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In the realm of estate and gift tax valuation, the concept of Discount for Lack of Marketability (DLOM) plays a crucial role in determining the fair market value of closely held business interests. The DLOM reflects the reduced value of such interests due to their limited marketability compared to readily tradable securities like publicly traded stocks.

Originally developed to assist Internal Revenue Service (IRS) engineers, the DLOM Job Aid is also used by appraisers and valuation professionals in navigating the complexities of DLOM determination.   This guide provides valuable insights into the factors that influence DLOM and offers guidance on applying the DLOM to various valuation approaches.

Understanding the IRS Job Aid for DLOM

The IRS Job Aid for DLOM outlines nine key factors to consider when evaluating the DLOM for a closely held business interest. These factors include:

  1. Financial statement analysis: The financial health of the company plays a crucial role in its marketability.
  2. Dividend history and policy: A consistent dividend history and policy enhances the attractiveness of the shares to potential investors.
  3. Nature of the company: Factors like industry, track record, and market position influence marketability.
  4. Company management: The experience and reputation of the management team affect marketability.
  5. Amount of control in the transferred shares: Controlling interests are more marketable than minority interests.
  6. Restrictions on transferability: Restrictions like buy-sell agreements reduce marketability.
  7. Holding period for the stock: Longer holding periods may warrant a higher DLOM.
  8. Subject company’s redemption policy: The frequency and terms of redemptions affect marketability.
  9. Costs associated with a public offering: The costs of taking the company public reduce the net proceeds to shareholders.

Discounting serves as a valuable tool for determining fair market value for tax or estate planning purposes.

Applying the IRS Job Aid to Estate and Gift Tax Valuation

  • Thorough Familiarization: Begin by thoroughly reviewing the IRS Job Aid to gain a comprehensive understanding of the DLOM concept, the factors that influence DLOM, and the various methodologies for applying DLOM.
  • Valuation Approach Selection: Identify the appropriate valuation approach for the specific business being valued. Common approaches include Discounted Cash Flow (DCF) Analysis, Comparable Transaction Analysis, Guideline Public Company, and Capitalization of Income Approach.
  • DLOM Factor Analysis: Apply the nine DLOM factors outlined in the IRS Job Aid to the specific business being valued. This involves evaluating each factor and documenting its impact on marketability.
  • DLOM Quantification: Based on the analysis of the DLOM factors, quantify the appropriate DLOM percentage to be applied to the valuation. This may involve utilizing comparable DLOMs from similar businesses identified through qualitative evaluation such as Mandelbaum Analysis or applying valuation models including quantitative methods and Options Models that incorporate DLOM adjustments.
  • DLOM Integration: Integrate the quantified DLOM into the chosen valuation approach. For instance, in DCF analysis, the discount rate could be adjusted to reflect the DLOM.
  • Documentation: Thoroughly document the DLOM analysis, including the identification of relevant factors, the rationale for quantifying the DLOM, and the application of the DLOM to the valuation approach.

The IRS Job Aid for DLOM serves as an invaluable resource for appraisers and valuation professionals involved in estate and gift tax valuations of closely held businesses. By carefully considering the DLOM factors and applying the guidance provided in the Job Aid, appraisers can ensure that their valuations are well-supported, defensible, and compliant with IRS guidelines.