Proposed U.S. Treasury Regulation Could Significantly Change Business Valuations

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation, fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley.

For nearly 100 years, business valuators have used Fair Market Value to define the value of business interests.  Fair Market Value, as defined by the U.S. Treasury Department is “the amount at which a property would change hands between a willing seller and a willing buyer when neither is acting under compulsion and when both have reasonable knowledge of the relevant facts.”

Under the Fair Market Value methodology, explained Anderson, a Certified Valuation Analyst in Philadelphia, business valuators have recognized that interests in non-publicly traded businesses require discounts for lack of marketability and lack of control.

The lack-of-marketability discount recognizes that, to sell an interest in a non-publicly traded business, a seller would have to incur added costs – such as marketing costs and business brokerage fees, due diligence costs, business “clean-up” costs, and opportunity costs due to the length of time it will take to sell the business interest.  These expected costs are incorporated into the discount for lack of marketability.

Similarly, the lack-of-control discount recognizes that a buyer of a non-controlling interest will not have the right to make the company pay dividends; force liquidation; determine compensation, especially to officers and shareholder employees; and control expenditures that may benefit other shareholders.

Accordingly, a buyer of a non-controlling interest would expect to pay less for that interest.  This price differential is incorporated into the discount for lack of control.  The combined discounts for lack of marketability and lack of control typically reduce the Fair Market Value of a business interest from the proportionate value by between 15 percent and 70 percent.

Business valuators have used these Fair Market Value principles to value business interests subject to federal estate, gift, and generation-skipping transfer taxes.  Tax planners have long used such valuations as part of plans to transfer interests between older and younger generations of family-owned businesses to maintain family continuity.

Now, the U.S. Treasury has proposed an entirely new methodology to apply to these transfers.   The proposed change in Internal Revenue Code section 2704 would replace Fair Market Value with “Minimum Value,” which essentially is the value of the business interest without applying either the discount for lack of marketability or the discount for lack of control.

Why is the U.S. Treasury Department proposing these changes?  Primarily because certain Treasury officials believe 1) the normal costs of selling a non-publicly traded business interest are eliminated when transferring such interests from one family member to another, and 2) because family members usually will act in concert – a non-controlling interest that is part of a family whose total interests provide control – and will not experience the same limitations as a non-controlling interest that is not part of such family.

Business valuators are concerned this proposed regulation is not only in conflict with the existing U. S. Treasury definition of Fair Market Value, but also could create the potential for multiple conflicting values for the same business interest.

For example, suppose a business owner wanted to gift 10 percent of his stock to his son and another 10 percent of his stock to a charity.  Under the proposed regulation, the value of the gift to his son would be higher than the value of his gift to the charity.  Furthermore, estates could also face multiple conflicting values depending upon whether business interests would remain in the family or be sold to outsiders.

Business valuators also are concerned adoption of this proposed regulation could be the beginning of a change in the way that all business interests are valued.

The Treasury Department is holding a hearing this December 1 regarding this change.  Professional valuators from such organizations as the National Association of Certified Valuators and Analysts and the American Institute of Certified Public Accountants plan to speak at the hearing regarding their concerns about the proposed changes.

This column will keep you up to date as this issue continues to unfold.

If you require the services of a Certified Valuation Analyst in Philadelphia or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert in Philadelphia who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Valuation Analyst and a Certified Fraud Examiner in Philadelphia.