Penalties imposed on naughty appraisers increases

by Erin Hollis

The provision amending the accuracy-related penalties apply to all returns filed after August 17, 2006.

On August 17, 2006, President George W. Bush signed the Pension Protection Act of 2006 (PPA). The new law contains comprehensive pension reform aimed at strengthening the pension system, and makes permanent many of the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 that were due to sunset after 2010. The PPA also addresses appraisal reform and imposes stiffer accuracy-related penalties for appraisers who aid or assist in the substantial valuation misstatement of tax.

The newly enacted PPA could not have come at a better time for the IRS. At a recent national conference held in St. Louis by the Institute of Business Appraisers, a representative from the IRS’ Engineering & Valuation Team reported that 24 appraisers, who provided appraisal services on behalf of taxpayers, are currently under investigation for aiding and abetting the understatement of tax. Nine appraisers have been referred to the Office of Professional Responsibility, an IRS watchdog created in 2003 to oversee professionals who represent taxpayers before the IRS. The IRS will present these cases before a judge to determine the appraiser’s final fate.

The previous law grouped appraisers with other professionals representing taxpayers. The PPA of 2006 places appraisers in their own class of penalties, which have significantly increased over historical penalties applied to all tax professionals. In an effort to intensify the number of investigations and likewise decrease valuation misstatements conducted by unscrupulous appraisers, the Service’s staff has grown approximately four fold. According to the IRS representative, the Service wants to make such information regarding appraisers readily available to the public.

Previously, the law stated a "qualified appraiser" was someone who held themselves out as an appraiser or who regularly performed appraisals; possibly had some adequate credentials; knew about civil fraud penalties and was not a disqualified person (or, someone who was prohibited from practicing before the IRS by the Secretary of the Treasury).

Based on the former qualifying criteria, it could be assumed that there were more people who could be considered a qualified appraiser than not. Professional credentials, designations, education and experience were secondary concerns if considered concerns at all.

Today, the PPA segregates charlatans and inexperienced accounting professionals posing as qualified appraisers, as well as non-credentialed individuals. The definition of who is a "qualified appraiser" is now determined by the Treasury Regulations and specifically includes an appraisal designation.

The PPA defines a "qualified appraiser" as an individual who:

1. Has earned an appraisal designation from a recognized professional appraisal organization or has otherwise met minimum education and experience requirements to be determined by the IRS in regulations;
2. regularly performs appraisals for which he or she receives compensation;
3. can demonstrate verifiable education and experience in valuing the type of property for which the appraisal is being performed;
4. has not been prohibited from practicing before the IRS by the Secretary of the Treasury at any time during the three years preceding the conduct of the appraisal; and
5. is not excluded from being a qualified appraiser under applicable Treasury regulations.

In the field of business appraisal, there are four recognized organizations that certify and educate professionals in the field of business valuation: American Society of Appraisers (ASA), Institute of Business Appraisers (IBA), National Association of Certified Valuation Analysts (NACVA) and the American Institute of Certified Public Accountants (AICPA).

In addition to defining a qualified appraiser, the PPA also provides a definition of what constitutes a "qualified appraisal" report to be submitted for a claim involving a taxpayer issue. A "qualified appraisal" is defined as:

An appraisal prepared by a qualified appraiser (stated previously) in accordance with generally accepted appraisal standards and any regulations or other guidance prescribed by the Secretary of the Treasury.

Although the sentiment of what was acceptable previously as a qualified appraisal for the purposes of a taxpayer claim was not ‘anything goes,’ there were cases where the quality and diligence of the work submitted was questionable. Taxpayers unknowingly and dutifully put their trust in so-called professional appraisers whose inexperience with report preparation led the taxpayer down a path laden with IRS audits and undervaluation (or overvaluation) penalties. Undervaluation claims are often associated with gifting, estate, and inheritance claims, especially when involving the transfer of assets and closely-held corporate stock between family members. Taxpayers have been found guilty of filing charitable donation claims stating artificially inflated values of property and other gifts for reducing taxable income. Regardless, if the misstatement involves an undervaluation or an overvaluation, an IRS audit will determine if an underpayment of tax exists.

Unfortunately, it was usually the taxpayer who experienced the majority of IRS whiplash even if the claim was filed with the assistance of a third-party professional. A taxpayer was assessed a penalty of up to 40 percent of the undervalued amount of an asset on a misstated valuation income tax claim. The Service defines an underpayment within the context of a "substantial valuation misstatement" or a "gross valuation misstatement", where a valuation claim differs by 200 or 400 percent, respectively, from the amount determined by the IRS to be correct.

The law was likewise imposed on taxpayers for estate and gift tax valuation understatements. In general, a substantial estate or gift tax understatement was applied if the value of any property claimed on any return was 50 percent or less of the amount determined to be the correct value; a gross estate or gift tax understatement was the value of property claimed that was only 25 percent (or less) of the amount determined to be the correct value.

Prior to the 2006 revisions, tax professionals and other related taxpayer representatives received a $1,000 penalty for aiding or assisting in the preparation of a tax return. The penalty is $10,000 for corporate returns. These penalties seem like a slap on the wrist compared to the taxpayer’s 20 to 40 percent penalty.

Under the new PPA, a lower threshold is established for accuracy-related penalties. Penalties will increase for the substantial and gross understatement of income tax. The threshold is lowered from 200 percent to150, and from 400 percent to 200, respectively. Penalties for a substantial valuation misstatement of estate and gift tax will now be triggered if the valuvaluation is 65 percent (or less) of the correct value, up from 50 percent (or less). Penalties for a gross valuation misstatement will now be triggered if the value is 40 percent (or less) than the correct value, up from 25 percent (or less).

To be clear, for gift and estate tax claims filed prior to August 17, 2006:

• Substantial understatements are 50 percent (or less) of the correct value [i.e., 50 percent (or more) wrong];
• gross understatements are 25 percent (or less) of the correct value [i.e., 75 percent (or more) wrong].

For gift and estate tax claims filed after August 17, 2006:

• Substantial understatements are 65 percent (or less) of the correct value [i.e., 35 percent (or more) wrong];
• gross understatements are 40 percent (or less) of the correct value [i.e., 60 percent (or more) wrong].

Previously, accuracy-related penalties did not apply if a taxpayer showed there was "reasonable cause" for an underpayment and the taxpayer acted in good faith. However, this too has undergone a substantial change: Reasonable cause is no longer available as a defense to gross valuation misstatements in either the income or transfer tax context.

Fortunately, Congress did not forget anyone when it came to appraisal reform. For any person who prepares an appraisal that is to be used to support a tax position, and this appraisal results in a substantial or gross valuation misstatement, a civil penalty is assessed equal to the greater of $1,000, or 10 percent of the understatement of tax, resulting from a substantial or gross valuation misstatement, up to a maximum of 125 percent of the professional fee(s) received from the appraisal engagement. In addition to civil penalties, disciplinary action may also be imposed on appraisers and may include suspending or barring an appraiser from preparing or presenting appraisals before the U.S. Department of Labor (DOL) or the IRS as well as appearing before the DOL or the IRS as an expert witness.

The provision amending the accuracyrelated penalties applies to all returns filed after August 17, 2006. The provision establishing a civil penalty imposed on any person who prepares an appraisal applies to appraisals prepared with respect to returns or submissions filed after the date of enactment.