BVWire Issue #167-2 | August 10, 2016


Task forces mobilize over controversial IRS discount regs

A few weeks ago, BVWire gave you a heads-up that the Treasury would soon release long-awaited proposed IRC Section 2704 regulations designed to curb estate valuation discounts. Well, they’re here—and quick as a wink the AICPA, ASA, and NACVA are forming task forces to study the regs and submit comments.

The IRS wants to eliminate the technique of putting valuable property into entities such as family-owned partnerships or corporations just to reduce the value in the property to avoid estate and gift tax. To do this, the proposed regs (available here) address the treatment of some lapsing rights and restrictions on liquidation in determining the value of transferred interests in corporations and partnerships. Liquidation restrictions would be disregarded for valuation purposes. Bottom line: It appears that the proposed regulations eliminate almost all minority discounts for closely held entity interests, including operating businesses owned by a family.

Frontal assault: “I view it as a full frontal assault on economic reality,” says Donald DeGrazia (Gold Gerstein Group LLC). “They are changing the definition of fair market value,” says Michelle Gallagher (Gallagher Valuation & Forensics PLC). She says the regs seem to carve out certain types of transfers from the definition of FMV under the federal gift tax regulations (Treas. Reg. Sec. 25.2512-1). “This is indeed a very significant issue for business appraisers,” adds Ronald Seigneur (Seigneur Gustafson LLP), a veteran valuation practitioner who, along with Gallagher, is on the new AICPA task force.

“This is going to be a major problem for all family-owned businesses,” attorney Richard Dees (McDermott Will and Emery) told the Wall Street Journal. “This all boils down to the question of whether a family business should be valued as if it’s owned by one person.” Last year, Dees sent a 29-page letter to the government critiquing the proposal as beyond the scope of its powers.

The valuation professional organizations we spoke with are on top of this issue. “The recently released IRC Section 2704 family limited partnership (FLP) discounts proposed regulations include much of what appraisers had been dreading for the past year,” Carol Carden (PYA PC) tells BVWire. Carden is chair of the AICPA FVS executive committee. “The AICPA plans to draft and submit comments to the IRS prior to the December 1 hearing.” William Johnston (Empire Valuation Consultants LLC), chair of the BV committee of the American Society of Appraisers (ASA), says that the ASA is also forming a task force and preparing an action plan. “NACVA is convening a task force of board members, instructors, and members to address this issue as it has significant impact to the membership and profession at large,” says Brien K. Jones, NACVA’s chief operations officer and executive vice president. “I invite interested members to contact me if they are interested in supporting this initiative.”

What to do: Of course, the regs would have a big impact on family wealth planning. “If the proposal is adopted as contemplated, there will be a powerful incentive for families with businesses and investment holding entities to initiate or complete transfers before these regulations take effect,” says Bryce Erickson (Mercer Capital). The new rules are not effective until 30 days after the final regs are published. But, before that can happen, there is a 90-day comment period and then a public hearing on Dec. 1, 2016. Erickson points out that the proposed regs could change, or they might never go into effect. BVWire urges readers to read them and submit comments to the IRS, which are due by November 2.

More details and expert insights will be in future issues of BVWire and also Business Valuation Update.

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Acronym unveiled for new fair value credential

Want to add CEIV™ to your list of credentials? It stands for Certified in Entity and Intangible Valuations™, and it’s part of the ongoing initiative designed to improve financial reporting valuations for U.S. publicly traded companies. The ASA, AICPA, and RICS have spearheaded the initiative that includes the development of the new CEIV credential. Individuals must attain the credential through one of the approved valuation professional organizations (VPOs) and adhere to the ethical and membership requirements of that VPO. There are other requirements for attaining the credential, including experience, education, submitting to an ongoing engagement-level quality review process, and complying with a new performance framework to ensure confidence in the consistency and transparency in the credential holder’s work, all to the benefit of the public interest. A special website is now up and running, so you’ll find more details there.

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Key tax ruling from Ohio Supreme Court concerning pass-through entity

A taxpayer successfully challenged an Ohio statute that imposed income tax on capital gain that the out-of-state investor realized when he sold his majority ownership interest in a pass-through entity. While this case does not focus on valuation specifically, it does raise a novel tax issue regarding a pass-through company.

The taxpayer owned a majority interest in a limited liability company that had plants in Texas and California and did some business in Ohio. It was organized as a pass-through entity for tax purposes. The taxpayer did not reside in Ohio. He was on the company’s board of managers but apparently did not actively manage the company.

After he sold his ownership stake in the company, Ohio claimed, under a statutory provision aimed at pass-through entities, he owed the state taxes related to capital gain from the sale.

The case ended up in front of the Ohio Supreme Court. The high court found Ohio had the authority to tax the taxpayer’s distributive share of the company’s income based on the company’s business activity in the state. However, without a showing that the owner’s activity was “unitary with” that of the business, the state lacked taxing jurisdiction over the nonresident’s income related to the sale of intangible property, i.e., the ownership interest in the business. The court ordered a refund for the taxpayer.

Mary Jo Dolson (Skoda Minotti), who has been monitoring the case, notes the case raises a key question: Would the outcome have been different if the owner had been involved in the day-to-day management of the company? Dolson adds that the state decided not to appeal the decision with the United States Supreme Court and that practitioners are awaiting guidance from the state on how it plans to handle refund claims.

The case is Corrigan v. Testa, 2016 Ohio LEXIS 1163 (May 4, 2016). A case digest and the court’s opinion are available in September at BVLaw.

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Will the Tax Court judge scandal KO prior rulings?

A taxpayer has filed a motion to reconsider an adverse ruling by former U.S. Tax Court Judge Diane Kroupa based on her recent indictment for cheating on her own taxes, says a report from BNA. Was the judge deliberately ruling in favor of the IRS to gain its favor in her own tax matter? Is this just the start of a slew of requests for reconsideration of the judge’s rulings while she was under audit? What does this say about the integrity of our court system? These are just a few of the intriguing questions BNA poses. We shall see!

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Latest angles to valuing early-stage companies

The valuation of a venture-backed, early-stage company requires a disciplined application of methodologies that are often misunderstood or misapplied. Also, while the fundamentals in  valuing this type of firm haven’t changed, some nuances have emerged.

Ingenious ways: “There have been a number of insightful valuation and allocation methodologies developed over the years to value early-stage companies that don’t have reliable forecasts, but may have transactions in certain classes of stock,” says David Dufendach (Alvarez & Marsal) who will co-present a four-hour workshop on this topic on August 18 (see below). “For example, while the backsolve method has been around for a while, there are some new and interesting ways it is now being implemented,” he says.   

“There are basically two methods for allocating the value of an early-stage company we see most often: an option-pricing framework and a scenario-based framework,” he observes.  Both are based on the evaluation of potential future liquidity events and are covered in the AICPA guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, issued in 2013. In some cases, the option-pricing approach may not be suitable for certain firms or industries because they don’t “follow the pattern” that forms the basis of option-pricing theory. In those cases, according to Dufendach, you go to a scenario-based method, which in its most basic form is akin to a best-middle-worst case analysis. Practitioners typically will choose one or another but not both, so a crucial step is determining which method to use.  

Common error: The valuation and allocation methodologies are based on certain critical assumptions, so a common error is when those assumptions are not developed in a rigorous enough way. There can be wide variations in a valuation if you assume, for example, that the company will be sold in two years as opposed to seven years. Therefore, valuation specialists should make every effort to develop assumptions that have a reasonably objective basis, Dufendach advises, consistent with the guidance for forecasts and projections.

While the description of the workshop mentions “venture-backed” start-ups, the methodologies and approaches to be discussed are relevant for companies with a complex capital structure that arefinanced from any source, both external and internal. Of course, you would have a different view of a startup if you assume the investment has come from a sophisticated and disciplined investor as opposed to “friends and family.”  Our primary focus will be on venture-backed companies as these types of companies typically follow a similar financing and development cycle.

The four-hour advanced workshop, Early Stage Companies: Mastering Valuation from Start-Up to Success, will be co-presented by Dufendach and some of his colleagues at Alvarez & Marsal: Jason Andrews, John Sawyer, and Tommy Tu.

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Final arbitrage regulations address investment valuations

The Treasury has issued final regulations under IRC Section 148 relating to arbitrage restrictions that finalize numerous provisions of prior proposed regulations from 2007 and 2013. Among other areas, the final regulations address working capital financings, qualified hedging transactions, and valuation of investments, including guaranteed investment contracts and external commingled funds.

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Global BV news:
RICS lauds IVS/USPAP bridge

The International Valuation Standards Council (IVSC) and The Appraisal Foundation (TAF) recently released “A Bridge From USPAP to IVS,” which connects the two sets of standards to help make appraisals compliant with both the IVSC's International Valuation Standards (IVSs) and TAF's Uniform Standards of Professional Appraisal Practice (USPAP).

A statement on the website of the Royal Institution of Chartered Surveyors says that the bridge document “marks a major and crucial step towards establishing a set of globally accepted ethical and professional standards” for valuation. “The increasing flow of international capital and investment makes valuation standards even more critical,” says Ben Elder, global valuation director for RICS. “As an international professional body focused on property standards, RICS has supported the harmonization of USPAP and IVS to drive investor confidence in the valuation profession. It’s our responsibility to ensure that the market has confidence in the profession and adopts international standards to provide the public with assurance of transparency and consistency.”

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BV movers . . .

People: Cherry Bekaert expanded its national valuation services practice with various new hires in its Charlotte, N.C., office: Zain Ahmed has joined the firm as a principal, Daniel Welborn as a senior manager, and Kate Waller as a manager … Jennifer Mannino joined Grant Thornton’s Phoenix office as a director in the national forensic, investigative, and dispute services practice.

Firms: For the 12th year in a row, Clayton & McKervey, of Southfield, was honored as one of Metro Detroit’s “101 Best and Brightest Companies to Work For” … The Dallas Business Journal named Montgomery Coscia Greilich a “Best Place to Work in the Dallas/Fort Worth” … Wipfli LLP has merged in a leading Oakland-based healthcare consulting firm HFS Consultants, along with their marketing division, the Placemaking Group.

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CPE events

Personal Injuries: Valuing the Impact (August 10), with Jonathan Brogan (Norman, Hanson & DeTroy LLC) and Joseph DeCusati (Meyers, Harrison & Pia). This is Part 5 of BVR's Special Series presented by The Comprehensive Guide to Economic Damages.

Early Stage Companies: Mastering Valuation from Start-Up to Success (Advanced Workshop) (August 18), with David Dufendach (Alvarez & Marsal), Jason Andrews (Alvarez & Marsal), John Sawyer (Alvarez & Marsal), and Tommy Tu (Alvarez & Marsal Valuation Services).

Cost of Capital: An Anti-Cookbook Approach to Understanding (August 24), with Michael Crain (The Financial Valuation Group).

Important note to webinar attendees: To ensure that you receive your dial-in instructions to BVR’s training events, please make sure to whitelist

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We welcome your feedback and comments. Contact Andy Dzamba (Executive Editor) or Sylvia Golden (Executive Legal Editor) at:
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In this issue:

2704 bombshell

CEIV credential

PTE ruling

Tax Court scandal

Startup valuations

Arbitrage regs

Global BV news

BV movers

CPE events

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