BVR Logo August 28, 2019 | Issue #203-4

BVWire is your go-to source for the latest in the business valuation profession. Highlights for this week include:


Distinguishing Gross, Tax Court adopts
tax-affected valuation of PTE

In an ingenious move, the U.S. Tax Court, ruling on an Oregon gift tax dispute, accepted the taxpayers’ tax-affected valuations of pass-through entities (PTE) without overturning Gross. The Tax Court’s decision is an all-out win for the taxpayers and comes on the heels of Kress, in which a federal district court adopted the taxpayers’ tax-affected valuations of an S corp.

The decedent, Aaron Jones, who died in 2014, founded two closely related companies. Seneca Sawmill Co. (SSC), a lumber manufacturer, was an S corporation; Seneca Jones Timber Co. (SJTC), which owned and managed tree farms and supplied the timber for SSC, was a limited partnership.

In 2009, as part of his estate planning, the decedent transferred blocks of shares and limited partnership units to his three daughters. In 2013, the Internal Revenue Service (IRS) issued a notice of deficiency of gift tax of nearly $45 million. The taxpayers asked the Tax Court for review. Both parties offered expert valuations for SJTC. For SSC, the IRS only offered a rebuttal expert report.

The focal point of the court’s detailed opinion is the valuation of SJTC. The experts disagreed on methodology—whether the company was an operating company that should be valued under an income approach, as the taxpayers’ expert did (using a discounted cash flow analysis), or a natural resources holding company, as the IRS expert argued, using a net asset value approach. (The IRS accepted the taxpayer expert’s market approach valuation.) The court found the asset approach was inappropriate because it was not likely that SJTC would sell its timberland.

Experts don’t disagree on tax affecting: In critiquing the taxpayer expert’s DCF valuation, the IRS argued the taxpayers’ expert should not have tax affected earnings in projecting net cash flow. The expert used a 38% rate (combined state and federal rate). He also calculated a premium to capture the benefit to the partners from dividend tax avoided, estimating the implied benefit in past years and considering an empirical study on S corp acquisitions.

The IRS, citing Gross and later cases, argued tax affecting was improper where SJTC had no tax liability on the entity level and there was no evidence the company would become a C corporation. Absent a showing that two unrelated parties dealing at arm’s length would tax affect, the outcome improperly favored a hypothetical buyer over the seller. In contrast, the estate, citing Bernier, argued that a zero tax rate on the entity level inflated the value of an interest in SJTC. A hypothetical buyer and seller would take into account that the individual partners had to pay income tax, at ordinary levels, regardless of whether SJTC made cash distributions.

The court said both parties in effect recognized that a hypothetical buyer and seller would consider SJTC’s business form but disagreed about how to do this. The IRS’ own experts did not defend a proposed zero tax rate, only the lawyers did, the court said.

Further, the court found that Gross and other Tax Court rulings that disallowed tax affecting could be distinguished from the instant case. The court noted that the Gross court was presented with a stark choice: 40% or 0% corporate tax. The Gross court did not believe the 40% rate reflected the benefit to the owners from avoiding dividend tax and, “on the record of the case,” decided that a 0% rate properly reflected the savings to the owners, the court in the instant case said.

It noted that the situation here was different. The taxpayers’ expert took into account both the tax burden and benefit to SJTC’s owner. The expert’s “tax-affecting may not be exact, but it is more complete and more convincing than respondent’s zero tax rate,” the court said.

Takeaway: Arguing for a zero tax rate, as the IRS has frequently done, seems a losing proposition. The U.S. Tax Court recognizes there are tax consequences to PTE owners that valuation experts must wrestle with, by quantifying the burden and benefit related to flow-through status.

Stay tuned for follow-up reporting on other aspects of this important case.

A digest of Estate of Aaron Jones v. Commissioner, T.C. Memo. 2019-101 (Aug. 19, 2019), and the court’s decision will be available soon at BVLaw.

AICPA releases final PE/VC guide

The AICPA has released the final version of a new accounting and valuation guide, Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies, which provides nonauthoritative guidance and illustrations regarding the accounting for and valuation of portfolio company investments investment companies hold within the scope of FASB ASC 946. This guide may also be useful for noninvestment companies, such as corporate venture capital groups or pension funds, that make similar investments. The guide was developed by the AICPA PE/VC Task Force, which includes members from the PE/VC industry, auditors, valuation practitioners, and AICPA staff, according to a news release.

Survey: Most appraisers look backwards for ERPs

The historical approach (ex post) is the preferred approach in estimating the equity risk premium (ERP), according to 76% of respondents to our latest survey. Fourteen percent of respondents prefer the implied approach (ex ante), which is a forward-looking estimate developed by examining stock prices today and expected cash flows in the future. The remainder (10%) use a combination of both approaches, plus the “survey” approach, which solicits information from investors about the returns they expect. For the historical approach, long-term data are primarily being used (see table below). The “Other” category includes responses that indicated multiple approaches being used and looking back over a shorter period (20 years or so). Sources of ERP data include Duff & Phelps recommended ERP (cited by 67% of respondents), Professor Aswath Damodaran of New York University, who favors implied ERPs (21%), internal models (7%), and “Other” (14%—mostly BVR’s Cost of Capital Professional platform). The total is more than 100% because multiple responses were allowed.

Our thanks to those of you who responded to the survey!

Data used for Historical ERP  
Long-term supply-side ERP (1926-current) 33%
Long-term historical ERP (1926-current) 24%
Historical ERP (1963-current) 12%
Conditional ERP (historical data adjusted for current economic conditions) 12%
Long-term historical ERP minus WWII interest rate bias 0%
Other (please specify) 10%
Not applicable 10%

Questions to ask amid economic jitters

Whatever your feelings about the recent inverted yield curve or downbeat economic surveys, more business owners may be awake at night worrying about an oncoming recession. Earlier this year, a survey found that over half of small-business owners felt that a recession was coming. A recent survey by the National Association for Business Economics reveals that 74% of U.S. business economists expect a recession in the U.S. by the end of 2021. If business owners feel bad times are coming, they will (hopefully) take steps to help survive, which may impact operations and forecasts.

Ask questions: Looming economic trouble should trigger some questions on an analyst’s part during the due diligence process. Examples: Are you taking any steps to conserve cash in case you hit a slowdown in sales? Are you arranging for financing now before credit tightens? Will you be delaying expansion or large capital expenditures? How do you think a recession will affect your suppliers and customers? Are you diversifying your base of customers and suppliers to blunt the recession’s ripple effects on your company? You get the idea. Make sure you understand the potential impact of these types of issues on your subject firm.

PCAOB issues new guidance on fair value

The Public Company Accounting Oversight Board has issued four documents that provide guidance on the new requirements for auditing accounting estimates and the auditor’s use of a specialist, which includes valuation experts. The four documents are:

The new requirements are effective for audits of financial statements for fiscal years ending on or after Dec. 15, 2020. For more information, the PCAOB has created two implementation pages on its website for the new estimates standard and amendments for the auditor’s use of the work of specialists.

Appraisers fare best at surviving a Daubert challenge

In 2018, appraisers had the lowest exclusion rate (38%) among all types of financial experts facing a Daubert challenge, reveals the PwC survey, “Daubert Challenges to Financial Experts.” The annual study analyzes challenges to financial expert witnesses under the Daubert standards from 2000 to 2018, the years following the U.S. Supreme Court’s Kumho Tire decision, which expanded Daubert’s reach to financial expert witnesses. Overall, there were 213 challenges against financial expert witnesses in 2018, with 91 challenges (43%) resulting in partial or full exclusion of the expert. Economists and accountants are the most frequently challenged financial expert witnesses, with economists being the least likely to survive a challenge, the study says.

Cost of capital platforms topline Virginia conference September 19-20

BVWire will be heading to Glen Allen, Va., for the Business Valuation, Fraud & Litigation Services Conference on September 19-20, sponsored by the Virginia Society of CPAs. Front and center in the three leadoff sessions will be a discussion of the online platforms for estimating the cost of capital, the Duff & Phelps Cost of Capital Navigator and BVR’s Cost of Capital Professional, including a panel discussion on the pros and cons of each platform. Speakers for these sessions are James Hitchner (Financial Valuation Advisors), Ron Seigneur (Seigneur Gustafson LLP, CPAs), and James Harrington (Duff & Phelps). Other speakers will present sessions on reasonable compensation, the cannabis industry, how to detect a rigged valuation, financial analysis and data analytics, and much more. For the full agenda and to register, click here (you can attend on-site or via simulcast).

Damodaran updates country risk data

These days, it’s very difficult to find a company that is only exposed to domestic risk, according to Aswath Damodaran (New York University Stern School of Business) in his midyear 2019 country risk update that includes free spreadsheets on country risk premiums, sovereign credit default swap (CDS) spreads, corruption scores, political risk scores, and more. He also points out that a company’s exposure to country risk should not be determined by where it is incorporated and traded but rather from where it gets its revenue. No longer can country risk be diversified away because what happens in one country will have an impact on other countries. When valuing companies with substantial foreign operations, the country-specific input can be critical. A country risk premium must be used, by either adjusting the cash flows or changing the discount rate.


BV movers ...

People: Daniel P. Callanan, ASA, has joined Prairie Capital Advisors Inc. and will lead the firm’s new office in Columbus, Ohio, which will provide financial reporting, ESOP advisory, and corporate/shareholder valuation advisory services to clients nationwide; he is on the Valuation Advisory Committee of the ESOP AssociationMatt Nadeau, CPA, CVA, CFE, has been promoted to senior manager at Concord, N.H.-based Nathan Wechsler & Co. PA; he joined the firm in 2012 … Bob Nemeth, CPA/ABV, CVA, CDFA, CFE, principal at Akron, Ohio-based Apple Growth Partners, has been appointed to the firm’s guiding board; he provides business valuation and litigation support services and leads the firm’s forensic accounting specialty … Nick Wood has joined New York-based AlixPartners as a managing director in the firm’s M&A services practice in London.

Firms: Albin Randall & Bennett (Portland, Maine) has joined CPAmerica, an association of independent CPA firms; the firm also refreshed its brand with a new tagline, “National Savvy. Local Sensibility,” as well as a new logo, color palette, and a new website … The Bonadio Group (Rochester, N.Y.) is introducing a new brand, FoxPointe Solutions, to support businesses’ growing and evolving needs for information risk management (IRM) services … Charlotte, N.C.-based Dixon Hughes Goodman has hired an executive coach; Bob Kunkle, formerly an executive coach at a Big Four firm, joined the firm as director of executive coaching and development … Gelman, Rosenberg & Freedman CPAs has relocated its metro Washington, D.C.-area headquarters to a new location within Bethesda (Maryland) and has rebranded itself as GRF CPAs & Advisors (GRF) … EisnerAmper will have a new corporate headquarters in the Turtle Bay section of Manhattan; the firm will have approximately 700 employees on five floors at 733 Third Avenue and is expected to move in June 2020.

Please send your professional and firm news to us at

Upcoming BVR training events

  • Fairness Opinions and Projections (September 12), with Craig Jacobson (GlassRatner), Jeffrey Rothschild (McGuireWoods), and Richard Peil (GlassRatner). This is part of BVR’s Special Series on Fair Value.

    Learn both legal and financial aspects of fairness opinions, with a special focus on the role of projections used in the underlying valuation analysis, with special insight on the interaction between management and the opinion provider.

  • Goodwill: A Discussion and a Debate (September 18), with R. James Alerding (Alerding Consulting LLC) and Alan Zipp.

    Two of the most knowledgeable experts in the area of goodwill will cover the key issues and controversies and discuss and debate frequently asked questions.

Holiday break
BVWire will take a break for the Labor Day holiday next week. We will resume publication on September 11. Have a happy and safe holiday!

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

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