By James P. Schnel
The Daily Record Newswire
The Pension Protection Act of 2006 introduced potential new penalties related to qualified appraisals and appraisers (which included business valuation reports and business valuation professionals) through Internal Revenue Code section 6695A.
In order for the new penalties to be triggered, several requirements must be met, including: 1) an appraisal must have been prepared in connection with a return (estate, gift for example) or a claim for a refund; 2) the person preparing the appraisal needs to know or have reason to know the appraisal will be used for such purpose; and 3) the appraisal must result in a substantial valuation misstatement defined under IRC section 6662(h).
If a 6695A penalty is applied, the penalty imposed would equal the lesser of 10 percent of underpayment of tax resulting from the appraisal or 125 percent of the gross income received by the professional to prepare the report.
The new penalties potentially create an unlevel playing field in that appraisers engaged by taxpayers would be subject to these penalties, whereas IRS appraisers face no similar penalties no matter how material their reported differences are from where the final values are determined for tax purposes.
In 2009, the IRS issued an internal memorandum regarding procedures for implementing penalties associated with IRC 6695A: Penalty for Substantial and Gross Valuation Misstatements. The memorandum proposed the creation of a Letter 4477 which the IRS would submit to preparers declaring a misstatement penalty upon (internal IRS only) examination of a report and with no other prior correspondence or warning to the practitioner.
IRC 6695A provides an exception to the imposition of penalties for appraisers who can establish, to the satisfaction of the IRS, that the value reflected was “more likely than not the proper value.” There was immediate concern that this section, as written, was too vague and would not provide any practical relief to practitioners who felt they were to be found guilty until proven innocent.
Subsequently, many appraisal and business valuation organizations (such as ASA, NACVA, IBA, etc.) met with, submitted comments, and provided testimony to the IRS in response to the memorandum during the time period of October 2009 through February 2010. The concerns raised were centered on two main points: 1) due process; and 2) fairness concerns. Letter 4477 would be issued without first providing the appraiser the opportunity to establish the basis by which the report was submitted and that it would require appraisers to disclose receipt of Letter 4477 if their status as an expert witness were challenged during any legal proceeding.
On May 24, 2010, the IRS provided an update to these various inquiries stating that it would revisit the content of Letter 4477 as well as consider suspending all valuation material misstatement penalty proceedings until it reviewed the “more likely than not the proper value” exception under 6695A.
On Oct. 1, 2010, the IRS further responded stating that it had revised Letter 4477 as the “Appraiser Appointment Letter” deleting the word/reference to penalty, stating that the purpose of the letter is to schedule a meeting with the appraiser to discuss the facts or legal arguments underlying the valuation submission. This would allow the IRS to more thoroughly determine if a penalty is (deemed by them) to be appropriate. IRC 6695A has been revised to conclude a statement “when two attempts to contact the appraiser by phone have been unsuccessful, the examiner uses Letter 4477 … to schedule an appointment.”
The interpretation is that the appraiser will avoid receiving Letter 4477 if they provide a timely response to the IRS contact. If it is determined that a penalty does apply, Letter 4485, Appraiser Penalty Assessment Notification Letter, will be issued to advise the appraiser of the proposed penalty. If it is determined a penalty does not apply, Letter 4478, Appraisal Penalty No-Change Letter will be issued. The IRS is suggesting that appraisers may want to use Letter 4478 as proof that the IRS review of their appraisal resulted in a no-change determination for purposes of professional practice.
The IRS, in its response to NACVA & IBA, was unable to address the “more likely than not the proper value” exception stating that the statute was enacted by Congress and that its examiners are “directed to consider all the facts and circumstances in making the determination of whether to impose the IRC 6695A penalty including those facts and legal arguments presented by the appraiser or the appraiser’s representative. As such, we believe further guidance is not necessary to implement this provision.”
NACVA, ASA, IBA & other organizations will continue to communicate and work with the IRS on these matters relevant to the appraiser penalty process.
Jim Schnell is a tax and business valuation partner with Mengel, Metzger, Barr & Co. LLP. He may be reached at jschnell@mmb-co.com.
