As we start to address some of your 401(k)’s recordkeeping requirements for the past plan year, one of the documents that will need to be prepared and filed is the Form 5500 informational tax return (“Annual Return/Report of Employee Benefit Plan”). The 5500 requires that the current value of all the plan assets, including QES, be reported as of the end of the plan year.
Who can do this annual valuation?
It is possible that your CPA could provide you with a valuation of the QES. Other possibilities include your tax advisor, financial consultant, or a business appraiser. You could conceivably do the valuation yourself so long as you did so based on data that could be independently reviewed by an auditor. You could also pay for a professional appraiser to do the valuation, and Guidant can make a recommendation to you of a qualified appraiser we have worked with in the past if you request. This appraiser’s fee is in the range of $1,800-$2,000.
The point is that the valuation, however it is made and whoever does it, must be a good faith effort to set the fair market value as of the last day of the plan year (December 31 for a calendar year plan), and must take into account the seven factors listed in the IRM. Additionally, the data upon which the valuation is made should be in writing and retained so it could be reviewed by an examiner in the event of an audit.
What does the IRS require for annual valuation of the QES?
The best authority on what the IRS requires for the QES valuation is set forth in the Internal Revenue Manual (“IRM”). The IRM is the manual that tells IRS agents who audit qualified plans what items should be reviewed and what standards to apply. We are providing citations to the IRM in the footnotes below to assist any CPA or other professional you may engage to help with the QES valuation.
While the QES must be valued each year,1 there is no absolute requirement that the annual valuation must be based on an independent appraisal.2 The formality of the valuation depends on the facts and circumstances of the particular situation.3 The IRS understands that the valuation in a self-directed account (such as with the 401(k) Guidant has set up for you) can be less formal in a year in which the plan receives no contribution from the employer and makes no distribution or change in investment.4 The IRS further understands that there are different acceptable valuation methods that can result in a range of acceptable values for the QES.5
The factors that need to be taken into account in determining the annual valuation for the QES include, without limitation, the following6:
- The nature and history of your business;
- The general economic outlook and the outlook for the specific industry in which your business operates;
- The book value of the QES and the financial condition of the business;
- Your company’s earning capacity;
- Your company’s capacity to pay dividends;
- Goodwill value;
- Any recent stock sales.
The IRS considers it to be a red flag that a valuation may be a problem if the same value for the QES is reported on the 5500 as was reported for the prior year.7 If the IRS agent who is conducting an audit of the plan determines that the reasonableness of the valuation method used for the QES is suspect, the IRS audit can request a more formal valuation of the QES.8
Ultimately you can decide, at least initially, the procedure you will use to value the QES. Whatever method you use must at a minimum take into account the seven factors listed above and must be based on written data (commonly referred to as “working papers”) that an IRS auditor could review to determine how you arrived at the valuation you listed.
1 Rev. Rul. 80-155.
2 IRM § 126.96.36.199.2 (07.31.2001)
5 IRS Announcement 94-101 § 350 (Introduction, “Valuation of Assets Examination Guidelines”)
6 IRM § 188.8.131.52.1 (07.31.2001)
7 IRM § 184.108.40.206.1 (07.31.2001)
8 IRM § 220.127.116.11.2 (07.31.2001)