IRS Valuation Discount Challenges: How to Defend DLOC & DLOM in Your Business Appraisal
Jeet Chaudhary
on
Introduction
A single percentage point of disagreement over a marketability discount can move a Tax Court outcome by six or seven figures. That is not an exaggeration; it is the recurring pattern in gift and estate tax valuation disputes, where the Discount for Lack of Control (DLOC) and Discount for Lack of Marketability (DLOM) applied to a family business, holding company, or closely held entity interest routinely account for 20% to 50% or more of the reported value.
If you are a business owner, founder, or executor transferring interests in a closely held company, family limited partnership, or LLC, the IRS will look closely at how those discounts were calculated, not just what number was used. Get the support wrong and an examiner can reallocate a meaningful share of your lifetime exemption or generate a deficiency notice years after the transfer closed.
This article covers what DLOC and DLOM actually measure, why the IRS challenges them, what recent Tax Court decisions require of an appraisal, the mistakes that most often trigger a dispute, and how the 2026 exemption figures change the stakes.
Key Takeaways
- DLOC and DLOM are well-established valuation concepts, not IRS-invented penalties, and both are generally applied as separate, factually supported steps.
- The IRS rarely disputes that a discount applies at all; challenges focus on the size of the discount and whether the methodology is tied to company-specific facts.
- Proposed Section 2704 regulations that would have curtailed family-entity discounts were withdrawn in 2017 and have not been replaced, so challenges proceed case by case rather than under a bright-line rule.
- Nelson v. Commissioner and Warne v. Commissioner show tiered and majority-interest discounts can be sustained with proper support; Estate of Anne Milner Fields v. Commissioner shows deathbed transfers without retained outside assets are a clear red flag.
- For 2026, the federal estate, gift, and GST exemption is $15,000,000 per individual, and the annual gift exclusion remains $19,000 per recipient, figures that raise the dollar stakes of getting a discount right.
An independent, credentialed appraisal built on documented, case-specific analysis is the strongest protection against a reduced or disallowed discount on examination.
What DLOC and DLOM Actually Measure
Every business valuation for gift and estate tax purposes starts from fair market value, defined under longstanding IRS guidance (Revenue Ruling 59-60) as the price a willing buyer would pay a willing seller, neither being under compulsion to act and both having reasonable knowledge of the relevant facts. That standard produces a value for the company as a whole. DLOC and DLOM adjust that value downward when the specific interest being transferred, a minority block, a non-voting class, or a stake with no ready market, is worth less than its arithmetic share of the whole.
Discount for Lack of Control (DLOC)
A DLOC reflects the reality that a minority owner cannot direct dividends, force a sale, set compensation, or control liquidation. It is generally derived from studies of control premiums paid in acquisitions of publicly traded companies, then applied in reverse to the pro-rata value of the interest being valued. The size of a DLOC depends heavily on the specific rights (or lack of rights) attached to the interest under the entity's governing documents.
Discount for Lack of Marketability (DLOM)
A DLOM reflects the cost and delay of converting a privately held interest into cash compared with a freely tradable security. The IRS Discount for Lack of Marketability Job Aid, developed for IRS valuation examiners, defines DLOM as an amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability, and it specifically notes that DLOM is applied after any DLOC, on its own supporting facts, not simply combined into one blended number.
DLOC and DLOM are conceptually distinct from a discount for lack of liquidity, and courts and appraisers generally expect each discount to be developed and documented separately, even though the same underlying facts often influence both.
Why the IRS Pushes Back on These Discounts
Congress addressed valuation discounts directly with Section 2704 of the Internal Revenue Code, enacted in 1990, which disregards certain liquidation restrictions in family-controlled entities when valuing an interest for transfer tax purposes. In 2016, the Treasury Department proposed regulations that would have significantly expanded the restrictions disregarded under Section 2704, which would have reduced the availability of DLOC and DLOM for many intra-family transfers. Those proposed regulations were formally withdrawn in October 2017 after extensive public criticism, and no replacement regulations have been issued since.
That withdrawal means there is currently no regulatory expansion narrowing these discounts. IRS challenges instead proceed case by case, generally through examination of the gift or estate tax return (Form 709 or Form 706) and, where unresolved, litigation in Tax Court. Examiners draw on internal guidance, including the IRS DLOM Job Aid referenced above, to test whether an appraiser's methodology reflects the subject company's actual facts or leans on unadjusted averages from published studies.
This is where Virtue Advisors' Gift & Estate Tax Valuation Services focus: producing a discount position built to withstand exactly this type of examination, rather than one that only looks reasonable until it is tested.
How Tax Court Has Shaped DLOC and DLOM in Recent Years
A landmark case, Mandelbaum v. Commissioner, T.C. Memo. 1995-255, set out a non-exclusive list of ten factors for evaluating a marketability discount, including the company's dividend history, financial condition, management, transfer restrictions, and the cost of an eventual public offering. The Mandelbaum factors remain the analytical backbone that both taxpayer and IRS experts are expected to work through, and courts have repeatedly emphasized the process over any specific numeric result the original case reached.
Methodology choice matters as much as the factors themselves. In McCord v. Commissioner, 120 T.C. 358 (2003), the Tax Court rejected reliance on pre-IPO pricing studies as the basis for a marketability discount, and later decisions have continued to require that an appraiser "get behind the data" of any benchmark study rather than simply cite its average or median result.
Two more recent decisions illustrate how the analysis plays out when ownership sits across multiple entity layers. In Nelson v. Commissioner, T.C. Memo. 2020-81, the court applied separate DLOC and DLOM percentages at the holding-company level and again at the limited-partnership level, an approach known as tiered discounting, rather than accepting one blended figure for the whole structure. In Warne v. Commissioner, T.C. Memo. 2021-17, the court accepted a modest lack-of-control discount even on majority interests in real estate holding companies, confirming that marketability and control concerns are not automatically limited to minority stakes.
Two 2024 decisions show where discounts fail. In Estate of Anne Milner Fields v. Commissioner, T.C. Memo. 2024-90, the Tax Court denied discounts associated with a family limited partnership formed shortly before death, where the decedent did not retain sufficient outside assets, a fact pattern the IRS treats as a red flag regardless of the appraisal's technical quality. Estate of Newberry, T.C. Memo. 2024-189, has been cited by practitioners as an example of the court rejecting a combined discount viewed as excessive relative to a consistently profitable operating business.
The consistent thread: discounts are not automatic and are not capped at a fixed percentage either. They are earned through company-specific data, appropriate comparable selection, and a documented, consistent methodology, applied to a base value built on sound business valuation methods in the first place.
Common Mistakes That Invite an IRS Challenge
- Citing an average or median from a restricted-stock or pre-IPO study without explaining why that average applies to the subject company's specific facts.
- Structuring transfers shortly before death without retaining adequate outside liquid assets, a pattern the Fields decision treated as evidence the transfer was not a genuine business transaction.
- Blending DLOC and DLOM into a single combined percentage instead of developing and supporting each discount on its own facts, contrary to the approach in the IRS DLOM Job Aid.
- Applying a large combined discount to a business with a strong, stable earnings and distribution history, which courts have generally viewed with skepticism.
- Skipping an independent, credentialed appraiser in favor of an internally prepared estimate, which carries little weight if the return is examined.
- Failing to preserve the underlying documentation, operating or partnership agreements, buy-sell provisions, distribution history, and board or member minutes, that a valuation analyst needs to support the discount if challenged.
2026 Figures That Shape Your Discount Strategy
Under the One, Big, Beautiful Bill Act, the federal basic exclusion amount for estates of decedents dying in 2026 is $15,000,000 per individual, up from $13,990,000 for 2025, according to the IRS 2026 tax year inflation adjustments release. The generation-skipping transfer tax exemption is unified with this amount at $15,000,000 for 2026 as well. The annual gift tax exclusion remains $19,000 per recipient for 2026 (unchanged from 2025), and gifts to a non-citizen spouse are excluded up to $194,000 for the year.
These figures reflect current law and are, as always with tax legislation, subject to change by a future Congress. What they mean practically for 2026 planning: a larger exemption reduces the number of estates exposed to federal estate tax, but it does not reduce the importance of a defensible discount for family businesses valued near or above the threshold, or for owners making lifetime gifts who want each dollar of exemption used efficiently. An unsupported discount that gets challenged and reduced on audit can consume more of that exemption than intended, an outcome that is just as costly under a $15 million exemption as it was under a smaller one.
These considerations sit alongside the broader planning picture covered by Virtue Advisors' Estate & Trust Tax Services, where valuation and transfer tax strategy are coordinated rather than handled in isolation.
Building a Defensible DLOC/DLOM Position
- Engage an independent, credentialed appraiser (CVA or ASA) working under AICPA Statement on Standards for Valuation Services or NACVA professional standards, not an internally prepared estimate.
- Develop DLOC and DLOM as two separate, factually supported steps rather than one blended number, consistent with the approach IRS valuation examiners are trained to expect.
- Work through the Mandelbaum-style factors explicitly and document how each one applies to the subject interest, rather than defaulting to a generic industry range.
- Avoid transfers timed immediately before death without a clear non-tax business purpose, and retain adequate outside liquid assets when a family entity is used.
- Match the benchmark data to the subject company's size, industry, and holding-period expectations, and be prepared to explain any adjustment from a study's average result.
- Preserve supporting records, governing agreements, distribution history, prior transactions in the entity's interests, and board or member minutes, as the appraisal is being prepared, not after an examination begins.
- Revisit the facts for each new transfer. A discount that held up in a prior valuation does not automatically transfer to a different valuation date or fact pattern.
How Virtue Advisors Supports Defensible Valuation Discounts
Virtue Advisors' valuation team holds the CVA® credential and works under AICPA SSVS compliance and NACVA professional standards, building DLOC and DLOM positions from company-specific data rather than unadjusted study averages. Engagements are tracked through TaxDome so the supporting documentation an examiner would ask for, operating agreements, distribution history, prior transactions, is organized from the start rather than reconstructed under audit pressure.
This work connects directly to Business Valuation Services, ESOP Valuation Services, and 409A Valuation Services, each of which can involve its own marketability and control considerations depending on the transaction and the entity structure involved.
Conclusion
DLOC and DLOM are not shortcuts, and they are not automatic. They are structured, factually intensive conclusions that hold up under IRS scrutiny only when the appraisal behind them does. Recent Tax Court decisions confirm both sides of that reality: well-documented discounts, including tiered discounts across multiple entities and modest discounts on majority interests, have been sustained, while discounts tied to deathbed transfers or unsupported by company-specific data have not.
With the 2026 exemption at $15,000,000 per individual, the businesses and families most exposed to a valuation discount challenge are exactly the ones with the most to gain from getting the appraisal right the first time. If you are planning a gift, sale, or estate transfer involving a closely held business interest, speak with the Virtue Advisors valuation team about a defensible DLOC/DLOM analysis before the transfer is documented.
Frequently Asked Questions
Jeet Chaudhary
Jeet Chaudhary serves as the Chief Operating Officer at Virtue Advisors, where he leads the firm’s Global Control Centre and oversees end-to-end operational excellence.
