Old Habits Die Hard—or Never—Even at the Tax Court

Estate of Cecil v. Commissioner, T.C. Memo 2023-24; 2023 Tax Ct. Memo LEXIS 24

The Tax Court recently allowed tax affecting for a pass-through entity in the case of Estate of Cecil v. Commissioner. As has been common in recent cases involving tax affecting pass-through entities, the Tax Court went kicking and screaming grudgingly into the decision.

Before the late Tax Court Judge Laro retired, he had thoughts that maybe tax affecting might be the appropriate way to treat the valuation of a pass-through entity (PTE). As you know, disallowing tax affecting on PTEs had its case law origin in the Gross v. Commr. case back in 2001. Though having many opportunities to backtrack from Gross, the IRS and the Tax Court have steadfastly stood on the principle that tax affecting is not appropriate in the case of valuing a PTE. As recently as the Michael Jackson Estate case, the Tax Court stated that:

We do not hold that tax affecting is never called for. But our cases show how difficult a factual issue it is to demonstrate even a reasonable approximation of what that effect would be. In Estate of Jones, there was expert evidence on only one side of the question, and that made a difference.

This statement in Jackson was made in defense of a 2019 case, Estate of Jones wherein the Tax Court allowed tax affecting for a PTE. But that decision, according to the Cecil decision, was done to fit the circumstances of that case. Here, in the Cecil case, tax affecting is allowed because experts on both sides had determined that tax affecting was appropriate. They also agreed that the way to determine the premium that should attach to a PTE’s value was to use the SEAM method, although the rate they each determined differed. 

The SEAM and several other similar methods of determining a PTE premium primarily in a noncontrol valuation setting was somewhat of a standard methodology until the TCJA came into being in 2017. That act turned the rate structure for C corporations and individuals on its head. So guess what? The premium pretty much disappeared and even turned negative with the TCJA changes.

As one who has never believed there is a true PTE premium, I was delighted to see this reversal. So why, then, does the premium still show up in the Cecil decision in 2023? Mainly because the valuation date is prior to the TCJA.

For a good frame of reference, the reader should note that the Gross case resulted in a 67% premium in the value of the company versus the value had tax affecting been used. That is a ridiculous result under any circumstance. It defies logic, and yet it lives on in the annals of Tax Court lore.