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What’s the Difference between Fair Market Value and Fair Value?

July 15, 2014

Fair market value and fair value are both important terms in valuation and often they are thought to be interchangeable.  However, this is a common misconception.  These two standards of value differ in their origins and, ultimately, in their applications.

Fair market value, the most widely utilized standard of value, was developed in the context of tax compliance.  It is defined in Revenue Ruling 59-60 as “the price at which property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”  Fair market value applies to all federal and many state tax matters, including gift and estate taxes.  There is a large body of interpretive case law.  Accordingly, many accountants and appraisers rely on fair market value as the standard of value for assets and real estate. 

In contrast, fair value was developed in the context of financial reporting.  The Financial Accounting Standards Board (FASB) observed that the definition of fair market value relates principally to assets (property) and chose not to adopt the definition of fair market value (and its interpretive case law) for financial reporting purposes.  ASC 820 defines fair value as the “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” 

Since 2006, GAAP has required that private companies report the value of stock options issued as compensation to employees and non-employees.  The requirements of GAAP, which rely on fair value, are more detailed than the requirements of tax regulation, which utilize fair market value.  As illustrated in Figure 1 below, a valuation report prepared for the lower requirements of IRC 409A may not meet the higher standard of ASC 718.  This can lead to difficulties during a financial audit or an acquisition. 

Figure 1:  Differences in Fair Value and Fair Market Value

When obtaining a valuation report to set the price for your company’s stock options, check to make sure the valuation professionals provide a dual-use report that meets both the tax and GAAP standards. 

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