Revenue Ruling 59-60: Valuing a Closely Held Business

Revenue Ruling 59-60 is guidance from the Internal Revenue Service (IRS) for determining the value of stock in a closely held corporation. These are businesses owned by a small number of individuals where shares are not publicly traded, making their value difficult to ascertain. The ruling was issued to create a consistent framework for valuing such stock for federal estate and gift tax purposes, which arise when an owner dies or gives away their shares.

The guidance is not a mathematical formula but a checklist of factors that must be analyzed to reach a supportable conclusion of value. Its principles are widely accepted and now applied in situations beyond taxes, including mergers, shareholder disputes, and divorce proceedings. The ruling’s purpose is to ensure valuations are thorough and grounded in financial principles.

Defining Fair Market Value

At the center of Revenue Ruling 59-60 is the concept of “Fair Market Value” (FMV). The IRS defines FMV as the price at which property would change hands between a willing buyer and a willing seller, where neither is under any compulsion to act and both have reasonable knowledge of all relevant facts. This standard is the goal of the valuation process prescribed by the ruling.

This definition requires an appraiser to consider all positive and negative attributes of the business from the perspective of hypothetical, informed parties negotiating at arm’s length. The specific date of the valuation, such as the date of death for an estate, is a component of this definition.

Key Valuation Factors in the Ruling

Revenue Ruling 59-60 outlines eight factors that must be considered to determine the value of a closely held business. These factors provide a structured approach to the valuation. The weight given to each factor can vary depending on the specific circumstances of the business.

The Nature and History of the Business

This factor involves examining the company’s origins, its record of stability or growth, the risks it faces, and its position within its market. A long-established company with a consistent record of success may be viewed more favorably than a newer, more volatile enterprise. This analysis provides context for other financial considerations.

The Economic and Industry Outlook

A business’s value is influenced by external economic forces. This analysis considers the overall health of the national economy and the condition of the industry in which the company competes. Industry-wide growth trends, competitive pressures, and regulatory changes can impact a company’s future prospects and its current value.

Book Value and Financial Condition

An appraiser analyzes the company’s balance sheet to understand its financial health. Book value, which is the company’s assets minus its liabilities, provides a baseline indication of value. The analysis also assesses liquidity, solvency, and the value of underlying tangible and intangible assets to determine financial stability.

Earning Capacity

For many businesses, especially those that provide services, earning capacity is a primary driver of value. This factor focuses on the company’s ability to generate profits. Appraisers review several years of income statements, often making adjustments for non-recurring items to project future profitability.

Dividend-Paying Capacity

While earning capacity looks at potential, dividend-paying capacity assesses the company’s ability to distribute cash to its owners. This is not the same as the dividends historically paid, as owners of closely held businesses may set dividend policies for personal or tax reasons. The analysis focuses on what the company could pay out after retaining funds for operations and growth.

Goodwill and Other Intangible Value

A company’s value often extends beyond its physical assets. Goodwill can arise from a strong brand name, a loyal customer base, or superior management. The existence of these intangible assets can give a business a competitive advantage and enhance its earning power, making them a component of its fair market value.

Prior Sales of Stock

Actual sales of the company’s stock can be a strong indicator of value, provided they were arm’s-length transactions. The appraiser must consider the size of the block of stock sold and the circumstances of the sale. A small, isolated sale may not be as representative of the company’s value as a more significant transaction.

Market Price of Comparable Public Stocks

Appraisers look to the market prices of stocks of publicly traded companies in the same or a similar industry to benchmark the valuation. Because a closely held business is not directly comparable to a public company, adjustments are necessary. This analysis helps ground the valuation in real-world market data, providing an objective reference point.

Application of Valuation Discounts

After an initial value is calculated, appraisers often apply discounts to reflect the characteristics of a non-public ownership interest. These adjustments are not in the original ruling but are now standard practice through court rulings and IRS acceptance. The two most common are the Discount for Lack of Control and the Discount for Lack of Marketability.

The Discount for Lack of Control (DLOC) applies to minority ownership interests. A shareholder owning less than 50% of a company cannot direct its policies, control management, or compel asset sales or dividend payments. Because these rights are valuable, a minority stake is worth less per share than a controlling interest.

The Discount for Lack of Marketability (DLOM) addresses the illiquidity of shares in a private company. Unlike public stocks, selling an interest in a closely held business can be a difficult and lengthy process with no ready market of buyers. This lack of marketability reduces the stock’s value to a potential buyer, who would pay less for an asset that cannot be easily converted to cash.

The Role of a Qualified Appraiser

Navigating Revenue Ruling 59-60 requires professional expertise. The IRS places weight on valuations performed by a “qualified appraiser,” an individual with a recognized appraisal designation and experience valuing similar businesses. The appraiser must be independent and objective in their analysis.

A formal, written appraisal report substantiates the value for tax purposes. This report must detail the methodology and show how each factor from the ruling was considered, as this documentation is necessary to defend the valuation if challenged by the IRS.

The appraiser’s judgment is an element of the process, as the ruling states there is no single formula for valuation. They must select appropriate valuation methods and weigh the factors based on the unique circumstances of the business. A well-supported report from a qualified professional provides the best defense against potential disputes with tax authorities.