Tax Court adopts tax-affected valuation of PTE without overturning Gross

Estate of Aaron Jones v. Commissioner, T.C. Memo. 2019-101 (Aug. 19, 2019)

For years, the appraisal community has wondered when the U.S. Tax Court will recognize the need for tax affecting when valuing pass-through entities (PTE) and how the court will square its decision with precedent, i.e., the Gross case in which the Tax Court rejected the taxpayer’s tax-affected valuation.  

In ruling on an Oregon gift tax dispute, the Tax Court recently managed to accept the taxpayers’ tax-affected valuations of PTEs and to do so without expressly overturning Gross.

The Tax Court’s recent decision represents a clear win for the taxpayers, and its importance is heightened because it comes close in time to the Kress case in which a federal district court adopted the taxpayers’ tax-affected valuations of an S corp. Both rulings show that courts are alert to the tax consequences PTE owners must shoulder and that they credit valuations that attempt to reflect the burden and benefit related to flow-through status.

The instant case involved two closely related companies. Seneca Sawmill Co. (SSC), a lumber manufacturer, was an S corporation; Seneca Jones Timber Co. (SJTC), which owned and managed tree farms and supplied the timber for SSC, was a limited partnership.

In 2009, as part of his estate planning, the decedent transferred blocks of shares and limited partnership units to his three daughters. In 2013, the Internal Revenue Service (IRS) issued a notice of deficiency of gift tax of nearly $45 million. The taxpayers asked the Tax Court for review. 

The focal point of the court’s detailed opinion is the valuation of SJTC. The experts disagreed on methodology—whether the company was an operating company that should be valued under an income approach, as the taxpayers’ expert did (using a discounted cash flow analysis), or a natural resources holding company, as the IRS expert argued, using a net asset value approach. Moreover, the parties argued over whether the taxpayer expert’s DCF valuation incorrectly tax affected earnings in projecting net cash flow. 

To find out how the court analyzed and resolved the issues, click here.