The Kress gift tax case is brimming with valuation issues (see our prior coverage), but one aspect in particular has captured the valuation community’s attention. In valuing the minority shares of an S corp, experts for both the taxpayers and the government applied a C corp tax rate to the company’s earnings and then considered adjustments because of S corp status. The government’s expert applied an S corp premium to account for the tax advantages related to S corp status; the taxpayers’ expert ultimately did not make a discrete adjustment related to it.  The taxpayers’ expert considered S corp status but ultimately did not make a discrete adjustment related to it. The court adopted his approach. Importantly, although the court did not accept the government expert’s analysis, the experts’ and the court’s attitude toward tax affecting provides an argument against longtime attempts by the Internal Revenue Service to eliminate tax affecting of pass-through entities.

The court’s opinion has left it unclear which S corp model the government’s expert used, but there have been hints that he used the S corp premium based on the S corporation equity adjustment multiple (SEAM) formula. We now know more.

Modified SEAM used: According to Daniel R. Van Vleet (The Griffing Group), the S corp adjustment the government’s expert used was a modified form of the SEAM formula. Van Vleet developed the formula in 2002 as part of the Van Vleet model. “In the [government expert’s] analysis, the SEAM formula was modified to reflect the possibility that the S corp structure of the company would terminate in 10 to 15 years after the valuation dates,” he says. “Ordinarily, the SEAM reflects the concept that the shareholders will benefit from the S corp structure in perpetuity.”

Van Vleet provides more details on the valuation experts’ S corp tax-affecting analyses in an article soon to appear in the June issue of Business Valuation Update. Certain details of the experts’ analyses are from a source with knowledge of the facts. Van Vleet does not typically comment on cases, but he feels that some commentary on the Kress case has been questionable, particularly with regard to the valuation treatment of S corp equity. In the article, he also urges readers to be “somewhat cautious when interpreting the published decisions of any court regarding valuation matters. That is certainly the case with Kress.”