September 19, 2019

What Attorneys Need to Know About Marketability Discounts

While the IRS identifies many valuation concepts to consider in preparing valuation reports, they less frequently specifically require methods to be used or how they should be applied. One such exception is Revenue Ruling 77-287. This Revenue Ruling outlines applying restricted stock transactions to determine marketability discounts and identifies the most important attributes to determining the discount’s magnitude.

Based on a SEC Study

The Revenue Ruling was based on financial metrics of a study performed by the Securities and Exchange Commission analyzing 1960s restricted stock transactions, which interestingly preceded current rules for determining restrictions under their Rule 144. Some criteria enunciated in the Revenue Ruling still provide a reasonable basis, whereas others do not.

Do the reports that you receive from your valuation experts identify and explain this important Revenue Ruling? Have your experts analyzed the data based on the criteria outlined in the Revenue Ruling?

Subject Expert

Martin Greene CPA\ABV, ASA, is an expert in determining marketability discounts. He has co-authored an article on how valuation experts should evaluate restricted stocks to comply with this Revenue Ruling. His article, published by Business Valuation Resources, is a treatise on marketability discounts.

Reviews

The authors of the Stout Restricted Stock Study™ (formerly FMV Restricted Stock Study™) have praised Mr. Greene’s work, and Willamette Management Associates, formerly owned by Shannon Pratt, quoted this work and included these findings with the most prestigious studies of the last 40 years. Furthermore, a recent panel of valuation experts in a national webinar on marketability offered by Business Valuation Resources identified and applied steps from this article.

Fair Market Value

Sometimes the concept of fair market value may not adequately be understood. Unfortunately for both attorneys and CPAs, sometimes judges and the IRS may not completely comprehend fair market value either, and what may be worse, other valuators also may not completely grasp this notion. By definition, fair market value should be based on hypothetical buyers and sellers; however, at times circumstances applicable to the actual buyer or seller are substituted for the hypothetical buyer or seller — and this can significantly change value. We see this difficulty comes when assuming events surrounding the actual decedent, donor, or litigant are applied to the hypothetical seller, which frequently can even overstate the value. In fact, several tax court decisions have been reversed by applying actual fact patterns to hypothetical buyers and sellers.

At Greene Valuation, we have instituted procedures to ensure this will not happen. We explain this carefully in our reports and identify the hypothetical factor pattern versus the actual. We also thoroughly explain this significant difference to the courts and to the IRS.