IRS rejects Kohler

The Internal Revenue Service has formally rejected the Tax Court’s holdings in Kohler v. Comm’r, T.C. Memo. 2006-152 (see BVWire™ #58-3, in which the IRS calls the case a “learning experience”).  “The Commissioner does NOT ACQUIESCE in the [Kohler] decision,” according to the Action on Decision published in the Internal Revenue Bulletin last week (2008-9, March 3, 2008) (emphasis in original).  “An Action on Decision will be issued at the discretion of the Service only in unappealed issues decided adverse to the government.”   A brief footnote provides the only elaboration:

Nonacquiescence relating to whether I.R.C. section 2032 allows a discount for transfer restrictions and a purchase option imposed on closely-held corporate stock pursuant to a post-death tax-free reorganization in determining the fair market value of the decedent’s stock on the alternate valuation date.

Section 2032 generally permits an estate to elect an alternate valuation date, six months after the date of a decedent’s death.  If the overall value of the estate has decreased during that time, the estate can reduce its tax burden.  The purpose “is to provide relief…when the MARKET causes a substantial diminution in value of an estate asset,” tax attorney Charles Rubin explains in his March 5th blog.  In Kohler, the change in value resulted when the company restricted the stock during the six month period.  “While the position of the IRS sounds reasonable,” Rubin says, “one has to wonder…how many cases will be litigated over the question whether a change in value is due to…market conditions vs. a voluntary act?”  Indeed—we asked attorney and frequent BV analyst John Porter (Baker Botts) to comment, but he’s currently involved in several similar matters, and is not at liberty to discuss.  To access the Action on Decision, on page 4 of the I.R. Bulletin, click here.

Schweihs responds to IRS rejection of Kohler  

“There were many important details in Kohler, including the fact that between the date of death and the alternate valuation date (six months later), the company issued a prospectus to shareholders and executed a reorganization,” says Robert Schweihs (Willamette Management Associates), who served as one of the taxpayer’s original appraisers.  “Shareholders decided whether to accept, in exchange for their original shares, either 1) cash or 2) new shares which had different characteristics than the original shares. This exchange of shares qualified as a tax-free exchange under IRC Section 368.  Whether an exchange of shares qualifies as a tax-free exchange is a legal question,” Schweihs adds, “and not a valuation question.”

However, Schweihs makes the following observations:

• The IRS nonacquiescence in Kohler means that the IRS will not automatically accept discounts that are attributable to characteristics of new shares held on the alternate date that are different than the characteristics of shares (for which the new shares were exchanged) that were held on the date of death.
• If the IRS were to acquiesce to automatically accept such a discount, then tax planners might encourage, for example, provisions for such in wills and corporate governance documents.
• In situations where the characteristics of shares have changed between the date of death and the alternate valuation date, analysts should be careful if they are concluding a different discount on the two dates; and if the analyst does conclude a different discount, then he/she should not cite Kohler as authority.

“The results of Kohler that were favorable to the taxpayer were the result of the many important details of the situation,” Schweihs says, including “the effective presentation of those details by the client, the attorneys and the appraiser, particularly when the analysis was 1) completed contemporaneously with the two valuation dates (which sandwiched the reorganization); and 2) at the time of the trial.”

FASB limits scope of FAS 157 leasing exception

At one of its more recent meetings, the Financial Accounting Standards Board (FASB) discussed comments to the proposed FSP FAS 157-a, Application of FASB Statement No. 157 to FASB Statement 13 and Its Related Interpretative Accounting Pronouncements that Address Leasing Transactions.  A number of respondents questioned whether the scope of the proposed FSP included measurements under FASB Statements Nos. 144, 146, and in particular, 141R Business Combinations, with the related FASB Interpretation No. 21, Accounting for Leases in a Business Combination.

After deliberations, the staff recommended that the scope of the proposed FSP include only Statement 13 and its related pronouncements.  “The scope exception will not apply to assets acquired and liabilities assumed in a business combination,” the staff decided.  FAS 141R (and 141) will still require these to be measured at fair value, “regardless of whether such assets and liabilities are related to leases.”

The staff did not recommend issuing further guidance on these points, noting that this could delay the final FSP—but it will consider alternatives to 141R requirements after further research and discussion regarding 157’s impact on acquired leases.  The next step: The Board will draft a final FSP to submit to written ballot.  The minutes of the Feb. 6th meeting are available here.

New case cites the oldest authority on BV

It’s what many consider the “bible” of the BV profession—Valuing a Business (VAB) by Shannon Pratt, who just released the updated 5th edition, with contributions by Alina Niculita.  Lest anyone doubt the staying power of this tome, first published in 1981, a new federal case calls VAB a “leading treatise,” citing its 4th edition for topics ranging from the selection of guideline public companies in the market approach to the application of marketability discounts to controlling interests.  At one point in Floorgraphics, Inc. v New American Marketing In-Store Services, Inc. (Feb. 5, 2008), the U.S. District Court (New Jersey) praises the expert for doing “precisely what Pratt instructs him to do” in the selection of company comparables, and qualifies his calculations of lost business value—along with his partner’s lost profits calculations—as both reliable and relevant under the applicable Daubert standards. 

The Floorgraphics case is the latest indication how the increasing and nearly rote frequency of Daubert challenges are turning into “mini trials” on the expert evidence.  This one examines the valuation analysis in depth, and an abstract appears in the next Business Valuation Update™ (April 2008).  But just in case you want to check the frequency of citations to Pratt’s authority (we count nine), we’ve posted a copy of the court’s opinion here. To obtain the latest edition of Valuing a Business (VAB5)—which evidently no BV professional should be without, click here.

‘MUM’ gains acceptance in Florida court

MUM—the Mulitattribute Utility Model—an allocation method for distinguishing enterprise from personal/professional goodwill in divorce cases, just went to trial in Florida and received ratification by both the court and the appraiser in Neary v. Neary, Case No. 06-DR-3254 (18th Cir., Seminole, FL).  “I’ve used this method in several divorce cases in Florida,” reports Kenton Thompson (RSM McGladrey, Inc., Orlando), “but this is the first one that has gone through the complete trial process and had a judge weigh in on the analysis.  I find it to be a very useful way to analyze and present the analysis of enterprise versus personal goodwill in these cases,” he adds.  “It obviously requires professional judgment and some subjective decision making by the valuation expert, but so does every method that we utilize.  We all recognize that cookie cutter approaches and formulas aren’t accurate and carry their own sets of assumptions.” 

The Neary case is not likely to see appellate court review, Thompson says.  So far, the Illinois Court of Appeals is the only jurisdiction to publish a decision accepting the model, developed by David Wood.  For more on MUM and its availability, see BVWire #54-1.  To learn even more about goodwill, consider adding BVR’s Guide to Personal vs. Professional Goodwill to your reference library.

Free FASB webcast on Codification Project

The FASB has scheduled the latest in its series of free webcasts—on the move to codification of U.S. GAAP—for tomorrow, Thursday, March 13, 2008, beginning at 1 p.m. EDT.  Panelists Larry Smith, a Board member, and Tom Hoey, director of the FASB codification project, will discuss and demonstrate the FASB’s Accounting Standards Codification, the online research system that organizes all authoritative U.S. GAAP by topic.  Jay Hanson (McGladrey & Pullen), will moderate.  Viewers will be able to email their questions during the live event.  To register for the webcast, click here.