Gift Tax Valuation: IRS Requirements for Transferring Business Shares

By James Lynsard , Certified Business Appraiser 16 min read July 10, 2025 Related guides in Tax & Compliance

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Executive Summary: The Strategic Imperative of Defensible Valuation in a Changing Tax Landscape

The transfer of privately held business interests is a closely scrutinized area of federal gift and estate tax practice. For 2025, IRS guidance lists a $13.99 million basic exclusion amount, a $19,000 annual gift tax exclusion for present-interest gifts to each recipient, and a $190,000 annual exclusion amount for certain gifts to a spouse who is not a U.S. citizen. These limits are planning inputs, not substitutes for a supportable fair market value conclusion. Later-year exemption amounts and legislative changes should be confirmed with current IRS guidance and a qualified tax adviser before implementing a transfer strategy (Internal Revenue Service [IRS], 2024, 2025a).

In this climate, the valuation of business shares transferred to heirs is more than a pricing exercise. A valuation for gift tax purposes documents the taxpayer’s fair market value position, explains the facts and methods used, and may help support the taxpayer’s position if the IRS reviews the gift. The IRS and the courts can scrutinize non-publicly traded interests, claimed valuation discounts, step-transaction facts, and whether the gift was adequately disclosed on Form 709.

Recent judicial developments, including the Supreme Court decision in Connelly v. United States regarding life insurance proceeds in a corporate stock redemption context and the Tax Court’s fact-specific treatment of tax affecting in Estate of Cecil v. Commissioner, have made careful valuation analysis more important. Treasury Regulation § 301.6501(c)-1(f) also ties the gift tax limitations period to adequate disclosure, which can include either a qualified appraisal or a detailed description of the valuation method and related information (Treas. Reg. § 301.6501(c)-1(f)(2)-(3), 2025).

This article summarizes key IRS requirements and valuation issues for gift tax valuations of business shares. It covers fair market value, qualified appraiser concepts, discounts for lack of control and lack of marketability, adequate disclosure, selected family limited partnership risk factors, and practical ways a professional valuation report can reduce, not eliminate, audit and penalty risk. This article is educational only and is not tax, legal, ERISA, accounting, or investment advice.

Section 1: The Regulatory Foundation of Fair Market Value

The Statutory Standard: Revenue Ruling 59-60

Revenue Ruling 59-60 remains a key IRS authority for valuing closely held corporate stock for estate and gift tax purposes. It does not provide a mechanical formula. Instead, it calls for a facts-and-circumstances analysis of the company, the subject interest, the financial record, the industry, and available market evidence. IRS business valuation guidance continues to use the ruling’s fair market value framework (IRS, n.d.).

The ruling describes fair market value as the price at which property would change hands between a willing buyer and a willing seller, with neither party under compulsion and both having reasonable knowledge of relevant facts. For gift tax purposes, that standard normally looks to a hypothetical transaction. The hypothetical buyer is not presumed to be the donor’s child, a family member, or a strategic acquirer with special synergies. This distinction matters because a minority, nonmarketable private-company interest may warrant discounts when the facts support them.

The Eight Pillars of Valuation Analysis

Revenue Ruling 59-60 identifies eight commonly cited factors that should be considered when relevant to the subject company and interest being valued. Omitting a relevant factor can make a gift tax valuation easier to challenge.

• Nature of the business and history of the enterprise: The valuation should describe the company’s operations, operating history, ownership interest being valued, and stability or volatility over time.
• Economic outlook in general and the specific industry: The appraisal should place the business in context, including the general economic setting and industry-specific conditions that affect risk and expected performance.
• Book value of the stock and financial condition of the business: The analyst should review the balance sheet, capital structure, liquidity, asset base, and financial condition rather than relying on book value as a proxy for fair market value.
• Earning capacity of the company: For operating companies, normalized earnings or cash flow frequently drive value. The appraiser should explain nonrecurring adjustments, owner compensation adjustments, and the risk assumptions used in income-based methods.
• Dividend-paying capacity: The analysis should distinguish between actual distributions and the company’s capacity to distribute cash, especially when a minority holder cannot force distributions.
• Goodwill or other intangible value: The appraisal should consider whether customer relationships, trade names, workforce, technology, or other intangibles contribute to earnings beyond a fair return on tangible assets.
• Sales of the stock and the size of the block to be valued: Arm’s-length transactions in the same stock can be strong evidence, but family or related-party transactions need careful review.
• Market prices of stocks of corporations engaged in the same or a similar line of business: Public-company or transaction multiples can be useful only when comparability and adjustments are explained.

Beyond 59-60: The Modern Regulatory Framework

Revenue Ruling 59-60 is not the only relevant framework. Depending on the appraiser’s credentials, engagement terms, and intended use, a business valuation may also need to align with professional standards such as the Uniform Standards of Professional Appraisal Practice (USPAP), AICPA Statement on Standards for Valuation Services (VS Section 100), or other recognized valuation standards. For gift tax adequate disclosure, the key question is whether the Form 709 and any attached valuation materials provide enough information to apprise the IRS of the nature of the gift and the basis for the reported value (Treas. Reg. § 301.6501(c)-1(f)(2), 2025).

Section 2: Valuation Methodologies and the “Tax Affecting” Debate

To arrive at a supportable conclusion of value, an appraiser generally considers the asset, income, and market approaches and then selects the methods that are relevant to the subject company, the subject interest, the valuation date, and the available evidence. Not every approach is reliable in every engagement.

The Three Core Approaches

• Asset-based approach: This approach estimates value by adjusting assets and liabilities from book value to fair market value. It is often important for investment holding companies, real estate entities, asset-heavy businesses, or companies whose asset base is the primary value driver.
• Income approach: This approach estimates value from expected future economic benefits. Common methods include discounted cash flow, which discounts projected cash flows at a risk-adjusted rate, and capitalization of earnings, which capitalizes a representative level of earnings when stable earnings are supportable.
• Market approach: This approach compares the subject company to reasonably comparable sold companies or public companies. Its reliability depends on the quality of the comparable data and the adjustments made for size, growth, margins, risk, control, and marketability.

The S-Corporation Controversy: Cecil v. Commissioner

One of the most contentious issues in gift tax valuation for pass-through entities, such as S corporations and many LLCs, is “tax affecting,” which adjusts projected earnings for an assumed income tax burden before applying an income method. The issue is fact-specific because pass-through entities generally do not pay federal income tax at the entity level, while a hypothetical buyer still considers after-tax economics.

Older Tax Court decisions, including Gross v. Commissioner, rejected unsupported tax affecting in specific S corporation valuation disputes. More recent cases have been more nuanced. In Estate of Cecil v. Commissioner, experts for both sides used tax affecting, and the court evaluated their competing methods in the context of the facts and record. That does not create a universal rule approving tax affecting. It means the appraiser should explain why tax affecting is or is not appropriate and should support the selected model, tax rate, and any S corporation benefit adjustment.

A tax-affecting model may involve applying a corporate-equivalent tax rate, valuing the business on a C corporation-equivalent basis, and then considering whether any pass-through benefit adjustment is warranted. The key QC point is not the model label. It is whether the valuation report explains the economics, avoids double counting, and applies the method consistently with the facts, relevant case law, and professional judgment.

Section 3: Applying Valuation Discounts Carefully

Valuation discounts can be appropriate when the transferred interest lacks control, marketability, or both. They are not automatic planning coupons. A discount must be tied to the legal rights of the interest, the governing documents, the company’s financial condition, empirical evidence, and the valuation standard.

Discount for Lack of Control (DLOC)

Also known as the minority interest discount, DLOC reflects the inability of a minority shareholder to influence corporate strategy. A minority holder cannot declare dividends, appoint directors, set compensation, or decide to sell the company.

The magnitude of DLOC is often supported by control premium evidence, closed-end fund evidence, transaction data, or other analyses. In Estate of Warne v. Commissioner, the Tax Court focused on the property actually transferred to each charity rather than simply treating the donor’s pre-transfer 100% position as controlling for each charitable donee. The case is useful because it shows that the unit of valuation and rights transferred matter. It is not a blanket authorization for a fixed minority discount in every case.

Discount for Lack of Marketability (DLOM)

DLOM accounts for the liquidity risk associated with private securities. Unlike public stock, which can be converted to cash in seconds, private shares may take months or years to sell. Empirical support for DLOM comes from two primary sources:

• Restricted stock studies: Compare the price of private placements of restricted public stock to freely traded shares of the same company.
• Pre-IPO studies: Analyze price differences between private transactions before an initial public offering and the later public offering price.

No single IRS-prescribed DLOM range exists. Restricted stock studies, pre-IPO studies, option models, transaction evidence, expected holding periods, distribution policy, redemption rights, transfer restrictions, and company-specific risk can all affect the conclusion. A report that simply drops in a percentage without analysis is vulnerable even if the percentage looks familiar.

Tiered Discounts in Holding Companies

For wealth transfer vehicles such as family limited partnerships (FLPs) that hold interests in other private entities, a tiered-discount analysis may be considered. This involves analyzing any discount at the underlying asset or subsidiary interest level and then separately analyzing the rights, restrictions, and marketability of the FLP interest being transferred.

Some cases have accepted multi-level analyses when the structure and evidence supported them, but courts can reject mechanical double-counting. The corrected publication draft should not cite an unsupported “principal operating subsidiary” exception as a fixed rule. The safe statement is narrower: tiered discounts require specific support at each level and should be reviewed with estate tax counsel and a qualified valuation adviser.

Level	Interest valued	Discount issue	QC implication
Underlying entity	FLP owns a noncontrolling interest in another private entity	Control and marketability at the lower level may be relevant	Analyze whether the FLP’s asset value should reflect restrictions on the underlying holding.
FLP interest	Donor transfers an LP or LLC interest in the FLP	The transferred interest may also lack control or marketability	Analyze the actual rights transferred and avoid unsupported compounding.
Total conclusion	Combined effect	The combined discount can be material	Explain each layer and avoid using a generic percentage table as proof.

The “Swing Vote” Premium Trap

While taxpayers often focus on discounts, a transferred block may have features that reduce or increase value. A “swing vote” argument can arise when a minority block, although not controlling by itself, could combine with another block to affect control. Courts have been cautious about speculative premiums, particularly when the premium depends on assumed future coalitions or a buyer’s imagined strategic goals. The practical lesson is that voting rights, ownership distribution, shareholder agreements, and actual market evidence should be analyzed rather than assumed.

Section 4: Qualified Appraisal and Qualified Appraiser Issues

Strict Substantiation under Regulation § 1.170A-17

Gift tax adequate disclosure should not be confused with the charitable contribution substantiation rules. Treasury Regulation § 1.170A-17 defines “qualified appraisal” and “qualified appraiser” for section 170 charitable contribution purposes and refers to generally accepted appraisal standards, including the substance and principles of USPAP (Treas. Reg. § 1.170A-17, 2025). Gift tax disclosure rules are in Treasury Regulation § 301.6501(c)-1(f). For Form 709 adequate disclosure, the donor generally must provide either a qualified appraisal or a detailed description of the valuation method and supporting information (IRS, 2025a; Treas. Reg. § 301.6501(c)-1(f)(2)-(3), 2025).

A short letter, book-value estimate, or broker rule of thumb may be insufficient if it does not explain the property transferred, the interest valued, the valuation date, the financial data used, restrictions considered, discounts claimed, and the method used to determine fair market value. The conservative approach is to use a valuation report prepared by a qualified valuation professional when private business shares are transferred.

Definition of a Qualified Appraiser

Under the gift tax adequate disclosure regulation, an appraisal submitted in lieu of the detailed valuation-method description must be prepared by an appraiser who:

• holds himself or herself out to the public as an appraiser or regularly performs appraisals;
• is qualified, based on background, experience, education, and any professional appraisal association membership, to value the type of property involved;
• is not the donor, donee, a family member of either, or a person employed by those parties; and
• provides the required appraisal information, including the date of transfer, appraisal date, purpose, property description, process, assumptions, restrictions, information considered, procedures followed, valuation method, and basis for the valuation (Treas. Reg. § 301.6501(c)-1(f)(3), 2025).

The “Substantial Compliance” Trap

Some cases discuss substantial compliance when a taxpayer did not perfectly follow every disclosure requirement but still provided enough information to apprise the IRS of the gift and the value basis. That should not be treated as a planning strategy. If the valuation method is opaque, the subject interest is unclear, or the appraiser lacks relevant qualifications, the taxpayer may lose the benefit of an adequately disclosed gift.

A better practice is to file a complete Form 709 package with a supportable appraisal or a detailed valuation-method disclosure that tracks the regulation. A comprehensive business valuation report can help document the fair market value conclusion, but no report can ensure IRS acceptance or eliminate the need for tax counsel and return-preparer review.

Section 5: Adequate Disclosure and the Statute of Limitations

The Indefinite Audit Risk

Generally, the IRS has three years to assess gift tax after a return is filed. However, if a gift is not adequately disclosed on Form 709 or an attached statement, section 6501(c)(9) and Treasury Regulation § 301.6501(c)-1(f) can leave the limitations period open for that gift. That creates long-tail risk for the donor or estate, especially when a private-company value is understated or the return does not disclose the basis for the value.

Requirements for Adequate Disclosure

To support adequate disclosure, Treas. Reg. § 301.6501(c)-1(f)(2) requires the return or attached statement to include information such as:

• a description of the transferred property and any consideration received;
• the identity of, and relationship between, the transferor and each transferee;
• trust identification and terms if the property is transferred in trust;
• a detailed description of the method used to determine fair market value, including financial data, restrictions, discounts, and comparable transactions when relevant; and
• a statement describing any position contrary to Treasury regulations or published revenue rulings.

Treasury Regulation § 301.6501(c)-1(f)(3) allows an appraisal meeting specified requirements to satisfy the detailed valuation-method description requirement. That is helpful, but it does not mean the IRS “approves” the value or that the return is immune from review. It means the disclosure is better positioned to start the normal limitations period if the other disclosure requirements are also satisfied.

Section 6: Family Limited Partnerships (FLPs) and “Bad Facts”

Family limited partnerships (FLPs) and similar family entities can centralize management and support estate planning, but they are frequently scrutinized when the facts suggest retained enjoyment, lack of non-tax purpose, poor formalities, or deathbed transfers. Section 2036 can bring transferred property back into the gross estate when the decedent retained possession, enjoyment, income rights, or certain control rights, subject to statutory and case-law limits (26 U.S.C. § 2036).

The Anatomy of an Audit Failure: “Bad Facts”

Cases involving FLPs, LLCs, and intrafamily transfers often turn on practical facts, not just the appraisal math.

• Late or deathbed transfers: Transfers close to death, especially through an agent under power of attorney, can invite arguments that the entity was a testamentary substitute rather than a real operating or management structure.
• Step transaction concerns: In Smaldino v. Commissioner, the court collapsed rapid related-party transfers where the intermediate spouse did not meaningfully exercise ownership rights. The safer lesson is not a fixed number of days, but documented dominion, economic substance, and respect for each step.
• Commingling and retained enjoyment: Using entity assets for personal expenses, making disproportionate distributions, or leaving the donor financially dependent on the transferred assets can support retained-enjoyment arguments.

Feature	More defensible practice	Higher-risk audit fact
Timing	Entity formed and funded with time for actual administration and documented activity	Formation or transfer close to death or after a known health crisis
Purpose	Documented non-tax purpose, such as consolidated management, asset protection planning, or succession governance	Entity appears to exist only to generate discounts
Formalities	Separate bank accounts, regular records, pro rata distributions when required, and respected governing documents	Commingling personal and entity funds or ignoring documents
Structure	Donor retains enough assets outside the entity for personal needs	Donor transfers substantially all assets and then relies on entity funds

Section 7: The 2025 Valuation Landscape

New Limits and Rates

For tax year 2025, IRS inflation guidance and Form 709 instructions list the following planning amounts. These are reporting and tax-computation inputs. They do not determine the fair market value of privately held shares (IRS, 2024, 2025a).

Limit type	2024 amount	2025 amount	Valuation implication
Annual exclusion	$18,000	$19,000	A present-interest gift at or below the annual exclusion may avoid using exemption, but the value still must be supportable.
Basic exclusion amount	$13.61 million	$13.99 million	Larger gifts may use lifetime exemption. Confirm current law before planning later-year transfers.
Noncitizen spouse annual exclusion	$185,000	$190,000	Applies to certain gifts to a spouse who is not a U.S. citizen.
Top gift and GST tax rate	40%	40%	This is a tax rate, not a penalty. Penalties are addressed separately under accuracy-related penalty rules.

The Supreme Court’s Connelly Decision

In June 2024, the Supreme Court decided Connelly v. United States, a corporate-owned life insurance and stock redemption case. The Court held that, on the facts presented, the corporation’s obligation to redeem a deceased shareholder’s shares did not reduce the value of the shares for federal estate tax purposes in the way the taxpayer argued (Connelly v. United States, 2024).

The corrected takeaway should be narrow. Connelly does not say every life insurance-funded buy-sell agreement is invalid or that insurance proceeds create the same valuation result in every structure. It does mean that business owners should review redemption agreements, cross-purchase structures, funding arrangements, and valuation formulas with tax counsel, estate planning counsel, and a qualified valuation adviser.

Section 8: Penalties for Valuation Misstatements

The IRS can impose accuracy-related penalties under IRC § 6662 when a valuation understatement causes an underpayment. The 2025 Form 709 instructions describe a substantial valuation understatement as a reported value that is 65% or less of the actual value and a gross valuation understatement as a reported value that is 40% or less of the actual value (IRS, 2025a; 26 U.S.C. § 6662).

Penalty issue	Threshold described in Form 709 instructions	Potential penalty
Substantial valuation understatement	Reported value is 65% or less of actual value	20% of the underpayment
Gross valuation understatement	Reported value is 40% or less of actual value	40% of the underpayment

Reasonable-cause and good-faith arguments are fact-specific. A qualified appraisal, contemporaneous documentation, adviser reliance, and a transparent return position can help support good faith. A do-it-yourself value or unsupported estimate usually makes that defense harder, but penalty outcomes depend on the facts and applicable law.

Section 9: The Role of Professional Valuation Solutions

In light of adequate-disclosure rules, valuation-discount scrutiny, and cases such as Connelly and Estate of Cecil, private-company gift tax valuations should not be based on unsupported back-of-the-envelope estimates. A business owner should coordinate the valuation report with the estate planner, CPA, return preparer, and any counsel advising on the transfer structure.

Simply Business Valuation provides business valuation reports that can support tax reporting and compliance workflows. The corrected article should describe the service carefully:

• Qualified valuation support: Reports should be prepared or reviewed by professionals with business valuation training and relevant experience for the property type.
• Disclosure support: A comprehensive report can help explain the transferred interest, valuation date, methods, financial data, restrictions, discounts, and assumptions needed for Form 709 disclosure.
• Methodological rigor: A report should consider relevant asset, income, and market approaches and support any DLOC or DLOM rather than assuming a generic discount.

A professional valuation report can reduce audit and penalty risk by improving documentation and transparency. It is not a legal opinion, tax return, or assurance that the IRS will accept the reported value.

Frequently Asked Questions

1. Why can’t I just use book value for the gift tax return?

Book value is an accounting measure based on the company’s books. It may not reflect fair market value, goodwill, earning capacity, off-book assets, embedded liabilities, or the rights and restrictions attached to the transferred interest. A book-value shortcut can be risky when the subject is an operating business.

2. How long should I hold an interest before transferring it to a trust?

There is no universal safe holding period. Step-transaction risk depends on the facts, including whether each owner had real dominion, economic exposure, voting rights, distribution rights, and documentation. Tax counsel should review the timing and structure before the transfer.

3. If the shares are worth less than the $19,000 annual exclusion, do I still need support for value?

Yes. A present-interest gift at or below the annual exclusion may not use lifetime exemption, but the value still must be supportable. If the IRS later concludes the value was higher, the donor may need to report the gift, use exemption, or address interest and penalty issues depending on the facts.

4. What starts the three-year gift tax limitations period?

Adequate disclosure on Form 709 or an attached statement is the key. A qualified appraisal can satisfy the detailed valuation-method description requirement, but the return package still needs to disclose the other required information.

5. Does the IRS approve a business valuation report in advance?

No. A valuation report supports the taxpayer’s reported value. It does not create IRS approval, immunity from audit, or assurance that the IRS will accept the conclusion.

6. Are DLOC and DLOM automatic for minority private-company shares?

No. Discounts for lack of control and lack of marketability must be supported by the rights transferred, restrictions, expected holding period, financial performance, distributions, redemption rights, and market evidence.

7. Does Connelly invalidate buy-sell agreements funded with life insurance?

No. Connelly is a warning that the valuation effect of corporate-owned life insurance and redemption obligations must be analyzed carefully. It does not replace fact-specific legal and valuation review.

8. Do I need a qualified appraisal for a gift of private business shares?

The adequate-disclosure regulation allows either an appraisal meeting specified requirements or a detailed valuation-method disclosure. In practice, a full valuation report is often the safer documentation path for closely held business interests.

9. Can a professional valuation eliminate penalties?

No. A professional valuation can help support reasonable cause, good faith, and adequate disclosure, but it does not eliminate penalties by itself. The taxpayer still needs accurate facts, a complete return, and proper tax advice.

10. Are 2025 exemption amounts enough for later-year planning?

No. The 2025 amounts should be checked against current IRS guidance before any later-year transfer. Estate and gift tax exemption amounts can change by inflation adjustment or legislation.

Glossary of Technical Terms

• Fair market value (FMV): The price at which property would change hands between a willing buyer and seller, neither under compulsion, both with reasonable knowledge of relevant facts.
• Qualified appraiser: For gift tax adequate-disclosure purposes, an appraiser who regularly performs appraisals or holds himself or herself out as an appraiser, is qualified for the property type, is independent of the donor and donee, and provides the required appraisal information.
• Discount for lack of control (DLOC): A reduction in value for an interest that lacks control over company decisions.
• Discount for lack of marketability (DLOM): A reduction in value for the difficulty, time, cost, and uncertainty of selling a private interest.
• Tax affecting: A pass-through entity valuation adjustment that considers an assumed income tax burden and any related pass-through benefit adjustment.
• Step transaction doctrine: A judicial doctrine under which separate steps may be treated as one transaction when the facts show they are interdependent parts of a single plan.
• Adequate disclosure: Form 709 disclosure sufficient to apprise the IRS of the nature of the gift and the basis for the reported value.
• Swing vote premium: A possible value enhancement for a block that may influence control by joining with another block, depending on the facts and market evidence.

Conclusion

Transferring private business shares can be an important estate and succession planning step, but the gift tax valuation should be documented with care. The relevant value is fair market value of the actual interest transferred as of the valuation date, not a convenient book figure or generic discount percentage.

A defensible gift tax valuation should address Revenue Ruling 59-60 factors, the appropriate valuation approaches, the subject interest’s rights and restrictions, the support for any DLOC or DLOM, and the Form 709 adequate-disclosure requirements. A professional valuation report can help reduce audit and penalty risk by improving documentation, but it should be coordinated with the taxpayer’s CPA, estate planning attorney, return preparer, and other advisers.

References

• Connelly v. United States, No. 23-146 (U.S. June 6, 2024). https://www.supremecourt.gov/opinions/23pdf/23-146_i42j.pdf
• Internal Revenue Service. (2024). Revenue Procedure 2024-40. https://www.irs.gov/pub/irs-drop/rp-24-40.pdf
• Internal Revenue Service. (2025a). Instructions for Form 709: United States Gift (and Generation-Skipping Transfer) Tax Return. https://www.irs.gov/instructions/i709
• Internal Revenue Service. (n.d.). IRM 4.48.4, Business Valuation Guidelines. https://www.irs.gov/irm/part4/irm_04-048-004
• Revenue Ruling 59-60, 1959-1 C.B. 237.
• 26 U.S.C. § 2036, Transfers with retained life estate. https://www.law.cornell.edu/uscode/text/26/2036
• 26 U.S.C. § 6662, Imposition of accuracy-related penalty on underpayments. https://www.law.cornell.edu/uscode/text/26/6662
• Treasury Regulation § 1.170A-17, Qualified appraisal and qualified appraiser. https://www.law.cornell.edu/cfr/text/26/1.170A-17
• Treasury Regulation § 301.6501(c)-1, Exceptions to general period of limitations on assessment and collection. https://www.law.cornell.edu/cfr/text/26/301.6501%28c%29-1

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James Lynsard , Certified Business Appraiser

Certified Business Appraiser · USPAP-trained

James Lynsard is a Certified Business Appraiser with over 30 years of experience valuing small businesses. He is USPAP-trained, and his valuation work supports business sales, succession planning, 401(k) and ROBS compliance, Form 5500 filings, Section 409A safe harbor, and IRS estate and gift tax matters.

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