Inputs to existing PTE valuation models are flawed

BVWireIssue #150-3
March 18, 2015

A new book presents research that challenges the pass-through entity valuation models used by the Tax Court and the IRS, which up to now have assumed that value is unaffected by shareholder taxes. The book, Taxes and Value: The Ongoing Research and Analysis Relating to the S Corporation Valuation Puzzle, by Nancy J. Fannon (Meyers, Harrison and Pia LLC) and Keith Sellers (University of Denver), is a major advance in thinking about S corp taxes and value.

Tax matters: The new book also challenges the inputs into the models used by the Delaware Chancery, the Supreme Judicial Court of Massachusetts, and those developed by valuation analysts. While these models generally make the assumption that shareholder taxes do affect value, they all inherently assume that the public-market return is affected by taxes as if such taxes were paid at the statutory rate, with no deferral opportunities.

The research demonstrates not only that all taxes affect value, but, further, that taxes are not borne at statutory rates. Rather, tax effects are muted by a combination of clienteles (most notably, institutional investors, many of whom pay no tax) and tax deferral opportunities. For this reason, prior models have likely overstated the magnitude of any adjustment that may be needed.

While not the focus, the book also points out the need for analysts to consider those instances in which an IRC Section 338(h)(10) election may be available to the parties to the hypothetical transaction.

The book will not be available until April, but it is available now for preorder if you click here.

In person: The authors will do a session on this topic at the NACVA 2015 Annual Consultants Conference, which will be held in New Orleans June 24-27. For details, click here.

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