SCOTUS struggles with COLI valuation case

Last week, the U.S. Supreme Court heard oral arguments in the Connelly case, which involves the question of how corporate-owned life insurance (COLI) designed to fund the redemption of a deceased shareholder’s stock impacts the fair market value of the subject company and the value of the decedent’s gross estate. Two circuits say the proceeds should not be included in the valuation, but one circuit (in Connelly) says it should be included. SCOTUS agreed to hear the case to resolve the circuit split.

The petitioner (estate) and the government both agreed that the value of the company was $3.86 million. But the IRS said the insurance proceeds of $3 million used for the redemption should be added in, for a total value of $6.86 million—and that amount should be used as the basis for valuing the decedent’s interest for estate tax purposes. The “fundamental problem” with that, said the attorney for the petitioner, is double taxation—once from the estate tax and then as capital gains tax on the increase in the remaining owner’s shares.

‘Weird’ case: The justices had trouble with this case. Justice Brett Kavanaugh found it “extremely difficult” and “weird,” Justice Ketanji Brown Jackson said, “I’m trying to follow,” and Justice Elena Kagan remarked that “it’s a little bit hard for me to get this through my head.” Justice Clarence Thomas was trying to follow the money. Referring to the $3 million in insurance proceeds, he said that extra value “has to go someplace … why isn’t the appropriate valuation $6.86 million?” Because it’s offset by the liability to redeem the shares, the petitioner’s attorney said. But Justice Jackson wondered “whether the proceeds of the life insurance are really going out when they’re being used to redeem the shares.”

One observer said the justices seemed to favor the government’s position. “The justices often bend over backwards to favor the IRS in tax disputes like this, especially when they involve (relatively) wealthy taxpayers worrying about the estate tax,” writes Columbia University law professor Ronald Mann on the SCOTUS blog. “So, I wouldn’t be at all surprised to see a lopsided victory here for the IRS just a few months from now.”

However, the court seemed to be concerned that, if the government were to prevail, it would upend private-business owners’ efforts regarding continuity of ownership. They asked whether COLI was a common strategy to use for this purpose. The government attorney was not sure and noted that a cross-purchase arrangement would be more effective, where the parties themselves hold the life insurance policies, not the company. An amicus brief the U.S. Chamber of Commerce and National Federation of Independent Business filed in support of the petitioner said that a redemption agreement a life insurance policy financed is “commonplace” and that a decision for the government “threatens that legitimate, long-established tool.”

The court also wondered whether the IRS was seeing a pot of gold here. Would the agency be going after huge amounts of back taxes and penalties from other estates in the same situation? The government downplayed this, saying that the IRS is not seeing a lot of this issue coming down the pike.

You can listen to audio of the oral arguments (click here), and there’s also a transcript available (click here). The case is Connelly v. United States, 23-146.

Court doesn’t appreciate active/passive analysis

An Alaska divorce case illustrates that the analysis of active and passive appreciation of a business during marriage continues to be a tricky one. This analysis is needed when a business is started before marriage and is not part of the marital estate. But, in some states, the marital estate includes the appreciation in the value of the business during marriage—but only that portion that results from the active efforts of the owner spouse. The job of the analyst is to determine what portion of the value appreciation is active and what portion is passive.

Split-up: In the Alaska case, the business was a contractor that did land clearing, such as excavation, site preparation, tree removal, and the like. The owner started the business in 1998 and got married in 2003, a marriage that ended in 2017. Therefore, the appreciation in value of the business from 2003 to 2017 needs to be split into its active and passive components. The husband’s valuation expert concluded that 60% of the appreciation was passive because of certain factors, such as customer relationships and increases in federal funding (the company had federal contracts). The remaining 40% was active appreciation, which amounted to $337,040, so this was the amount to be included in the marital estate, per the expert’s analysis.

While the court relied on the report of the husband’s expert, the court did not agree with the analysis. The court found that all the appreciation except inflation was active appreciation, which it valued at $842,600.

From the court opinion, there are few details of the expert’s methodology and analysis, so we don’t know whether the problem was the methodology itself or the inputs or assumptions that were used. In any event, this type of analysis continues to be a complex one that needs solid support to pass muster with the court.

Last chance! Take the Pepperdine survey on private capital markets

A recent BVR survey found that over a quarter (26%) of respondents use the Pepperdine Private Capital Markets Study to estimate the cost of equity. The study is based on an annual survey of expected rates of return with respect to private companies. This year’s survey will close very soon, so, if you have not yet participated, please do so. For a direct link to the survey, click here. The information you provide is confidential. The published study will be free if you fill out the survey—plus, you’ll get it a week early.

Accountants’ wariness of AI may spell trouble

Although accounting professionals see big changes ahead for their profession due to artificial intelligence, a significant proportion see no use case for AI in either their private of professional lives, according to a new study in AccountingToday. A combination of the profession’s conservative approach to new technology and the perceived risks of AI are holding the profession back compared to its rivals. Other financial services sectors, such as wealth management, banking, fintech, and insurance, are adapting to generative AI at a “much faster rate, raising the risk of outside disruption if the accounting profession cannot evolve and adapt in time,” the study says. In other words, clients will go elsewhere if the accounting profession does not optimally embrace AI. The key to overcoming the profession’s hesitancy about AI is more education about the technology and clear rules for its use by way of standards and regulatory oversight.

Extra: The ASA will host a virtual symposium on AI in the valuation profession on June 27 that will include two panel discussions: Introduction to AI and The Intersection of AI and USPAP. For more details and to register, click here.

What are your firm’s policies regarding BVFLS credentials?

Many credentials are found in business valuation, forensics, and litigation services firms and practices. Which ones are more prominent? Is there a “preferred” credential? Who covers the cost? Please take just two minutes to answer a quick survey on this—click here for the direct link. This short survey is part of BVR’s ongoing BV Firm Benchmarking Study in collaboration with Rod Burkert (Burkert Valuation Advisors). All responses are confidential, and the results will be published in the last BVWire issue of the month. Thank you for participating

IVSC launches ESG survey

To investigate the evolution of how environmental, social, and governance (ESG) factors are being incorporated into the valuation process, the International Valuation Standards Council has launched a survey. The survey relates to all types of valuations including those for financial reporting, market capitalizations, secured lending, and tax reporting purposes and will only take approximately five to 10 minutes to complete. The survey will be open until May 31, and the results are expected to be published during the latter half of 2024. To access the survey, click here.

BV movers . . .

People: Ioanna Fokianou, a senior manager in the New York City office of Empire Valuation Consultants, has received her ASA designation from the American Society of Appraisers … Mercer Capital has promoted three professionals to senior vice president: Brooks Hamner, CFA, ASA; Karolina Calhoun, CPA, ABV, CFF; and Sujan Rajbhandary, CFA, ABV … Robert Evans, CPA/ABV, CFF, CGMA, has joined Brady Ware in the firm’s Business Solutions Group in its Columbus, Ohio, office; he concentrates on business valuation, mergers and acquisitions, forensic accounting, economic damages, litigation support services, and income tax.

Firms: York, Pa.-based Stambaugh Ness has acquired Left Brain Professionals, an accounting and advisory firm serving government contractors in the architecture and engineering sector … Dallas-based Embark, a business consulting firm, has expanded into the U.S. Northeast with an office in New York City; the firm has practices in financial accounting advisory, business transformation, transaction advisory, valuation, capital markets, and ESG and sustainability … New York City-based EisnerAmper has merged with Birmingham, Ala.-based Tidwell Group, a tax, assurance, and advisory firm with 40 partners and over 200 professionals with a large presence in the real estate sector.

Please send your professional and firm news to us at editor@bvresources.com.

CPE events

Appraisal Review: Common Areas of Critique and Risk in Litigation, April 4, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Brandon McFarland (JS Held) and Andrew Duncan (JS Held). CPE credits: 2.0.

This presentation includes a discussion of the common areas of critique in the context of appraisal review, including examples of subjective inputs and assumptions (as well as common rebuttal responses), and an examination of data sources and relevant reference material to corroborate these inputs and assumptions.

The Valuation of Dealerships, April 9, 10:00 a.m.-11:15 a.m. PT/1:00 p.m.-2:15 p.m. ET. Featuring: Kevin Janke (Wipfli) and Jackie Zablocki (Wipfli). CPE credits: 1.5.

This will be a background and history of automobile dealerships, a look at the profit centers of dealerships, and a high-level mock valuation.