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Almost as Riveting as Game of Thrones...

Well, maybe that's a bit of an oversell, but certainly having a greater impact on the pocket book, the battle over how to value non-controlling interests in S Corporations appears to have been joined again.

 

The IRS recently made public a Job Aid outlining their position on this topic - they conveniently summarize their position as follows: "With respect to the attribute of pass-through taxation.....no entity level tax should be applied in determining the cash flows of an electing S Corporation." This position coincides with the position taken by the Tax Court in a series of cases dating back to the case of Gross V. Commissioner in 2001.

 

In valuing a C corporation using the income method, general valuation practice requires estimating the projected operating cash flows of the business, applying a tax burden at C corp rates and then determining the present value of these cash flows. The IRS position is that in valuing an S Corp, the same approach can be taken except that, since the S Corp does not pay taxes, the tax burden should be calculated at a rate of zero per cent.

 

The Job Aid goes on to say that from the perspective of the IRS "it is far from clear" that buyers and sellers of S Corps reduce the projected earnings stream to reflect an imputed C Corporation tax liability as they analyze their investments. In effect, the IRS position means that the same business wrapped in an S Corp could be worth as much as 40% more than the same business held within a C Corp. Many valuation analysts have resisted this position over the past 15 years and in a future e-mail, I will examine the response from the profession.