Insights



Autumn 2014


insights journal cover

Focus on Health Care Valuation Insights


Editor for This Issue: Fady F. Bebawy

Gift Tax, Estate Tax, and Generation-Skipping Tax Valuation Insights
Fady F. Bebawy
This introductory discussion summarizes all of the discussions presented in this autumn 2014 issue of Insights. The discussions cover the intergenerational wealth transfer management continuum. The discussions are prepared and presented by a mix of (1) trust and estate attorneys covering various topical legal issues and (2) business valuation analysts and financial advisers from Willamette Management Associates covering aspects of the judicial process and a number of topical valuation issues. These valuation issues affect just about every valuation analysis (1) attached to a federal gift tax and estate tax return or (2) challenged by the Internal Revenue Service (the “Service”). Such valuation issues are commonly the subject of dispute in cases that go before the federal courts.

Gift and Estate Tax Planning Insights

Important Considerations in Intra-Family Loans
Michael L. Van Cise, Esq., and Kathryn Baldwin Hecker, Esq.
Intra-family loans can be an effective estate planning tool in a variety of circumstances. Practitioners need to be aware of both federal tax law requirements and state law requirements when structuring an intra-family loan.

Thought Leadership:
Digital Assets in Estate Administration: Concerns and Considerations for Fiduciaries
Glen Goland, Esq.
Estate fiduciaries increasingly encounter “digital assets” in estate administrations. Digital assets are electronically stored information, which may have sentimental value (such as photo files), monetary value (such as a blog that generates advertising revenue), or both. For estates with digital assets, fiduciaries should properly value such assets and report the values to the Service and in the probate filings. But the unique characteristics of digital assets—including that many are subject to the terms and conditions of terms of service agreements—create challenges in accounting for this new category of assets. Fiduciaries are also subject to potential liability for attempting to gain access to a decedent’s digital accounts and property. The federal anti-hacking laws contained in the Computer Fraud and Abuse Act (as well as individual state’s anti-hacking laws) and the federal privacy protection laws contained in the Stored Communications Act create obstacles for fiduciary access. For example, fiduciary use of a decedent’s password to access an e-mail account may expose the fiduciary to both civil and criminal liability. Despite these challenges, certain steps taken during a person’s life can ease the transfer of digital assets at death.

Guide to Intangible Asset Valuation by Robert F. Reilly and Robert P. Schweihs
Roger J. Grabowski
When I first opened the book, the scope of the book as shown in the table of contents immediately brought back memories of the numerous intangible asset valuations that I have had the opportunity to prepare over my nearly 40 years in the valuation profession.

The Perils and Prospects of Portability
Jeffrey M. Cheyne, Esq.
With the passage of federal tax relief laws in recent years, the porting of unused federal estate tax exemptions has proven to be an important federal estate tax saving strategy, especially among individuals who have accumulated substantial wealth. This discussion considers the changing legal landscape, requirements for federal portability elections, the status of portability under state law, complications with portability. This discussion also presents some helpful practitioner guidance and tips.

Judicial Guidance Insights

The U.S. Tax Court Process: Practical Guidance for Valuation Analysts
Samuel S. Nicholls
After a determination of deficiency by the Internal Revenue Service, a valuation analyst may be engaged and called upon as an expert witness to submit direct testimony to the U.S. Tax Court. Direct testimony often consists entirely of the written report. It is on cross-examination, redirect examination, and rebuttal testimony that the expert witness is challenged to demonstrate oral and cognitive abilities that are a bit different from routine professional endeavors. Legal counsel often have difficulty finding a suitably experienced, even-keeled, and apt testifying expert.

Tax Court Guidance Regarding Petitioner and IRS Valuation Analysts— Understanding What to Do and What Not to Do When Valuing a Closely Held Business within the Gift, Estate, and Generation-Skipping Tax Context
Stephen P. Halligan and Michael A. Harter
The U.S. Tax Court regularly provides guidance as to appropriate petitioner valuation analyst and Internal Revenue Service (the “Service”) valuation analyst analysis, specifically as it relates to valuing closely held businesses within the federal gift tax and federal estate tax context. Understanding why the Tax Court views certain analyses and reports more favorably than others is crucial when conducting a closely held business valuation for gift, estate, and generation-skipping tax purposes. This discussion (1) summarizes the valuation analyst’s role within the gift and estate tax context, (2) highlights several recent court decisions related to the valuation analyst’s role within the gift, estate, and generationskipping tax context, and (3) provides insights into the court’s expectations as they relate to petitioner valuation analyst and Service valuation analyst opinions.

Valuation Analysis Insights

The Treatment of Management Projections That Require Analyst Input
Kevin P. Carey
Management-prepared financial statement projections are an important component of the income approach to business valuation, specifically the discounted cash flow valuation method. And, the discounted cash flow valuation method is frequently used and assigned material weighting in the business valuation performed for gift tax, estate tax, and generation-skipping tax purposes. This discussion considers how to approach managementprepared projections when the valuation analyst considers them to be of low quality—or not reflective of the subject company’s true risk profile.

Valuation of Licenses and Permits
Robert F. Reilly, CPA
Valuation analysts are often called on to perform valuations of the licenses and permits category of intangible assets for various gift, estate, and generation-skipping tax purposes. This discussion describes the different types of licenses and permits, summarizes the applicable generally accepted intangible asset valuation approaches and methods, and reviews the factors that valuation analysts generally consider in the intangible asset valuation. In addition, this discussion presents a simple illustrative example of a license and permit valuation analysis.

Best Practices
Considerations in Applying Multilevel Discounts to Tiered Entities
Weston C. Kirk
Multilevel valuation discounts applied to multitiered entity ownership interests are often subject to dispute. Complex ownership interests considered as part of a gift, estate, or generation-skipping tax valuation may involve multitiered ownership interests. Therefore, the valuation of these tiered ownership interests may incorporate multilevel valuation discounts for (1) lack of control, (2) lack of marketability, (3) lack of voting rights, and/ or (4) other valuation adjustments (e.g., market absorption). The valuation of multitiered interests should take into consideration many factors, including, but not limited to, (1) prior court decisions involving the transfer of multitiered ownership interests, (2) the standard of value and the purpose of the analysis, (3) the level of value of the ownership interest being valued at each tier, (4) the risks associated with the assets held by the tiered entity, (5) the risks associated with the contractual restrictions of tiered ownership interests, (6) the avoidance of double discounting, and (7) the overall reasonableness of the discounts applied to reach the value conclusion of the subject interest. These considerations should be made during the valuation analysis to develop reasonable support for the valuation conclusion and, thus, the value at which the subject interest may be exchanged.

Fair Market Value and Blockage Discounts: When the Market Doesn’t Give You the Answer
Charles A. Wilhoite, CPA, and Aaron M. Rotkowski The fair market value of publicly traded stock is often a controversial issue in valuations performed for gift tax, estate tax, or generation-skipping tax purposes. This controversy occurs when the ownership interest of publicly traded stock is restricted, or when the subject block of stock is so large relative to the stock’s daily trading volume that it cannot be sold in open market transactions at the quoted trading prices without exerting negative price pressure on the stock. The difference between (1) the value of the block of stock based on the quoted stock price and (2) the fair market value of the subject block of stock—that is, the blockage discount—is the subject of this discussion.

Regression Analysis and the Discount for Lack of Marketability
Nathan P. Novak
This discussion considers the use of regression analyses for purposes of estimating a discount for lack of marketability within a valuation analysis. This discussion focuses on two published studies, which each employ a regression analysis. The first study is entitled “Firm Value and Marketability Discounts” by Mukesh Bajaj, David J. Denis, Stephen P. Ferris, and Atulya Sarin, which is referred to here as the “Bajaj Study.” The second study is entitled “Market Discounts and Shareholder Gains for Placing Equity Privately” by Michael Hertzel and Richard L. Smith, which is referred to here as the “Hertzel and Smith Study.” Collectively, the above studies are referred to as the “Private Placement Studies.”

Willamette Management Associates Insights

Willamette Management Associates Presents 2013 Standard of Excellence and Best Practices Literary Awards
Charlene M. Blalock
Each year the Insights editorial board presents one or more literary awards to Insights authors who are not associated with Willamette Management Associates. The editorial board has presented three awards this year. The first literary award—the Thought Leadership Award—was discussed in the last Insights issue. In this discussion, we present the Standard of Excellence Award and the Best Practices Award.

Communiqué