BVR Logo October 21, 2020 | Issue #217-3

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

Key Tennessee appeals court ruling finds tax affecting ‘relevant’ to fair value buyout

In a Tennessee buyout dispute involving a limited liability corporation organized as an S corporation, the parties disagreed over whether it was appropriate to tax affect in calculating the fair value of the terminated member’s interest. The trial court declined to tax affect. In contrast, the Court of Appeals, after explaining the concept of fair value, said tax affecting was a consideration as it assisted the court “in determining the going concern value of the S corporation to the shareholder or member.”

Citing to IRS job aid: In 2011, the plaintiff (seller) and defendant (buyer) formed an LLC that owned and operated a “Wurst-Burger Joint,” in Nashville. Each member had a 50% interest. The LLC had S corp status. While the restaurant blossomed, the members’ business relationship soured and litigation between the members ensued.

Eventually, the trial court terminated the plaintiff’s membership interest in the LLC, finding his wrongful conduct adversely affected the business. The defendant opted to buy out the plaintiff’s interest under the applicable statute, which required the court to determine the fair value of the plaintiff’s membership interest. Both sides offered valuation expert testimony.

The buyer’s (defendant’s) expert applied discounts for lack of control and marketability (the use of discounts was another contested issue) and tax affected. Specifically, he used a 38% tax rate, which, he said, “was entirely appropriate and comports with generally accepted valuation standards and methods.” The appeals court opinion notes the expert explained “in considerable detail” his reasons for applying this rate to the income stream in his income-based model. Among other things, he said, because “all of the components of the Capitalization Rate are based on after-tax values or after-tax income data, the income stream to which the Capitalization Rate is applied in the Income Approach must also be an after-tax amount in order to be comparing apples to apples.”

The plaintiff objected to the use of discounts and tax affecting. In arguing against tax affecting, he referred to a job aid for IRS valuation analysts that said “no entity level tax should be applied in the valuation analysis for a non-controlling interest in an electing S corporation, absent a compelling demonstration that independent third parties dealing at arms-length would do so as part of a purchase price negotiation.” He also cited the landmark Gross case, in which the U.S. Tax Court rejected tax affecting in a gift tax dispute.

The trial court agreed with the plaintiff. It said its decision not to permit tax affecting “rests primarily on the reasoning that the LLC elected to be taxed as an S corporation.” The court said, “to a lesser extent,” it was also guided by Gross. It noted that Gross was “not on point but only analogous,” as it dealt with a fair market value determination done in a different context.

Correlation issue: The Court of Appeals noted the applicable statute required the trial court to consider all relevant evidence for the valuation. Tax affecting was relevant evidence, the appeals court said. It said the trial court, in rejecting tax affecting, “applied the fair market value standard, as the Gross court did.” This was the wrong standard here, the appeals court found. A more persuasive case was Delaware Open MRI, in which the Court of Chancery determined the going-concern value of an S corp. Citing Delaware MRI, the Court of Appeals said tax affecting was relevant to determining “what the investor ultimately can keep in his pocket,” assuming he maintains his investment position.

It added the statute required the court to consider the “recommendations of any of the appraisers of the parties to the proceedings.” Here, the defendant’s expert stated tax affecting was a generally accepted factor in the fair value calculation of an S corp, Also, the court said, in the recent gift tax case, Estate of Jones, the U.S. Tax Court noted the importance of treating the cash flow and the discount rate consistently by using after-tax or pretax values for both. “Therefore, we find that, for the purpose of correlation, tax affecting was relevant to the fair value determination of [the company],” the Court of Appeals said. It remanded “to allow the parties to present evidence relative to tax-affecting.”

A digest on all the issue in Raley v. Brinkman, 2020 Tenn. App. LEXIS 341 (July 30, 2020), and the court’s opinion, will be available soon at BVLaw. Digests of the other cases mentioned in the text, as well as the court opinions, are available to BVLaw subscribers.

Additional note: This court’s decision, which references the recent key gift tax cases, Kress and Estate of Jones, contrasts with R.D. Clark & Sons, Inc. v. Clark, a January 2020 buyout decision from a Connecticut appellate court that upheld the trial court’s decision not to tax affect when valuing the departing shareholder’s interest.

IRS addresses fears over change in
appraisal reviews

Earlier this year, the IRS issued a memorandum that described changes to the way the IRS reviews appraisals prior to imposing a civil money penalty for valuation misstatements under IRC Section 6695A. This change reduced the number of individuals involved in the decision to impose the penalty. The appraisal community was concerned that this change could result in a penalty being imposed without having anyone with valuation experience review the appraisal (see our coverage here). Now, the IRS has come out and said that appraisers should not be concerned.

IRS speaks: Individuals with valuation experience and credentials will continue to do appraisal reviews, according to Cheryl Teifer, IRS director, field operations engineering. Tiefer made her remarks at last week’s American Society of Appraisers (ASA) 2020 International Conference.

BVWire reached out to the ASA for comment (the ASA was one of the signers of a joint letter to the IRS and Treasury expressing concern over the change). “While we appreciate IRS staff sharing that appraisers continue to be heavily involved in reviews prior to the imposition of a Section 6695A valuation misstatement penalty, our strong preference is for those verbal reassurances to be reduced to writing,” says Lorrie Beaumont, ASA international president. “That way, valuation professionals can have written confirmation regarding how the process works and who is involved.”

BVWire will keep you updated on any developments in this issue. And we’ll have more coverage of the ASA conference in the next issue.

Mercer and Harms release new edition of their Integrated Theory book

BVR is pleased to announce that the new third edition of Business Valuation: An Integrated Theory is now available in its bookstore. Co-written by Z. Christopher Mercer and Travis W. Harms (both with Mercer Capital), the book is designed to demystify modern valuation theory and show how to apply fundamental valuation concepts. There is also a detailed discussion of the quantitative marketability discount model (QMDM), a shareholder-level DCF model Mercer developed that values interests in a business in the context of an appraisal of the entire enterprise. For more information, click here.

‘The “Normalized” Risk-Free Rate: Fiction or Science Fiction?’

That’s the title of a new paper from Pablo Fernandez, a professor in the department of financial management at the University of Navarra—IESE Business School in Spain. The concept of normalizing the risk-free rate emerged around the time of the 2008 financial crisis and is a rate that should exist in a world that certain analysts and consultants call “normal,” but “it is not the world in which we live,” writes Fernandez. For example, he points out that no one can invest in any financial instrument and earn the normalized risk-free rate with little or no risk. The paper shows other inconsistencies in the use of a normalized risk-free rate that results in “important valuation errors.” Fernandez also includes a case study of a hypothetical consulting firm advising a client to use a normalized rate with some interesting comments from his MBA students that back up the notion that such a rate is an “unacceptable invention.” You can download his new paper if you click here.

As with many aspects of business valuation, there are different camps of thought—some analysts use a normalized rate and others do not. In a BVWire survey from last year, two-thirds of respondents said they use the spot yield on Treasury bonds. Most (58%) use the 20-year spot yield, and the rest (9%) use the 10-year spot yield. A quarter of respondents use a normalized rate, and the remainder use something different (e.g., a 30-year spot yield) or a custom rate. Most respondents who use the spot yields said they get their information right from the U.S. Treasury website.

ABA and BVR team up for annual BV wrap-up

Here’s your chance to hear a summary of all the key issues in business valuation this year. Join speakers from the American Business Appraisers (ABA) network for a special four-hour Annual Key Issues Update webinar on October 29. Of course, the impact of COVID-19 on business valuation is on the agenda—and everything that has been discussed on that topic has been synthesized into a concise set of best practices. In addition, you’ll get up to speed on other important issues that the pandemic may have overshadowed. For more information and to register, click here.

The ABA National Network is a consortium of experienced and credentialed business valuation professionals. The strategic objective of the ABA is to provide its member firms with the resources and expertise of a national network of highly qualified business appraisal specialists. Member firms enjoy exclusive member territories defined by geographic regions, as well as the benefit of group purchasing discounts on many business valuation research subscriptions. For more information on the ABA National Network, click here.

CBV Institute appoints new president and CEO

Christine Sawchuk has been selected as the new president and CEO of the Chartered Business Valuators Institute (CBV Institute), Canada’s valuation professional organization (VPO), which was effective October 1. She assumes the head management position from Mary Jane Andrews, who is retiring after five years in the role. “I could not be more excited, or be more honored, to take on this opportunity” says Christine in a statement. “CBV Institute has evolved tremendously over the past five years under Mary Jane’s leadership, and I believe the Institute is primed to leverage the influential position of CBVs in the business community at home and abroad.”

Reminder: Survey on valuation user perspectives

If you have not already done so, please take a short survey looking for input from users of business valuations on the role of internationally recognized valuation standards. The Europe Board of the International Valuation Standards Council (IVSC) launched the survey to gather the perspectives of a selected group of senior finance executives such as CFOs and (group) finance directors, asset managers, investment managers, or bankers across the world within various industries working for either listed firms or larger nonlisted firms. There’s a particular interest in hearing from individuals in those countries that have not yet adopted valuation standards. If you fit the above criteria, you can take the survey—it will take just 10 minutes—if you click here. If you know of someone else who qualifies, please forward the link to them.

BV movers . . .

People: Melissa Cline, CPA, CVA, CFE, CIRA/CDBV, has joined Fort Worth, Texas-based Whitley Penn LLP as a director in the forensic, litigation, and valuation group … Kathy Klang, CPA/ABV, has stepped away from her duties as managing partner at Minnesota-based Cummings, Keegan & Co. PLLP but will remain active leading the firm’s business valuations niche; she is succeeded by Peter Maddalena, CPA, who was named leading partner effective October 1.

Firms: Greensboro, N.C.-based DMJ & Co. has acquired Roberson CPA Firm of Durham, N.C.; the combined firm will employ more than 100 people, including 13 partners, with four office locations across North Carolina in Greensboro, Durham, Sanford, and Wilmington … Fargo, N.D.-based Eide Bailly has acquired Mukai Greenlee & Co. of Phoenix; the deal expands Eide Bailly’s presence in Arizona and adds seven staff members to the firm’s team … Atlanta-based Aprio LLP has acquired Relevant Data Technologies (RDT), a provider of electronic discovery and data management services to law firms and general counsels.

Please send your professional and firm news to us at

CPE events

A new court case involving a buried body and sex surrogates kicks off a compelling discussion of key issues in valuing family-owned businesses.

This special four-hour webinar recaps all the key issues in business valuation this year, including some best practices that have emerged concerning the impact of COVID-19.

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


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