IRS extends 409A compliance deadline to next year

The Treasury Department and the Internal Revenue Service (IRS) announced Monday that taxpayers will have until December 31, 2008, to bring documents into compliance with the final nonqualified deferred compensation regulations under section 409A of the Internal Revenue Code.  Last April, the Treasury and IRS issued final 409A regulations, which provide guidance regarding the requirements for deferral elections and payment timing under section 409A.  Affected plans and arrangements were required to comply with the final regulations by December 31, 2007.

IRS Notice 2007-78 extends the document compliance deadline for one year and provides additional limited transition relief.  Importantly, the Notice does not postpone the January 1, 2008 effective date of the final regulations (which were already extended once; see BVWire #50-3). The Treasury and the IRS do anticipate issuing further guidance “containing a limited voluntary compliance program that will permit taxpayers to correct certain unintentional operational violations of § 409A and thereby limit the amount of additional taxes due under § 409A,” although the Notice does not indicate when to expect the additional guidance.

Federal court revisits Bajaj and restricted stock studies

It’s the first major case this year to address the valuation of restricted stock, including the all-important discount for lack of marketability (DLOM) as determined in part by various restricted stock studies.  Arising from “the failure of individual and corporate taxpayers to report one consistent value for almost 10 million shares” of restricted stock, Litman v. United States (August 22, 2007) finds the U.S. Court of Federal Claims considering several valuations by well-known and accredited business appraisers, including Dr. Mukesh Bajaj:

1. The taxpayer enlisted two experts, selected the more conservative opinion and subjected it to a “reasonability review” by a national accounting firm.  The conclusion, based primarily on a Black-Scholes and capital asset pricing analysis and relying on restricted stock studies as a “sanity check,” determined that the marketability discounts increased over the four-year period of legal and contractual restrictions from just about 50% to 79%.

2. The IRS expert relied primarily on an “option collar approach” (calculating the cost of put/call options on the stock less certain “key person” factors) as supported by three restricted stock studies to conclude a weighted average DLOM of 20.3%.

3. Dr. Bajaj, on behalf of the stock issuer and based on his own and one other restricted stock study, calculated an average DLOM of 20%.

Notably, the Court rejected reliance on the restricted stock studies, finding that the studies failed to disclose underlying data (and simply reported averages) or the experts focused on limited factors such as earnings or revenues.  It also rejected the IRS option collar analysis for failing to include “real world” variables. Ultimately, it concluded that the taxpayer’s methodology carried the most weight and adjusted its expert’s DLOM to 22% in the first year, and to 50% in the fourth.  The lengthy opinion is an important, must-read for business appraisers and attorneys, and we’ve posted it here. To review the debate on DLOM and restricted stock studies, see “A Response to Dr. Shannon Pratt’s Critique of my Work on Marketability Discounts,” by Mukesh Bajaj, Ph.D., currently available as a free download at

A very happy ‘state of the union’ for CICBV

The Canadian Institute of Chartered Business Valuators (CICBV) celebrated record attendance at their sold-out Eastern Regional Conference last week in Montreal.  Lorne Siebert, current CICBV Chair and partner at Siebert Pask Weston (Calgary), pointed to indications of expansive good health enjoyed by the organization:

  • Membership has risen to 1,150, with 115 new candidates writing the Institute’s entrance exam on September 17th, nearly 25% more than last year.
  • Half of the CICBV students are NOT chartered accountants, helping to distinguish Canadian business valuators from their accounting peers.
  • CICBV “enjoys the respect of Canadian securities regulators and Revenue Canada,” Seibert said, “unlike the situation in the U.S. where the presence of five professional associations means that it’s sometimes difficult for business appraisers to get the ear of the SEC or FASB.”
  • Besides working jointly with AICPA, ASA, NACVA, IBA, and the Appraisal Foundation, CICBV has joined the International Valuation Standards Committee, and through IVSC is working with the fifty member countries.
  • The organization is working on a range of new standards in areas as contentious as independence, draft reports, valuation for financial reporting, and communications other than for business valuation.
  • CICBV now offers eleven training courses, many developed with York University, and most are available on-line.
  • Jeannine Brooks, CICBV President, added that the organization is expanding outreach to universities and researchers.  Its Research Institute Committee offers awards for the best research papers on emerging valuation issues.

Siebert’s major concern for the BV profession in Canada?  “We’re not growing fast enough to serve the legal and other communities who need us.”

State-by-state analysis of active/passive appreciation

Don’t miss today’s  teleconference on “Active and Passive Appreciation in Divorce,” which includes among other timely reading materials a fifty-state (and District of Columbia) summary of case law related to the issues of active/passive appreciation.  Recently prepared by attorneys Jeff Weinstein and Scott Danaher of Weinstein Snyder Lindemann Sarno (Roseland, NJ; The summary is just one reason to tune into the expert panel led by Jay Fishman and including Ashok Abbott, Ph.D., William Morrison, and Steve Wagner.  Other reasons include the topics of discussion and practice tips, such as:

  • Relationship between separate, commingled, and transmuted property
  • Practical examples of the treatment of separate property
  • Does separate property receive different treatment in community property states versus common law and equitable distribution states?
  • Problems with traditional ways of measuring passive appreciation
  • New or non-traditional tools available to practitioners to measure passive appreciation

To register, click here.

FASB broadens conceptual framework, issues
FSP APB 14-a on convertible debt

At their last meeting in August, the Financial Accounting Standards Board (FASB) advanced the staff-backed portions of its Discussion Paper (DP), Preliminary Views on an Improved Conceptual Framework for Financial Reporting: The Objective of Financial Reporting and Qualitative Characteristics of Decision-Useful Financial Reporting Information.  Specifically, the Board addressed concerns raised by constituents about the role of stewardship in the overall objective of financial reporting.  Among other recommendations, the Board decided to expand the objective’s scope to encompass information useful to investors and creditors, present and potential, in their capacity as capital-providers—including information related to protecting/enhancing their claims on the entity’s resources.   Copies of handouts for this and prior FASB meetings are available here.

This past week, the FASB also published its proposed Staff Position (FSP) No. APB 14-a, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion; for more information, click here.  Comments are due by October 15, 2007.

Fair, flair, and fools’ market value: the debate continues

Responding to Mike Pellegrino’s suggestion of a new standard, “fools’ market value." in the last BVWire, Robert W. Levis, CPA/ABV, ASA, CFE (Levis Consulting, Colorado Springs), writes:

The ‘market’ is the relevant marketplace for the subject company as of the valuation date.  A ‘hot’ market may yield an indication of value in excess of one using the income approach (e.g., DCF method) and ‘traditional’ methods of estimating the relevant cost of capital.  With all due respect, that does not necessarily make the ‘hot market’ investors fools.  Hindsight makes us all smart.

Financially sophisticated investors make these decisions with risk and reward expectations, and most of the time, they do so with a diversified portfolio perspective.  Strategic investors have their own reasons, which may be difficult to identify from the outside.  Although we, as a profession, may be well informed and knowledgeable about the companies we appraise, it would be foolish to ignore the relevant market and arrogant to profess that we are more knowledgeable than those active in the market.  I expect a lot more money could be made by those with such insights by participating in the market rather than appraising the businesses in the market.

Dexter Braff (The Braff Group, Washington, D.C.) comments: “I would argue that the 'rational' buyers Pellegrino is referring to are, for various strategic, synergistic, or market driven reasons ‘compelled’ to make certain acquisitions.  As such, by definition, their standard of value is not fair market value—rather it is ‘investment value.’  Sometimes the deals work out, and sometimes they don't.  But such investment value premiums are often necessary—and worthwhile—to acquire an attractive company in a competitive M&A market.”

“Your humorous poke at the IRS and attorneys regarding ‘flair’ market value was spot on,” says John C. Williams, CPA (Henjes Conner & Williams, P. C., Sioux City, IA), referring to the offhand quip that began this hands-on debate. “Very few appraisers have ever had to ‘eat their own cooking.’  I learned valuation techniques in the ‘kitchen’ of Beatrice Foods in the early to mid-70s where any of us who paid too dearly for a new subsidiary, paid for it with his or her career.  That kind of focus sharpens you unlike anything the [IRS or plaintiffs’ bar puts into their valuations].  I suspect none of them ever had to finance and pay for a business based on their determination of fair market value,” Williams adds.  Only those who do are the true valuation experts.  The rest of us are mere academics.”

Finally, John Borrowman (Borrowman Baker, Franklin, TN) may say it all with, “Flair market value.  Is that what you apply to mortgage-backed securities?”   Keep the comments, quips, and queries coming on this or any valuation-related topic by emailing the editor.

Estate tax returns decline by 58%

The total number of filed estate tax returns fell from just about 108,000 in 2001 to 45,000 in 2005, according to the Summer 2007 IRS Statistics of Income.  By the same token, the total amount of assets encompassed by those returns fell only 14% during the same time period, from $216 billion in 2001 to $185 billion in 2005.  According to tax attorney Charles Rubin (Boca Raton, FL), the reduction in returns is due to the “steady increase in the unified credit equivalent amount allowed for federal estate taxes,” which rose from $600,000 in 2001 to $1.5 million for decedents in 2005.  “Since estates with less than the available credit equivalent in assets do not need to file, increases in the credit result in [fewer] returns.”  The current credit equivalent amount is $2 million, suggesting the declining trend in estate tax returns will continue.


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