Valuing Pass-Through Entities E-Book

Eric J. Barr

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 376

Veröffentlichungsjahr: 2014

Beschreibung

The clarity and guidance valuation analysts have been thirsting for The business appraisal community regularly names the valuation of pass-through entities as a major issue of concern. Courts, appraisers, and the IRS have long been at odds on the topic, and the contention within the appraisal community itself over methods and inputs further complicates the issue. Valuing Pass-Through Entities provides clarity for the analyst tasked with valuation, offering clear explanations of the different perspectives and approaches to the process. Valuing Pass-Through Entities cuts through the chatter to: * Explain the advantages and limitations of different types of pass-through entities * Analyze the different viewpoints currently dividing the appraisal community * Gain a fresh perspective on landmark cases * Explain how to properly utilize a court-tested model * Examine detailed sensitivity analyses of different inputs under the income and market approaches The book includes illustrative examples, templates, and a useful technical supplement, plus case studies that demonstrate the real-world effects of various pass-through entity valuation methods and inputs. Detailed analyses and an easy-to-apply model simplify the process while positively affecting outcomes. The companion website provides the text of landmark court decisions, a blog featuring industry trends and tidbits, additional articles, and the insight of the author and other industry leaders. Valuation requires the successful juggling of multiple variables, many of which can have a major impact on value. Analysts need to know how to balance each factor and apply the appropriate rates and discounts, but a lack of standard practice often leaves the issue too subjective. Valuing Pass-Through Entities clears the air, providing real-world guidelines and tools.

Leseprobe

CONTENTS

Cover

Series Page

Title Page

Copyright

Dedication

Foreword

Preface

Acknowledgments

About the Author

Chapter 1: Introduction

Definition of Value

Beauty and Value

Premise of Value

Approaches to Value

The PTE Conundrum

Chapter 2: The History of Federal Statutory Tax Rates in Maximum Income Brackets and the Evolution of Different Forms of Business Entities

Origins of the United States Internal Revenue Code

Years 1913 Through 1938

Years 1939 Through 1953

Years 1954 Through 1985

S Corporations

Tax on Unreasonable Compensation

General Utilities Doctrine

Years 1986 Through 2013

Limited Liability Companies

Summary

Chapter 3: Effective Federal Individual and Corporation Income Tax Rates

Effective Federal Income Taxes on $10,000 of 2012 CPI Adjusted Taxable Income, 1913–2013

Effective Federal Income Taxes on $100,000 of 2012 CPI Adjusted Taxable Income, 1913–2013

Effective Federal Income Taxes on $1 Million of 2012 CPI Adjusted Taxable Income, 1913–2013

Summary

Chapter 4: Comparison of Different Entity Forms

Business Life Cycle

Benefits and Limitations of PTEs

Financial Statements of C Corporations and PTEs

PTE Status and Bank Financing

Prevalence of PTEs

Change in Form of Entity

Chapter 5: Income Approach and Value to the Holder

Value to the Holder versus Value to the Buyer

Jurisdictional Issues

Delaware Open MRI Radiology Associates, P.A. v. Howard B. Kessler4

Bernier v. Bernier

Limitations OF Delaware Open MRI and Bernier

The Modified Delaware MRI Model

Flexibility of the MDMM

Chapter 6: Inputs to Modified Delaware MRI Model

Normalized Pretax Income

Entity-Level Income Taxes on Pass-Through Earnings

Income Retained in the Business

Effective Federal and State Income Tax Rates on Pass-Through Income

Dividend Tax Rates

Summary

Chapter 7: Income Approach and Investment Value

Measuring Investment Value

Deal Structure

Chapter 8: Income Approach and Fair Market Value

Characteristics of FMV

Determining FMV

Example of Failing to Consider Floor and Ceiling Values

Chapter 9: Fair Market Value Court Decisions

Number of Federal Estate and Gift Tax Returns

Gross V. Commissioner9

Estate of Heck V. Commissioner

Wall V. Commissioner

Estate of Adams V. Commissioner

Robert Dallas V. Commissioner

Gallagher V. Commissioner

Analysis of Cases

Chapter 10: The Market Approach

Revenue Ruling 59–60

Appraisal Standards Board Standards

Aicpa Statement on Standards for Valuation Services

Guideline Public Company Method

Guideline Public Company Method and PTE Value to the Holder

Guideline Public Company Method and PTE Investment Value

Guideline Public Company Method and PTE Fair Market Value

Guideline Transactions Method

Chapter 11: Individual State Income Taxes

Statutory Individual State Income Tax Rates

Effective Individual State Income Tax Rates

Chapter 12: Discounts, Premiums, Bylaws, and State Laws

PTE Agreements

State Law

Nevada Senate Bill 350

Chapter 13: Valuing Complex PTE Ownership Interests

Reasons for Complex Capital Structures

Option-Pricing Method1

Example 1: Preferred-Member Units

Example 2: Joint Venture

Example 3: S Corporation with Unreasonable Officer/Stockholder Compensation

Appendix A: Checklist

Appendix B: Case Study: Bob's Cruises

Part I: Introduction

Part II: Sam's Cruises

Part III: Valuing Sam's Cruises

Part IV: Valuing Betty's Cruises

Part V: Closing the Deal

Part VI: Looking Back

About the Website

Index

End User License Agreement

List of Tables

Table 1.1

Table 1.2

Table 2.1

Table 2.2

Table 2.3

Table 2.4

Table 2.5

Table 2.6

Table 2.7

Table 2.8

Table 2.9

Table 2.10

Table 2.11

Table 2.12

Table 2.13

Table 3.1

Table 3.2

Table 3.3

Table 4.1

Table 4.2

Table 4.3

Table 4.4

Table 5.1

Table 5.2

Table 5.3

Table 5.4

Table 5.5

Table 6.1

Table 6.2

Table 6.3

Table 6.4

Table 6.5

Table 6.6

Table 6.7

Table 6.8

Table 6.9

Table 6.10

Table 7.1

Table 7.2

Table 9.1

Table 9.2

Table 9.3

Table 10.1

Table 10.2

Table 10.3

Table 10.4

Table 10.5

Table 11.1

Table 11.2

Table 11.3

Table 13.1

Table 13.2

Table 13.3

Table 13.4

Table 13.5

Table B.1

Table B.2

Table B.3

Table B.4

Table B.5

Table B.6

Table B.7

Table B.8

Table B.9

Table B.10

Table B.11

Table B.12

Table B.13

Table B.14

Table B.15

Table B.16

List of Illustrations

Chart 2.1

Chart 2.2

Chart 2.3

Chart 2.4

Chart 2.5

Chart 2.6

Chart 2.7

Chart 2.8

Chart 3.1

Chart 3.2

Chart 3.3

Chart 3.4

Chart 3.5

Chart 3.6

Chart 3.7

Chart 3.8

Chart 3.9

Chart 8.1

Guide

Cover

Table of Contents

Begin Reading

Chapter 1

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Valuing Pass-Through Entities

Eric J. Barr

Cover design: Wiley

Copyright © 2014 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Barr, Eric J., author.

Valuing pass-through entities / Eric J. Barr.

pages cm

Includes index.

ISBN 978-1-118-84866-1 (cloth); ISBN 978-1-118-84861-6 (epub); ISBN 978-1-118-84868-5 (ePDF); ISBN 978-1-118-93669-6 (obook)

1. Business enterprises—Taxation--Law and legislation—United States. 2. Business enterprises—Valuation—United States. 3. Tax assessment—Law and legislation—United States. 4. Valuation—Law and legislation—United States. 5. Income tax—Law and legislation—United States. I. Title.

KF6450.B37 2014

343.7306′8—dc23

2014022326

Dedication

This book is dedicated to my wife, Linda; my children, Aimee, David, and Lori; and my granddaughter, Brooke, who fill me with inspiration, magic, and love.

Foreword

Pass-through entities have been an enigma to many valuation professionals over the years. Experts from Nancy Fannon to Chris Treharne to Dave Dufendach have all written extensively on pass-through entities, and specifically, S corporations. In this book, Eric Barr takes the handling of pass-through entities to new heights. Starting with the first chapter and continuing on to the last, Eric takes the reader through the byzantine nuances of valuing pass-through entities.

Valuation can be a daunting undertaking, akin to a paint-by-number picture without the numbers. In the introductory chapter, Eric lays the foundation by covering the basic building blocks of valuation. But unlike other valuation treatises, Valuing Pass-Through Entities provides a succinct, yet comprehensive overview of valuation fundamentals before tackling the often-thorny issue of valuing pass-through entities. And even more refreshing is Eric's weaving in the historical perspective that has given rise to these unique business structures, and how that historical perspective has changed over time. Like many endeavors, the original purpose for which pass-through entities were created has long since been forgotten. But understanding the genesis of pass-through entities provides a rich fabric from which the valuation professional can create a more understandable, and accurate, pass-through entity valuation. Eric's book provides the tools that allow for such a rich understanding.

And don't let me forget the deep technical construct that Eric builds throughout his book. Drawing upon his 40 years of experience, Eric provides a practical, well-reasoned journey through the pass-through entity landscape. From insights on the federal tax structure to changes in individual income tax rates, Eric explores rational business behavior and how such behavior is influenced by the overall tax system. Not being content with mere observations, Eric then provides a framework and structure that allow the valuation professional to address what he terms the PTE conundrum.

The practical side of Eric's book can be found in the many checklists and illustrations that accompany the narrative portions of each chapter. The examples are easy to follow, intuitive, and rational. And because there are so many permutations in the PTE conundrum, there are a lot of examples. Think about fair market value, fair value, investment value, and strategic value when combined with a merger or acquisition, estate or gift tax valuation, or in a divorce setting, and the number of permutations gets enormous. Although there isn't an example for every conceivable permutation, there are plenty of examples that will make you think through the process in a much more organized way.

Eric is the first valuation expert to attempt to solve the PTE conundrum, and he probably won't be the last. However, Eric's contribution to the body of knowledge goes a long way toward bringing the disparate approaches, and often contrary views, together in an easy to read and understandable book. So grab a cup of coffee, a valuation report, and Eric's book for a good read about the PTE conundrum.

—Neil J. Beaton

Managing Director

Alvarez & Marsal Valuation Services

Seattle, Washington

Preface

I have addressed many complex accounting, valuation, and forensic issues during my approximately 40-year career. In my work, with only one notable exception, I have generally found a consensus in technical literature, the industry, or expert opinions on the proper way to handle an issue. That notable exception is how or even whether one should tax-affect the earnings of a partnership, S corporation, limited liability company, or sole proprietorship (collectively, pass-through entities, or PTEs) when valuing such business ownership interests. I call this the PTE conundrum.

There have been many qualified, experienced professionals who have analyzed the PTE conundrum. It is a topic that has been the subject of articles and books. It has been contested in numerous litigations, in different courts, with varying facts and circumstances. In my opinion, there has been no lack of attention to this issue—only a lack of consensus and clarity.

I decided to take on this issue and started reading many court decisions, articles, and so on. Then I experimented with different Excel models, trying to develop a simple and understandable model that could properly address the different relevant possibilities that a potential buyer/seller would face when buying/selling an ownership interest in a PTE as compared with buying/selling an ownership interest in a C corporation. In time, my model evolved into something that I thought was practical, thorough, and worthy of consideration by the valuation community and users of our work, such as lawyers, judges, and purchasers of PTEs.

Tommy Lasorda, the former manager of the Los Angeles Dodgers, has said that there are players who make things happen, there are players who watch things happen, and there are players who wonder what happened. In certain respects, valuation analysts are the same as the players described by Mr. Lasorda. Since I had developed deep convictions on how to address the PTE conundrum, I decided I could no longer sit on the sidelines and watch things happen. I needed to get on the field and make things happen. It's safe on the sidelines, but it's much more fun being on the field of play.

My challenge was how to effectively communicate my findings, which were too long for a series of articles. The solution was this book. What follows is a discussion of the reasons for operating a business in the form of a PTE, how the appraisal community has tried to address the PTE conundrum, my proposed solution, and a detailed sensitivity analysis of each of the factors potentially impacting the valuation of PTEs under different facts and circumstances. I have always found it effective to communicate a message through a story, so I've also illustrated my solution to the PTE conundrum in a case study through the eyes of the parties to a hypothetical transaction. Since most interesting stories are told with some degree of emotion or humor, I tried to include both. Bob and all of the characters have a compulsive “get it right” attitude, a healthy skepticism, and patience—attributes that are useful when trying to value or purchase/sell a business.

The analyses contained in the following pages are based on 2013 federal income tax laws. Although we can say with certainty that such laws will change over time and that the calculations contained herein are subject to modification, the theories underlying the calculations will still hold true.

Please enjoy my contribution to the PTE conundrum discussion.

Acknowledgments

This book includes the thoughtful input of exceptionally talented professionals who generously contributed their time and expertise. My sincere and deep appreciation to Ashok Abbott, John E. Barrett Jr., Neil J. Beaton, Jay A. Soled, and Steven A. Loeb for their important contributions to the business valuation and income tax chapters. Also, a special thank-you to Sheila V. Sybrant, editor extraordinaire. To this list I add Sheck Cho, Lia Ottaviano, and all of their colleagues at John Wiley & Sons, who were easy to work with and polished my work into the text you have before you.

Writing a book was quite an undertaking and a remarkable learning experience. At times exhilarating, at times eye-opening, it was never boring or a grind. Of course it took longer than expected, therefore requiring the understanding, encouragement, and support of my partners, which I enthusiastically received from my firm's cofounders, O. David Fischer and Spencer V. Wissinger. Monica Kaden, a very experienced and respected colleague, was always there as a sounding board and provided focus and clarity. I thank each of you.

Over the course of my career, I have been fortunate to work with colleagues who contributed to my development as a professional advisor and critical thinker. So it is with deep appreciation that I acknowledge and thank Ronald G. Weiner, Ted M. Felix, Joseph P. Cipolla Jr., and Barry S. Sziklay.

As a baby boomer born to Depression-era parents, I was the first in my immediate family to attend college and learn a profession. My parents, Harold and June Barr, always stressed the importance of education, integrity, and hard work. I am the person I am today because of my parents, and it is with great pleasure and love that I publicly recognize and thank both of you.

My greatest source of inspiration and support is my wife, Linda. As a fourth-grade teacher, her frequent admonition to “show, don't tell” still reverberates. Make it simple, package your message in a story, and make it the type of text that you would want to read—all key messages—were the touchstones of my communication style. Her ever-present encouragement, love, and faith in me enabled me to see this project through to its completion. Thank you.

About the Author

Eric J. Barr is a founder and comanaging member of Fischer Barr & Wissinger LLC in Parsippany, New Jersey. He is a certified public accountant, accredited in business valuation and certified in financial forensics (all designations of the American Institute of Certified Public Accountants); a certified valuation analyst (a designation of the National Association of Certified Valuation Analysts [NACVA]); and a certified fraud examiner (a designation of the Association of Certified Fraud Examiners [ACFE]).

Mr. Barr has more than 40 years of public accounting experience specializing in litigation support, consulting, and traditional accounting and auditing services. He provides consulting and expert witness services in connection with the valuation of control and minority business interests, matrimonial dissolutions, shareholder/member disputes, estate/gift planning, mergers/acquisitions/disposals, purchase price allocations, and employee stock issuances. He has performed investigations to determine the amount of lost profits, fraud, marital lifestyle, and equitable distribution.

Mr. Barr is called upon to speak at seminars, conferences, and webinars of various professional groups. He has been published in the Wall Street Journal (online edition), the CPA Journal, the Value Examiner, and Business Valuation Update. He is a member of the editorial board of the Value Examiner.

He received his BS in accounting at the State University of New York at Buffalo.

Chapter 1Introduction

In our daily lives we have come to expect—even demand—comfort, convenience, and choice. When we desire entertainment, we click on the remote and at our fingertips are hours of television viewing. When we want to speak with someone, we take out our portable telephone and dial the number, and we are instantly in conversation with someone who may be far away. We can change the climate in our home from hot to cold and back to hot simply by moving a dial. We can access encyclopedias with a few computer keystrokes. There is fast food, ethnic food, gluten-free food, carbohydrate-free food, fat-free food, and so on. Never before has so much been available so quickly to so many people.