During the past 25 years, the number of S corporations and LLC’s has mushroomed from 750,000 IRS tax filings to about six million, according to Dan Van Vleet (Stout Risius Ross), who spoke at last week’s 2011 ASA Advanced BV Conference. During this same time, C Corp filings have declined from about 2.5 million to just under two million, Van Vleet added. “The market is telling us something here about the relative value of S corps and C corps.”
And for the first time, in Estate of Gallagher the Tax Court considered a tax-affecting analysis that included “an S Corp value premium to the C Corp equivalent value,” Van Vleet said. Although Judge Halpern (who also wrote Gross v. Commissioner) ultimately rejected the analysis for lack of convincing support, he also acknowledged the theoretical rationale for tax affecting: i.e., that most data on which appraisers base private stock values is derived from publicly traded C corps. That may leave the door open for a better-reasoned—and better-supported—tax-affecting analysis to persuade the Tax Court in the future.
What went wrong in Gallagher? According to Van Vleet, the analysis:
- Failed to reflect the full tax benefits associated with S Corps vis-a-vis C Corp;
- Contemplated only the dividend tax savings associated with S Corps based on the expected distributions of the subject S Corp;
- Ignored the S Corp capital gains tax benefit associated with retained earnings; and
- Was not peer-reviewed and was only sparsely supported by the expert’s report, with no supporting articles or authority.
And it doesn’t end with tax-affecting. In Gallagher, the Tax Court took on a bulleted list of valuation techniques and “tough” spots, including adjustments to a DCF analysis and the reliability of the guideline public company method. BVR kicked off its 2011 Online Tax Summit with “Estate of Gallagher: How the Court Sees the State of Business Valuation,” featuring Chris Mercer (Mercer Capital) and attorney L. Paul Hood, Jr.
Consider continuing your tax and valuation curriculum with the rest of the Summit series, including a Lawyers Roundtable on Oct. 28, followed by a Judges Roundtable: View From the Bench on Nov. 4 (both moderated by Jay Fishman); and culminating with Valuing a Majority Fractional Interest on Nov. 11, with Neil Mills-Mazer (IRS).