A BVWire subscriber recently asked if we’d seen any case law on charitable contributions with put rights—i.e., when a taxpayer donates private company stock together with a put right to sell the stock back to the company, how does the related put right affect any discount for lack of marketability (DLOM) in valuing the gift at fair market value (FMV)?
To get at the answer, Robert Duffy (Grant Thornton) first referenced Hackl v. Comm’r, a 2003 decision in which the 7th Circuit upheld the Tax Court in finding that donations of private company stock were gifts of “future interests” and thus did not qualify for the annual gift tax exclusion (court opinions available at BVLaw). To protect against a “Hackl-type” exclusion, tax attorneys began adding put rights to any agreement to donate private company interests. “But, the issue you raised is: Does the put right impair the ability to get a credible DLOM,” Duffy says. “To ‘fix’ this, the put right was worded to buy back at FMV but FMV was to be computed as if the put right did not exist. That, in my opinion, allows for a fully-discounted value.”
Mercer: the devil is in the details. Court decisions are generally too fact-specific to provide appraisers with sufficient guidance, comments Chris Mercer (Mercer Capital). Similarly, the value of a put right in this case will depend on the facts and circumstances and is a matter of “diligent investigation,” he says. For instance:
- Is the put exercisable immediately? Or is there a required holding period or any other conditions precedent?
- At what price can the put be exercised?
- How is the exercise price to be determined—at a specific appraised value, or a negotiated value? “All put rights are not equal,” Mercer notes.
- Once exercised, how long does the company have to fulfill its responsibilities under the put, and under what terms? (e.g., cash or an interest-bearing note)
“When the facts and circumstances are [more clearly] specified, the value of the put right becomes clearer,” Mercer says. For his complete case study on how to value a put right related to the gift of an illiquid interest, including guidance from USPAP, the ASA BV Standards, and shareholder-level DCF models, check out Mercer’s article in the next (Nov. 2010) BVUpdate.
In the meantime, get all the answers to current tax questions at BVR’s Advanced Summit on Business Valuation: Resolving Tax & Legal Issues this November in Washington, D.C., featuring experts Duffy and Tim Lee (Mercer Capital), plus comments from the always-candid Judge David Laro, top tax attorney John Porter, and conference co-chair Mel Abraham.