When transferring assets through gifts or upon death, the value assigned to those assets is crucial for determining the applicable gift or estate taxes in the USA. The Internal Revenue Service (IRS) has the authority to review these valuations, and sometimes, they may disagree with the figures reported. If you find yourself in this situation, it's essential to understand your rights and the options available to challenge the IRS's valuation.

Why Might the IRS Challenge a Valuation?

The IRS scrutinizes gift and estate tax returns, particularly those involving significant asset values or complex holdings. Common reasons for challenging a valuation include:

• Underreporting Fair Market Value: The IRS aims to ensure that assets are valued at their true fair market value, which is defined as the price a willing buyer would pay a willing seller, both having reasonable knowledge of the relevant facts. ¹ If the IRS believes the reported value is too low, they may challenge it to increase the taxable amount.   
   
• Lack of Qualified Appraisal: For certain non-cash assets, such as real estate, artwork, or closely held business interests, a qualified appraisal by a certified appraiser is often required. If the appraisal doesn't meet IRS standards or if no appraisal was provided when necessary, the IRS may question the valuation.
• Disagreement on Valuation Methods: Different valuation methods can yield varying results. The IRS may have its own experts who use different approaches and arrive at a different value than what was reported.
• Insufficient Documentation: Failing to provide adequate documentation to support the reported valuation can raise red flags and lead to an audit and potential challenge.

Your Rights and Options When Facing a Valuation Challenge:

If the IRS challenges a gift or estate tax valuation, you have several rights and options to consider:

1. Understand the Challenge: The first step is to thoroughly understand the IRS's reasons for the challenge. Request a detailed explanation of their concerns, including their appraisal if they obtained one, and the specific points of disagreement.

2. Consult with Professionals: Immediately seek advice from experienced tax attorneys, CPAs, and valuation experts. These professionals can help you understand the complexities of the situation, assess the strength of your original valuation, and develop a strategic response.

3. Re-evaluate Your Valuation: Work with your original appraiser to review the IRS's concerns and determine if the initial valuation remains defensible. They may be able to provide additional supporting documentation or clarify their methodology.

4. Obtain a Second Appraisal: If the IRS's challenge seems reasonable or if your original appraisal is weak, consider obtaining a second qualified appraisal from a different expert. A second opinion can provide further support for your position or identify potential flaws in the initial valuation.

5. Negotiate with the IRS: Often, valuation disputes can be resolved through negotiation with the IRS. Your attorney or tax advisor can represent you in these discussions, presenting your evidence and arguments to reach a settlement. The IRS Independent Office of Appeals offers an avenue for resolving tax disputes outside of court, where an impartial officer will review your case.

6. File a Formal Appeal: If negotiations fail, you have the right to file a formal written protest with the IRS Office of Appeals. This protest should clearly outline your disagreement with the IRS's valuation and provide supporting documentation and legal arguments. You generally have a limited time (usually 30 days from the date of the IRS notice) to file this appeal.

7. Consider Litigation: As a last resort, if you cannot reach an agreement with the IRS through the appeals process, you have the option to take the case to court. You can either pay the disputed tax and sue for a refund in a U.S. District Court or the Court of Federal Claims, or you can petition the U.S. Tax Court without first paying the tax. Litigation can be costly and time-consuming, so it's crucial to carefully weigh the potential benefits against the risks.

Key Considerations for Challenging a Valuation:

• Burden of Proof: Generally, the taxpayer bears the burden of proving that the IRS's valuation is incorrect. Therefore, strong documentation and qualified expert opinions are crucial.
• Timeliness: It's essential to act promptly upon receiving an IRS notice of valuation challenge, as there are strict deadlines for filing appeals and pursuing legal options.
• Cost-Benefit Analysis: Carefully consider the costs associated with challenging the IRS's valuation, including professional fees and potential litigation expenses, against the potential tax savings.
• Valuation Discounts: In some cases, discounts for lack of marketability or lack of control may be applicable, particularly for interests in closely held businesses. Understanding and properly applying these discounts can significantly impact the taxable value.

Challenging an IRS gift and estate tax valuation can be a complex process. By understanding your rights, seeking professional guidance, and gathering strong supporting evidence, you can navigate this process effectively and work towards a fair resolution. Don't hesitate to explore all available options to protect your interests and ensure accurate tax assessment.