attend two weeks of business valuation training including the one-week course offered by NACVA.[ii]¬† They also are assigned an on the job instructor (OJI) who works closely with the new hire as a mentor to assist the new employee during their first year with the IRS.
The IRS also has its own standards regarding business valuation.¬† These were prepared upon a review of business valuation standards from the AICPA, NACVA, USPAP, and, at the time, the IBA.¬† These business valuation standards are in the IRM at 18.104.22.168.[iii]¬† If the IRS completes a valuation, that valuation is to meet these standards whether the valuer is a CVA or not.¬† Officially, this is an overview of the major elements of the IRS valuation program as well as the standards used at the IRS.
IRS Job Aids
In my prior life, I served as a territory manager with the IRS and headed the business valuation area nationally.¬† I had a simple mantra for myself and my managers.¬† This was (1) catch employees doing something right at least once a week and thank them, (2) get them the resources they need from their perspective and do not micromanage, and (3) give them a chance to shine.
As leader of the business valuation area, I encouraged a small group of some of our best business valuation employees to solicit ideas to improve quality and consistency on major issues within the program.¬† Based on a prioritization of issues and recommendations from this group, action plans were developed that led to the publication of white papers.¬† After approval from IRS headquarters of these efforts, a team would be formed to work on a topic over a period of time to prepare a white paper for all employees in the program.¬† One or two ideas would be worked on at any given time.¬† Topics included: valuing S corps, discount for lack of marketability (DLOM), reasonable compensation, 409A, penalties on appraisers, and others.¬† Of all the topics, three have been released to the public.¬† These are:
- Discount for Lack of Marketability‚ÄĒJob Aid for IRS Professionals.[iv] Many of the models in the Discount for Lack of Marketability Job Aid are now dated, but the concepts: the 33 areas to consider, the pro-forma information document requests, how to review a DLOM, and how to determine a DLOM, offer real insights into how the IRS looks at this issue.¬† The models and approaches have all been updated and more recent models are included in the latest book.
- Reasonable Compensation‚ÄĒJob Aid for IRS Professionals[v] supplemented with Appendix to Reasonable Compensation‚ÄĒJob Aid for IRS Professionals.[vi] I believe the Reasonable Compensation Job Aid and the Appendix are very well written and they provide very good information for anyone working in this area.
- S Corp Valuation‚ÄĒJob Aid for IRS Professionals.[vii] The S Corp Valuation Job Aid is inconsistent between the executive summary and conclusion, compared with the body of the text regarding tax affecting non-controlling interests in S corps.¬† This (the application of example two in the job aid and an internal memorandum obtained by a Freedom of Information Request [FOIA] between SBSE and LB&I on this topic) presents that non-controlling valuation determination for S corps is currently a work in progress and not being consistently applied at the IRS.¬† This is a real issue at the IRS and it is an area of concern given differences between divisions and geographic differences in application nationally.
In the book, Business Valuations and the IRS: Five Books in One, readers will find two chapters on each of these topics.¬† One chapter discusses the issue and provides readers with examples to assist them address these three most commonly audited areas on business valuations by the IRS, and the other chapter includes these job aids with a critique on each.¬† The critique shares with the readers information not included in the job aid that readers really should be aware of as a business valuer, should reports be challenged in one or more of these areas by the IRS.
A Real World Check
The IRS is underfunded and overworked, and as a result, there are genuine concerns regarding quality reviews and determinations at the IRS.¬† The commentary below follows the outline of the previous commentary with some practical commentary included.
The official Information Document Request (IDR) pertains only to the LB&I division.¬† However, it is suggested that this process be requested at the beginning of the audit in any division of the IRS.¬† This helps the process move more smoothly and encourages dialogue regarding any concerns informally.¬† This helps resolve issues quicker.¬† Other division personnel do not know this exists but have been very receptive to using this process.¬† It can save professionals valuable time and reduce frustration.
Although the processes of an informal consultation, formal consultation, limited scope examination, and full examination were explained earlier, the IRS has interpreted these broadly.¬† For example, formal consultations have expanded from eight hours and no taxpayer contact to up to 40 hours.¬† In the early stages, however, no report has been given to the taxpayer because the case has still been classified as a consultation case only.¬† This makes it hard for the taxpayer that has no written commentary from the IRS business valuers, but has an adjustment by the agent, who has no background in valuation.¬† At times like this, it may be a good idea to remind the IRS agent of your rights as a taxpayer[viii] in a diplomatic manner and request a meeting with the agent‚Äôs manager.¬† In that meeting it may be necessary to remind the agent and manager of the IRS mission statement, ‚ÄúProvide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.‚ÄĚ[ix] ¬†Often times, the agent manager may intervene to address what appears to be inconsistent treatment on a case like this and work with the taxpayer to resolve the issue given the limited development by the IRS business valuer.
With the IRS training budget having been cut 90% since 2009,[x] there can be a real issue when working with IRS business valuers regarding knowledge application.¬† Think of how you have changed what you do since 2009 regarding your work product, sources, approaches, and other concerns.¬† When working with the IRS, realize the person you are working with may not have maintained their CVA or if the person has, may have maintained the credential at a minimum level on their own.¬† Their employer only had a very limited ability to help with the process.¬† This means not having attended conferences and a host of other activities that many of us do regularly.¬† Be prepared to develop a relationship, listen, and then educate; not with an attack, but with an attitude to educate as you would a judge to demonstrate the reasonableness of your approach and work with the IRS valuer to collaborate on a reasonable determination.¬† The end result is fair market value, and different routes may be taken to arrive at this value.
The commentary on each of the job aids mentioned above is well beyond this QuickRead or even a series of articles on each job aid.¬† Simply stated, it is recommended that valuers obtain a copy of each and glean information on how the IRS will approach each issue.
Michael A. Gregory, CVA, ASA, MBA, worked for the IRS for 28 years as a specialist through executive level. Twice he was nominated by his employees and received the honor of IRS civil servant of the year in his career; both as a front-line manager and a territory manager. In 2011, he founded Michael Gregory Consulting, LLC. In June 2014, he received the Outstanding Member Award from NACVA. He served on the Valuation Credentialing Board June 2015 to May 2018. His web page is www.mikegreg.com offering his over 200 blogs and books.
Mr. Gregory can be contacted at (651) 633-5311 or by e-mail to email@example.com.