IRS agents and auditors may tell you that the Internal Revenue Service does not have an official position on tax affecting Subchapter S corporations—but “don’t believe it,” Dan Van Vleet (Duff & Phelps) told the NYSSCPA gathering. The “official” IRS position “is to assess the reasonableness of the analysis and make a determination,” he said. The problem: The Service may presume that tax affecting is not reasonable—a position based in large part on prior Tax Court Memorandum decisions (Gross, Heck, Adams, Wall, Dallas - all are available to subscribers of BVLaw) in which neither the IRS nor the taxpayer’s expert presented a good model for tax affecting the subject interests. But only one of these—Gross, which concerned an “extreme” set of facts—has been affirmed by a federal court of appeals (6th Cir.). The rest are not binding. “The current reality is that the IRS has audited—and accepted—numerous reports involving substantial matters” that Van Vleet and his colleagues have prepared using his S Corporation Economic Adjustment Model (SEAM). “If you use a model that explains [tax affecting] reasonably,” he said, “they’ll accept it.”
“I’ve never been challenged,” agreed Chris Treharne (Gibraltar Business Appraisals, Inc.), who presented his S Corp model to attendees. “If you’ve got an S Corp that’s distributing enough to cover [shareholder] tax liability, then for heaven’s sake, tax affect. If you can explain it in your report with sound economic reasoning,” he said, “you will win.” The economic issues that lie at the heart of the valuation of any pass-through entity are “absurdly simple,” said Nancy Fannon, the third expert on the topic—but they have been wrapped in “deceptively complex” models. She reminded conference attendees that her article comparing the various models—including those used by the Tax Court and the Delaware Chancery Court—is available as a Free Download at BVResources (fifth on the current list) along with her book, Fannon’s Guide to the Valuation of Subchapter S Corporations).
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