Internal IRS memo unearthed re: S corp valuations

BVWireIssue #188-1
May 2, 2018
S corps
discount for lack of control (DLOC), S corp valuation, tax affecting, discount for lack of marketability (DLOM), internal revenue service (IRS), s corporation

During a webinar, Michael Gregory (Michael Gregory Consulting LLC) discussed an internal IRS memo he recently obtained via a Freedom of Information Act (FOIA) request that has implications for valuing noncontrolling interests in S corps. Gregory, a former IRS manager, filed the FOIA request for the memo after the IRS denied his request to see it.

The key points, Gregory notes, quoting from the memo, are that: “In valuing the subject entity, if an income approach is used, please assume a zero percent tax rate in the subject entity’s earnings stream.” Also, the report should clearly state: “[A] zero percent tax rate was used at the request of the Examiner.” However, the valuer is “to consider” the IRS Job Aid (it does not say which one, but the implication is the noncontrolling interests in S corps, but it can also include the Job Aid on DLOMs) and Revenue Ruling 59-60. Implications of the internal memo include:

  • Not tax affecting a noncontrolling interest;
  • Thinking about increasing the risk for the discount rate for reasons related to the disadvantages of an S corp;
  • Taking into account the impact on the discount for lack on marketability (DLOM) consistent with the Job Aid;
  • Considering the impact on the discount for lack of control (DLOC); and
  • Potentially considering pretax cash flows should be discounted with pretax tax rates, but this is not uniformly accepted by all IRS valuers.

The authors of the memo, dated April 8, 2015, are the director of engineering Large Business and International (LB&I) and the director of policy Small Business Self-Employed (SBSE) at the IRS. Gregory notes that the IRS has 13 divisions, and this is only a policy request from SBSE to the LB&I engineering and valuation area. It has no policy impact on any other divisions at the IRS. Also note this is a request for a calculation only. This is not a request for an appraisal consistent with Revenue Notice 2006-96 nor does the content requested meet the IRS Internal Manual Requirements in 4.48.4 Business Valuation Guidelines. It is simply a request for a calculation by an employee of SBSE. The subject is “S Corporation Valuation Procedures.” The full text of the memo is included in Gregory’s newest book, Business Valuations and the IRS: Five Books in One.

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