• April 5, 2022


There are numerous reasons that the owners of a business may need a valuation of their business. Importantly, when a valuation is performed for a purpose that will result in a tax filing the Internal Revenue Service (IRS) has established a set of guidelines for the valuation process. 

Some of the reasons the IRS require business valuations include:

  • Succession planning, gift and estate taxes: Business owners who wish to gift company shares  or a company shareholder who has died will need a valuation to determine their tax liability for gift or estate tax planning as the case may be.
  • Charitable donations: When a shareholder gives away privately held company stock to a charitable entity, the IRS also requires a valuation. The fair market value for such a donation determines the charitable deduction that the shareholder can deduct from their taxable income.

The need for qualified valuation appraisal is generally needed to prepare IRS gift tax Form 709 and to meet adequate disclosure requirements. It is also needed for all illiquid assets made as charitable donations in excess of $5,000 and the appraiser must sign IRS noncash charitable contribution Form 8283. For an estate, a qualified valuation appraisal is likely required to complete Schedule F of IRS estate tax Form 706 if there are non-publicly traded assets. 

Businesses with interests held by baby boomers represent a significant potential source of revenue to the IRS through estate and gift taxes over the coming decades. The IRS regularly audits a portion of the estate and gift tax returns filed every year involving the valuation of privately held assets. Acquiring a business valuation from an independent appraiser is a critical piece in implementing a solid strategy, complying with IRS regulations, and being able to successfully navigate a potential tax audit. 

The IRS Guidelines

Closely held or privately owned companies aren’t publicly traded in the stock market, which means there is no easily available market price for the business as is the case for a company stock traded on a public exchange. The IRS has created specific guidelines that qualified appraisers must use to value these companies for tax purposes. The IRS publishes the Internal Revenue Manual (IRM) which is a set of internal guidelines utilized by IRS personnel. Specifically, Section 4.84.4 Business Valuation Guidelines specifically provides the guidelines to be used in appraising a privately owned company.

A professional appraiser will utilize company-specific information in their appraisal process. They will typically review 3 to 5 years of historical financial data such as annual profit and loss summaries, cash flow analysis, bank statements and the past three years of tax returns to support the valuation. In addition, the appraiser will review other company documents including operating and shareholder agreements, financial projections or budget just to name a few. 

Before preparing your taxes for any scenario where business interests change hands, you will need an independent, third-party appraiser to value your company or interests. A CPA or your attorney can recommend when such an appraisal is necessary. Your appraiser will provide a report containing your final valuation, which you can then use for tax purposes related to any gifted, sold or bequeathed business assets. 

The IRS requires you to obtain a qualified appraisal, meaning that it:

  • Follows the IRS valuation guidelines in IRM 4.48.4. 
  • Meets relevant requirements of the Internal Revenue Code (IRC) Regulations.
  • Includes relevant details, such as the property description, appraiser identifiers, terms of sale, date of appraisal and methods used – in a format that complies with IRS reporting guidelines. 
  • Next, each appraisal requires a qualified appraiser, who:
  • Has earned a recognized professional valuation designation from an accredited institution such as the American Society of Appraisers (ASA) or has met minimum related experience and education requirements.
  • Regularly appraises property and receives payment for those appraisals.

Is educated and experienced appraising the type of property associated with the valuation at hand.

Successful Appraisal Development & Process Guidelines

A qualified, successful appraisal process will involve these steps:

  • Defining the scope and purpose of the valuation: First, the appraiser must determine why the appraisal is taking place. Is the business owner planning for their estate or succession? Are they planning to donate or gift a portion of their property? The valuation date must be determined as well as the information required to perform the analysis.
  • Identifying the correct valuation methodologies: Next, the appraiser must determine the relevant methodology or combination of methodologies to utilize.
  • Due Diligence: The appraiser must perform proper due diligence which typically includes meeting with key company management to discuss company history, review the financial information provided and perform a SWOT (strengths, weaknesses, opportunities, and threats) assessment.
  • Documenting: The appraiser’s work papers should correctly document the steps and techniques used and support any facts, data and conclusions listed in the final report. 

Defining the Scope and Purpose of the Valuation

The appraiser, in collaboration with the client and their tax and legal advisors must define the purpose of the valuation, the standard of value to be employed, detail on the owner’s interest to be valued and the valuation date to be used. Discussion around the appraisal timeline of the project, fees to be charged and the information needed to initiate the appraisal project are discussed. An engagement letter will then be prepared and distributed for relevant party’s signatures. 

Identifying the Correct Valuation Methodologies

Next, the appraiser must determine the relevant methodology or combination of methodologies to utilize.


The appraiser must analyze which valuation approach or approaches make sense based on the business and situation. The IRS recognizes three general methods. They include:

  • Market approach: In this approach, the company’s competition and competitive landscape play the most significant role in determining value. The appraiser will use the selling prices of similar businesses to value the company.
  • Asset-based approach: Here, the valuator will sum up the company’s tangible assets. They determine a value based on the sell prices of all the company’s equipment, stock and supplies. The dollar amount achieved after hypothetically selling every one of the company’s assets separately determines the overall value of the business.
  • Income approach: The income approach encompasses several valuation methods. This approach’s primary goal is to find the expected economic rewards and risk level of investing in the company. Using the income approach will require computations surrounding the company’s expected future cash flow to determine the market value of the business.

The appraisers must consider all three options before choosing which approaches are best for a particular valuation assignment. Then, they must determine which specific methods within each broad method category make sense and will be the best indicators of business interest and value.  Finally, the appraiser must explain why certain approaches were or were not selected.

If using the income or market approaches, the appraiser must determine the appropriate rate of return or appropriate market multiple for the company after weighing:

  • The industry.
  • The nature of the business.
  • The risk involved.
  • The irregularity or predictability of earnings and cash flow.

If not already considered through the other valuation methods, the appraiser must weigh a few more factors separately before concluding. Those factors include: 

  • The company’s level of marketability, given the business nature, ownership interest, security, legal or contractual restrictions and current market conditions. 
  • The business owner’s ability to control the sale, liquidation or operation of their company.
  • Other considerations may include synergistic or strategic contributions that generate value.
  • Any other factors the appraiser deems appropriate for the situation.

Due Diligence

To ensure a comprehensive analysis, the appraiser will conduct extensive due diligence with company management including:

  • The enterprise’s history from its start, and the nature of the business.
  • The company and industry’s economic outlook, alongside the general economic outlook.
  • The company’s financial condition and the book value of any interest or stock. 
  • The earning capacity and dividend-paying capacity of the company.
  • The ownership of any intangible assets such as corporate goodwill, branding or proprietary knowledge.
  • Past sales of the interest or stock at hand and the proportion of the total stock being valued.
  • The economic value of subsequent sales of the company or interests in the company, if those transactions were reasonably foreseeable at the time of valuation.
  • Company customer concentration issues.
  • The SWOT analysis.
  • Other relevant information.


The appraiser’s final, fully documented report should thoroughly detail the steps and techniques used and support any facts, data and conclusions listed.

The final report will include the information needed for a reader to understand the analysis process and how they reached their conclusions.

The report should also convey the judgment calls, methodology and reasoning used alongside supporting documentation and worksheets. It should list sufficient details on each requirement as listed in the IRS guidelines.

The qualified appraiser must also submit a signed statement demonstrating they conducted the valuation in good faith. The declaration should attest that, to the best of the appraiser’s knowledge:

  • The facts in the report are correct and true.
  • The opinions, analysis, judgments and conclusions rely only on the limiting conditions and assumptions identified and listed in the report.
  • The appraiser has no current or potential interest in the property being valued and no personal interest in the parties involved.
  • The appraiser has no bias toward or against their subject or the parties involved in the project.
  • The project’s compensation is neither tied to any event or actions resulting from the report’s conclusions, analysis, or opinions in the report or the report’s uses.
  • The appraiser’s participation in the valuation was not conditioned on reporting or supporting predetermined results. 
  • The appraisers who provided significant assistance have signed the report. 
  • The report’s conclusions, analysis and opinions conform to the IRS Valuation Guidelines wherever applicable.

The signed certification may include other statements as required by professional bodies like the American Society of Appraisers (ASA) and the Uniform Standards of Professional Appraisal Practice (USPAP).

Business Valuation With Management Planning, Inc.

As a business owner, it is critical to understand the IRS business valuation guidelines governing your company’s appraisal. These proceedings ensure that your appraiser arrives at a fair conclusion without placing any undue bias toward you as the taxpayer or the IRS. Understanding what facts and data your appraiser will look for can also help you prepare for the process and gather all the documents and information that your appraiser may request. 

At MPI, we take this process very seriously and aim to make it as smooth and fast as possible. We pride ourselves on being easy to work with. We’re quick to respond to your emails and calls and are always happy to answer your questions and discuss your concerns. We also stick to the completion timelines we tell you from the start, helping you value your business relatively quickly.

Want to learn more about how MPI can help you value your business? Contact us today!