A business valuation may be subject to heightened IRS scrutiny when prepared in support of an estate tax return, gift transfer, or charitable contribution. Taxable estates, particularly larger estates or those involving assets that are difficult to value, may be more likely to receive IRS attention. The likelihood of review generally increases as estate size and valuation complexity increase. The issue is not simply the value itself. The IRS may examine the assumptions, methodologies, adjustments, discounts, and supporting documentation used to arrive at that value. For owners of closely held businesses - and the advisors guiding them - a well-supported valuation can make an important difference if the IRS raises questions.
Because closely held businesses generally do not have an active public market to establish value, owners planning ownership transfers, gifts, charitable contributions, or other tax-related transactions should rely on accepted appraisal methods, clear documentation, and supportable assumptions consistent with IRS guidance.
The IRS audit guidance explains that examinations review books, accounts, and financial records to determine whether a return and the reported tax are correct.
Valuation errors can prompt additional review, leading to additional costs, penalties, and legal fees. Maintaining clear support for the concluded value can make the review process more manageable if questions arise. No planning can eliminate audit risk, but understanding common red flags and maintaining clear support for the concluded values can reduce disputes and strengthen the taxpayer's position during an examination.
For many business owners, proactive planning is the best strategy. Obtaining a valuation before a transaction or filing deadline often allows time to address issues before they become problems.
Practical next step: If an ownership transfer or tax filing is approaching, consider obtaining a valuation well before the filing deadline.
Business Valuation for Gift, Estate & Charitable Tax Planning
Originally issued by the IRS in 1959, Revenue Ruling 59-60 is the foundational framework for determining the fair market value of stock in closely held companies when no active market exists. It is widely used in estate and gift tax matters and other valuation contexts, and it continues to guide the IRS, courts, and appraisers in assessing whether a valuation is adequately supported.
The ruling explains that no single formula applies to every valuation. Instead, all relevant factors and circumstances must be considered. Major factors include:
(a) The nature of the business and the history of the enterprise from its inception.
(b) The economic outlook in general and the condition and outlook of the specific industry in particular.
(c) The book value of the stock and the financial condition of the business.
(d) The earning capacity of the company.
(e) The dividend-paying capacity.
(f) Whether or not the enterprise has goodwill or other intangible value.
(g) Sales of the stock and the size of the block of stock to be valued.
(h) 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.
For owners and advisors: Identify each factor that is relevant to the privately held entity being valued.
For a broader overview of accepted valuation methods and documentation, see Business Valuation 101: A Guide for Owners, CFOs, and Advisors.
A valuation performed by a qualified appraiser is generally required when a non-publicly traded asset, such as an interest in a closely held business, is reported on a tax return. Mathematical errors and unsupported assumptions may draw IRS attention. Common valuation report issues include:
Before a filing: Work with a qualified appraiser who can prepare a well-supported valuation and clearly explain the assumptions, methods, and documentation used.
An IRS audit is a review of an organization's or individual's books, accounts, and financial records. The IRS uses the examination to determine whether the tax return was reported correctly under tax law and whether the reported amount of tax is correct.
Yes. The IRS may challenge or reject portions of a valuation if assumptions, methods, or supporting evidence are insufficient. In many cases, scrutiny focuses on support rather than the ultimate value conclusion.
Revenue Ruling 59-60 is foundational IRS guidance that outlines the factors and framework used to determine fair market value for closely held business interests. It remains one of the most frequently cited authorities in business valuation.
Common supporting documents include historical financial statements, tax returns, ownership agreements, buy-sell agreements, forecasts and budgets, industry research, market transaction data, and documentation supporting adjustments and discounts.
An independent valuation does not eliminate audit risk. However, a well-supported valuation prepared by a qualified appraiser can improve credibility and reduce the likelihood of disputes over methodology or documentation.
A well-prepared business valuation follows accepted guidance, documents key assumptions, uses reliable data, and explains the methods applied.
If the IRS reviews a valuation, the strength of the support behind the conclusion matters. Clear documentation of assumptions, reliable data, and appropriate methodologies can put the valuation in a stronger position to withstand examination.
Revenue Ruling 59-60 continues to provide the foundation for valuing closely held businesses, while IRS valuation guidelines emphasize the importance of evidence, documentation, and professional judgment. Together, these principles help create a more defensible valuation.
In our experience, the strongest valuation engagements begin well before a filing deadline or transaction closing. Documenting evidence for assumptions as well as for supporting adjustments, and thoughtfully applying accepted methodologies can help owners and advisors move forward with greater confidence that the valuation is prepared to stand up to scrutiny.
Sadikshya (Sadi) Karki, ASA
Sadi Karki is an Associate in PCE’s valuation practice, specializing in valuations for estate and gift tax, shareholder disputes, ESOPs, and other business needs. With deep expertise in financial modeling and quality control, she delivers precise, insightful valuations that support confident decision-making.