Autumn 2007


Focus on Intergenerational Wealth Transfer

Editor for This Issue: Trey Stevens

Gift and Estate Tax Valuation Insights

Factors that Affect the Selection of the Discount for Lack of Marketability
Aaron M. Rotkowski
The application of the discount for lack of marketability (DLOM) is often an important procedure in valuations of noncontrolling ownership interests in closely held companies. This discussion will address some of the key factors that affect the valuation analyst’s selection of the DLOM, including (1) the subject company dividend payment history, (2) the owner’s expected investment holding period, and (3) the subject- company-specific risk.

The Use of Theoretical Models to Estimate the Discount for Lack of Marketability Travis R. Lance
Valuations of noncontrolling ownership interests in closely held companies are often performed for estate tax, gift tax, charitable contribution, or other taxation-related purposes. One important procedure in the closely held business valuation analysis is the estimation and application of an appropriate discount for lack of marketability (DLOM). The models commonly used to quantify the DLOM generally fall into one of two categories: (1) empirical models and (2) theoretical models. This discussion focuses on the common theoretical models used by valuation analysts to quantify the DLOM applicable to a noncontrolling ownership interest in a closely held company.

Current Controversies Regarding Discount for Lack of Marketability Analyses
Aaron M. Rotkowski and Scott S. Cobb
For years, valuation analysts have relied on restricted stock studies and pre-IPO studies for empirical guidance with respect to estimating the DLOM related to the valuation of nonmarketable securities. Even though these empirical DLOM models represent the consensus among valuation analysts, some observers have developed contrarian positions regarding these generally accepted DLOM estimation procedures. This discussion will summarize the current controversies with regard to the estimation of the DLOM. Valuation analysts should be familiar with the bases for (and the responses to) these DLOM controversies.

Court Rules Transactions in Stock of Privately Held Company Considered Arm’s-Length Transactions
Craig A. Jacobson
Valuation analysts often consider any prior sale transactions in the stock of the subject closely held company when performing a business/security valuation analysis. One important criteria in determining whether these prior sale transactions provide meaningful valuation information is whether or not the transactions can be considered “arm’s-length.” A recent Tax Court decision discusses many of the factors that valuation analysts can use in this determination.

Fifth Circuit Reverses the McCord v. Commissioner Tax Court Decision
Kelly R. (“Bucky”) Wright and David P. Burdette
This discussion summarizes the Fifth Circuit Court of Appeals 2006 reversal of the controversial 2003 Tax Court decision Charles T. McCord Jr., et al. v. Commissioner. The Tax Court had rejected a “defined value” formula clause used to value gifts of the McCord family limited partnership interests. In contrast, the Fifth Circuit upheld the taxpayer’s values and the taxpayer’s valuation methodology. Valuation analysts who practice in the estate planning area should be generally familiar with this taxpayer- friendly Fifth Circuit decision.

Pension Protection Act of 2006 Establishes New Section 6695A with New Penalties for Appraisers
Curtis R. Kimball
The Pension Protection Act of 2006 increased the requirements related to valuations prepared for federal income tax purposes. The new rules include (1) new definitions of a qualified appraisal and a qualified appraiser, (2) changes in the thresholds for what qualifies as a valuation misstatement and (3) appraiser penalties under a new Internal Revenue Code Section 6695A. This discussion summarizes the relevant provisions of the Pension Protection Act of 2006. This discussion also addresses the implications of the new rules for valuation analysts who practice in the federal gift and estate tax area.

Valuation Analysts Who Practice Before IRS Should Be Familiar with Circular 230—Related Penalties
Robert F. Reilly
Valuation analysts (and other professionals) who practice before the Internal Revenue Service (the “Service”) must comply with the provisions of Circular 230. Internal Revenue Service Notice 2007-39 provides the most current professional guidance with respect to the penalties that the Service may impose with regard to a valuation analyst’s professional misconduct. This discussion will summarize this professional guidance regarding the penalties that the Service may impose related to such prohibited conduct.

The Federal Estate Tax: Repeal, Reduction, and Reform—Past, Present, and Future
Ronald D. Aucutt, Esq.
The effort to repeal the federal estate tax has been a controversial and complex issue for decades. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) reduced and eventually repealed the estate tax in 2010. However, the estate tax is currently scheduled to return to its pre-2002 levels in 2011. This discussion provides (1) a brief history of the estate tax repeal efforts, (2) an overview of recent legislative activity with regard to the status of the estate tax, and (3) clues to the possible future of the estate tax.

Section 2703—Keeping Buy-Sell Agreements Intact for Estate Planning of Family-Owned Businesses
Edward A. Renn, Esq., and N. Todd Angkatavanich, Esq
Buy-sell agreements serve an important role in many closely held businesses. Such agreements establish the transfer price for a number of transaction and other events, such as: shareholder liquidity, incentive and deferred compensation, change of control, disability, and death. In a closely held, family-owned business, establishing the ownership interest transfer price can also become a key underpinning in the succession and estate plans of the subject family. A critical examination and understanding of Code Section 2703 are important to insuring that the buy-sell agreement transfer price does not create a “price/value gap.” This “price/value gap” can result in negative consequences to the family’s estate plan and gift/estate tax liabilities.

Gift and Estate Tax Litigation Insights

Estate of Manship: Documents Are Discoverable and Not Covered by Work-Product Doctrine
James J. O’Sullivan
The U.S. District Court for the Eastern District of Louisiana overruled the plaintiff’s objection to the production of certain documents used by an appraiser and mistakenly provided to the defendant. The plaintiff claimed that the subject documents were protected by the work-product doctrine and by the attorney-client privilege. The District Court found that, by naming the appraiser as an expert witness, the plaintiffs had made discoverable all of the documents “considered” by that expert in rendering his opinions. In addition, the District Court found that the plaintiff had waived any privilege applicable to the subject documents when the plaintiff allowed the opposing party to review the documents.

Tax Court Addresses Several Fundamental Issues in Kohler v. Commissioner
Trey Stevens
The Kohler case was one of the most talked about U.S. Tax Court decisions in recent years. Since the publication of the Kohler judicial decision on July 25, 2006, many commentators have described it as a “total victory for the taxpayer.” Willamette Management Associates analysts provided expert testimony in the Kohler case. For this issue of Insights, Trey Stevens had the opportunity to solicit the “expert perspective” of Robert Schweihs, a Willamette Management Associates managing director, who provided expert testimony on behalf of the taxpayer.

Estate of Gimbel Addresses FMV of Block of Restricted Stock in Publicly Traded Company
Curtis R. Kimball
Most valuation disputes in the federal estate and gift tax arena relate to the value of an ownership interest in a closely held entity. However, disputes can also occur in determining the value of publicly traded stock. In situations where blocks of stock in a publicly traded company may be subject to transferability restrictions, valuation adjustments may be required to determine the fair market value of the subject stock. One example of this situation is presented in the Estate of Gimbel. In the Estate of Gimbel, the Tax Court was faced with determining the appropriate discount for blockage and for restriction on the immediate marketability of restricted stock shares in a publicly traded company.

The District Court Considers the Application of Valuation Discounts in Estate of Temple v. U.S.
Paul W. Daddio
Courts have increasingly demanded that valuation discounts for family limited partnerships be supported by a thorough search for, and an appropriate application of, empirical data related to the subject entity. The Estate of Temple case is useful for understanding the generally accepted methods that are commonly used to determine valuation discounts for asset holding company entities. Such entities include family limited partnerships and other closely held entities that hold real estate and/or marketable securities.

Tax Court Rules Against Tax-Affecting S Corporation Earnings in Dallas v. Commissioner
Lynn H. Whang
The Dallas v. Commissioner case is a gift tax valuation matter that highlights, among other issues, the ongoing dispute over whether or not to tax-affect S corporation earnings. The Dallas decision also addresses the valuation issue of how to determine the appropriate discount for lack of marketability for an S orporation equity interest. This discussion summarizes (1) the facts of the Dallas case, (2) the key valuation issues addressed by Dallas the judicial decision, and (3) the implication of the Tax Court’s published decision.

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