October, 2006

The Pension Protection Act’s New Appraiser Penalties *


The Pension Protection Act of 2006 (the “PPA”) added to the Code new penalties that are potentially applicable to persons who provide appraisals of property for income and transfer tax purposes. The penalties, found in new Code §6695A, will generally be triggered when the appraised value of property diverges from the amount determined to be the correct value by certain prescribed percentages. The new penalties are generally applicable to appraisals provided in connection with returns or claims for refunds filed after August 17, 2006.

In order for the new penalties to be triggered, several requirements must be met. First, an appraisal must have been prepared in connection with a return or a claim for a refund. Second, the person preparing the appraisal (whether or not a professional appraiser) needs to know or have reason to know that the appraisal will be used for such purpose. Finally, the appraisal must result in a “substantial valuation misstatement under chapter 1” of the Code (within the meaning of Code §6662(e)) or a “gross valuation misstatement” (within the meaning of Code §6662(h)).

A “substantial valuation misstatement under chapter 1” will be present if the value of property claimed on a return of tax imposed by chapter 1 is 150 percent or more of the amount determined to be the correct value.” For example, if a taxpayer claims an income tax charitable deduction of $15,000,000 based on an appraisal of a painting that he donates to a museum, and the correct value of the painting is later determined to be only $10,000,000, the appraiser who prepared the appraisal is likely to be subject to penalties under Code §6695A.

A “substantial valuation misstatement under chapter 1” should not occur in connection with an appraisal provided for purposes of an estate or gift tax return. This is because the transfer taxes are found in chapters 11 through 14 of the Code, not in chapter 1. The exclusion of transfer tax-related valuations from “substantial valuation misstatements” should not be surprising. Section 6662(e) provides that a “substantial valuation misstatement” will exist only where the value of property claimed on a return exceeds the amount determined to be the actual value. There are few, if any, circumstances where the government would be interested in imposing penalties for an inflated value claimed on an estate or gift tax return.

Appraisals provided for transfer tax purposes do not, however, escape the new penalties of Code §6695A. Code § 6695A also applies to appraisals that result in “gross valuation misstatements” within the meaning of Code §6662(h). A “gross valuation misstatement” will generally be present where the value of property reflected on an estate or gift tax return is determined to be 40 percent or less of the correct value. (see beloow)

Code §6695A provides an exception to the imposition of penalties for appraisers who can establish to the satisfaction of the IRS that the value reflected in the appraisal was “more likely than not” the proper value. This exception is likely to provide little relief. Once a court has determined that the appraisal produced a “substantial valuation misstatement” or a “gross valuation misstatement,” an appraiser is likely to have difficulty persuading the IRS that his appraisal was more likely than not the proper value.

If Code §6695A applies, the penalty imposed on an appraiser will generally equal the lesser of (1) 10% of the amount of the underpayment of tax resulting from the appraisal and (2) 125% of the gross income he received in connection with his preparation of the appraisal. Prior to the PPA, the maximum penalty that appraisers confronted was generally $1,000 for a given appraisal, and this penalty was applicable only if the IRS could prove that the appraiser had actual knowledge his appraisal would result in an understatement of tax. (see below) Given that penalties under Code §6695A have the potential to be far more severe, appraisers may be more conservative than they were prior to the PPA. Appraisers may also choose to restructure or raise their fees, although as described above, the more gross income an appraiser derives from an appraisal, the larger the potential penalty under Code §6995A.

The new penalties create an unlevel playing field for appraisers engaged by taxpayers and appraisers engaged by the IRS. Taxpayer appraisers must face the possibility of penalties if their appraisals are later rejected; IRS appraisers face no similar penalties no matter how far their appraisals are from the values finally determined for tax purposes.



A summary of the provisions of the PPA relevant to estate planners can be found in this edition of E-State in “Pension Protection Act of 2006 – Overview of Items of Particular Interest to Estate Planners” by Steve Akers.

A “gross valuation misstatement” also includes a “substantial valuation misstatement” that exceeds certain thresholds described in Code §6662(h). These thresholds are not relevant to the new appraiser penalties; once an appraisal results in a “substantial valuation misstatement,” the new appraiser penalties will apply independently of whether the Code §6662(h) thresholds are reached.

See Code §6701, which was neither repealed nor amended by the PPA.