Bernier goes back to the trial court—again—ontax affecting

BVWireIssue #119-3
August 15, 2012

As one of the first U.S. jurisdictions to require tax affecting when valuing an S corporation in divorce cases, the Massachusetts Supreme Court in Bernier v. Bernier caused quite the stir in BV and legal circles, with many commentators believing the court may have “opened the door” to similar holdings in other states. But has the case—what is now being called Bernier I—only helped to expose the continuing complexity and confusion that surrounds the concept in the Tax Court and elsewhere?

As a reminder, Bernier I remanded the case for the trial court to apply the same metric as in Delaware Open MRI Radiology Assocs. v. Kessler, finding that its effective 29.4% rate was the most precise and fair. The problem: The federal dividend rate was 15% when Kessler came down, but it was 40% as of the valuation date (December 2000) in Bernier. So this time around, when the wife’s expert input the applicable tax rates into the Kessler metric, the overall tax effect was zero. By contrast, the husband’s expert (a CPA only) combined a 5.85% state rate with a 39.6% federal rate to reach a 46% applied rate. The trial court wasn’t happy with either approach; the wife’s expert ignored the “fairness” mandate of Bernier I, but the husband’s 46% rate resulted in a “significant” understatement of value for the parties’ two grocery stores. Instead, the trial court strictly applied the 29.4% Kessler rate, and both parties appealed.

Held: “Application of the Kessler metric, even as it results in a zero percent tax affecting rate, does not necessarily lead to an inequitable result,” the Court of Appeals explained. “There is a distinction … between failing to tax affect at all the earnings of the supermarkets because an S corporation does not pay federal taxes at the entity level (a basis for the approach taken by the wife's expert in Bernier I), and utilizing a zero percent tax affecting rate arrived at through application of ‘all applicable rates.’” The appellate court also scolded the husband for failing to offer a BV expert who could testify specifically to tax affecting as part of commonly accepted appraisal techniques and remanded the case for a redetermination of value—including a new evidentiary hearing, if necessary. Read the complete digest of Bernier v. Bernier, 2012 Mass. App. LEXIS 211 (June 29, 2012) in the September Business Valuation Update; the court’s opinion will be posted soon at BVLaw.

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