Connecticut court affirms lower court's decision not to tax affect

R.D. Clark & Sons, Inc. v. Clark, 194 Conn. App. 690 (Dec. 10, 2019)

In a buyout dispute involving a Connecticut family business, an appellate court recently upheld the trial court’s earlier decision not to tax affect the earnings of the company in valuing the departing shareholder’s interest, even though experts for both sides tax affected. The appellate court's decision discusses some of the important decisions that have shaped the body of law on tax affecting.

At the same time, the Connecticut decision comes on the heels of two 2019 decisions in which a federal district court and the U.S. Tax Court each approved of tax-affected valuations. The cases are Kress v. United States and Estate of Aaron Jones v. Commissioner. They do not figure into the instant court's discussion. It's reasonable to wonder what went on.

The instant case arose in the context of a dispute among three siblings who each held a one-third interest in a family business that was organized as an S corp. In 2011, the siblings had a falling out and litigation ensued. The defendant (departing shareholder) eventually claimed oppressive conduct and fraud by the remaining two shareholders vis-à-vis him. After he sought dissolution of the company, the company opted to buy out his shares.

Because the parties could not agree on what the fair value of the shares should be, the case went to trial in late 2015 and early 2016. Both parties offered expert testimony, and both experts valued the company under income approach and tax affected earnings. The company’s expert applied a 25% rate, and the departing shareholder’s expert applied a 12.6% rate.

The trial court, “for the most part,” agreed with the company’s expert. However, the court did its own valuation and declined to tax affect. (The trial court also declined to apply a minority discount or marketability discount.) There was no Connecticut law mandating a specific approach to tax affecting (or, for that matter, to the use of discounts) in this context.

The company appealed the trial court’s valuation on several grounds, including on the tax-affecting issue.

Click here to learn more about the appellate court’s analysis.