Has the other side's expert tax-affected? Here's how to tear their testimony apart

Mark Harrison (Meyers Harrison & Pia) asks you to consider some statistics that undermine the “29.4% benefit” that seems to often appear  when financial experts "tax-affect" the values of S-corporations post-Bernier and Delaware MRI.

  1. Few private companies pay the maximum 40% C corporation rate every year–or any year. The model used in the Delaware MRI case compares pass through tax rates to the maximum (40%) tax rate. But, this isn’t true. In a small business, the profits may be small compared to compensation, or other fact patterns might be present. So, rather than taking 40%, it’s important to calculate the real likely tax rate on a year-by-year basis (for a multi-period analysis). It’s likely to be much less than 40%, and even if you drop it to an average of 30%, the benefits of S corp taxation are reduced to less than 1%.
  2. State taxing agencies offer fewer benefits to S corps–simply by adding a 4% pass-through state tax reduces the benefit of the federal pass-through.   Omitting state taxation will overstate this tax-affecting value benefit.
  3. Actual distributions to owners are rarely at 100%–most corporations don’t distribute all their earnings, or distribute only to cover taxes. So, you need to look at actual distributions, and thereby adjust the implied corporate tax rate. The lack, consistency, ability, or timing of distributions all guarantee that a blind application of the Delaware MRI model will give you the wrong answer.  “They also guarantee that you’ll be torn apart on cross-examination,” Mark warns.

Mark Luttrell (Mayer Hoffman McCann), who joined the panel with Mark Harrison, also pointed out statistically that over 90% of C corporations in the U.S. pay less than $10,000 in tax at the enterprise level.   This confirms Harrison’s concern about using the actual federal tax paid when tax-affecting, rather than just plugging in the maximum tax rate.