Using a Form 409A Valuation Report for a Gift or Estate Tax Filing
Some clients and their advisors may think it’s okay to use a 409A Valuation Report for a gift or estate filing. While they may get away with it if there’s no audit, it’s not advisable. Section 409A valuations establish a “safe harbor,” which the IRS recognizes as a reasonable method to ensure the exercise price is at FMV. However, 409A Valuation Reports aren’t filed with the IRS.
Value of Equity Compensation
Internal Revenue Code Section 409A states that deferrals of compensation under a nonqualified deferred compensation plan for all taxable years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. Compensation is deferrable on stock options that are issued at an exercise price (that is, the price at which an underlying security can be purchased or sold when trading a call or put option) greater than or equal to the stock’s fair market value (FMV) on the grant date.
A privately held company should hire a qualified independent valuation professional to determine the FMV of equity compensation. Valuation professionals are typically engaged to value a client company’s common stock, and the client then uses this value to establish an exercise price of options being granted and to determine the FMV (or fair value when also done in compliance with Accounting Standards Codification Topic 718) of the options.
Estate and Gift Tax Valuations
Valuations of businesses or business interests are often needed for estate-planning purposes, such as in determining the probable amount of estate or gift taxes to aid in planning before the owner’s death. In the case of the estate of a deceased individual, a valuation of a business interest owned by the estate is frequently necessary for the preparation and filing of an estate tax return (IRS Form 706).
In the case of a gift, a valuation report determines how much lifetime exclusion the taxpayer uses and establishes a statute of limitations for audit (and sometimes to pay a gift tax). It’s filed with the gift tax return (IRS Form 709). Unlike the 409A Valuation Report, the valuation report for gift and estate purposes is attached to the applicable tax return and filed with the IRS.
Five Risks
Valuations are very purpose-specific. How the client will use the valuation dictates the applicable standard of value, the valuation methods used, the report’s content, the depth of due diligence, the effective date of valuation and the equity interest being valued, among other factors. The standard of value – FMV – is the same for the 409A Valuation Report and gift and estate valuations. But then things diverge. There are at least five reasons (and other more subtle reasons) why there’s risk and possible liability in using a 409A Valuation Report for a gift or estate tax filing:
While there are several reasons not to use a 409A Valuation Report for a gift or estate tax filing, referencing one can be very helpful. If a 409A valuation report has recently been completed, it helps save time (and, therefore, fees) in completing a gift tax valuation. Ultimately, it will depend on the quality of the 409A report.
Chris Mellen, ASA, MCBA, CVA, ICVS, CM&AA, is a Senior Managing Director with VRC
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Originally posted on: https://www.wealthmanagement.com/estate-planning/using-form-409a-valuation-report-gift-or-estate-tax-filing