How the IRS Values Non-Controlling Interests in S Corps

with Job Aid Commentary by the Original IRS Issue

Champion

The IRS has a new Job Aid entitled Valuation of Non-Controlling Interests in Business Entities

Electing to be Treated as S Corporations for Federal Tax Purposes, a Job Aid for IRS Valuation

Analysts. This and the Job Aid on Reasonable Compensation were acquired via a lengthy Freedom

Of Information (FOIA) Request, and are shared with you with a new book and the companion

Reasonable Compensation book. These Job Aids have not been released to the general public at this

time. Michael Gregory was the original issue champion of these Job Aids at the IRS. In this new

book, after providing you in depth background in Part One, Part two presents the entire Job Aid on the

right with side by side commentary on the left tying in Part One commentary and offering you further

insights into the document.

The IRS Job Aid on Valuing Non-Controlling Interests in S Corps

The Valuation of Non-Controlling in S Corps Job Aid presents the IRS perspective on this issue. The

Table of Contents of the 32 page Job Aid are:

TABLE OF CONTENTS

Executive Summary

Discussion and Analysis

Introduction

Identification of the Property to be Valued

Valuation Background and Approach

Additional Factors for Consideration

Public Market Data C Corporations

Shareholder Agreements

Appropriate Tax Rates

The Universe of Hypothetical Buyers

The Hypothetical Seller

The Hypothetical Sale

Identifying the Most Important Factors

Evidence Based Valuation Analysis

A View from the Tax Court

A View from Academia

Theory-Based Valuation Analysis

Weighting of Factors and Approaches

Assessment and Synthesis

Setting a Framework for Evaluation

Example 1 The Tax Status of the Electing S Corporation

Example 2 Cost of Capital and Lack of Marketability

Summary

Appendices

A Revenue Ruling 59-60

B A View from the U.S. Tax Court

C A view from the Academic Community

Some Further Thoughts on Valuing Non-Controlling Interests in S Corps

S Corp valuations are often an area of contention between business appraisers and the IRS.

Prior to the Gross case (U.S. Tax Court Memorandum 199-254) appraisers automatically tax

affected an S Corp the same way they valued C-Corps. Six court cases later, the decisions still

state:

We do not, however, think it is reasonable to tax affect an S corporation's projected earnings with an undiscounted corporate tax rate without facts or circumstances sufficient to establish the likelihood that the election would be lost.

With the facts provided none of the cases (Gross, Gross on Appeal, Wall, Heck, Adams, Dallas, Gallagher) provided have overcome this hurdle. The IRS decides which cases go to court and thus decides which cases present the best facts to sustain the IRS position. Today there are practitioners and business appraisers that believe this is a factual issue and those that believe this is a legal issue. For the business appraiser that elects to tax affect this is the high hurdle that needs to be overcome. Michael A. Gregoryi critiqued this process and offers business appraisers alternatives to consider when faced with how to value a Subchapter S Corporation and includes this as a chapter in his book, Business Appraisers and the IRSii and as a separate book in his book Valuing Interests in S-Corpsiii.

Given this as background there are five models being promoted today. The authors of these models are

Fannon-Sellers, Grabowski, Mercer, Treharne and Van Vleet. The IRS also appears to be looking at the

decision of MRI Radiology Associates from the Delaware Chanceryiv and would like to potentially litigate

on this matter. There is also a new book written by Nancy Fannon and Keith Sellers entitled Taxes and

Value: The Ongoing Research and Analysis Relating to the S Corporation Valuation Puzzle from BV

Resources that is sure to have a significant impact. It was Michael Gregorys pleasure to serve as one of

the reviewers of that book. Critiquing the methods and having championed the IRS internal S-Corp

valuation paper Michael Gregory recommends that business appraisers use the Treharne model and the

application of additional specific company risk and a higher equity risk premium for S-Corps (from the

work by Fannon and Sellers) as two approaches that can be reconciled for an S-Corp valuation.

The Treharne model considers a premium for an S-Corp valuation consistent with the work done at the

University of Chicago by Merle Ericksonv and then tax affecting. This may not be acceptable to some at

the IRS. If that is a concern the application of a higher equity risk premium and a higher company

specific risk without tax affecting may provide a similar valuation. These two methods can be

reconciled and a valuation can be determined that meets both the IRS Estate and Gift tax attorneys

perspective and resolves the matter in a reasonable manner with the taxpayer. It is not clear that tax

affecting is a legal matter, but there are those at the IRS that have that perspective.

These concepts prior to the release of the IRS Job Aid are presented and elaborated on in Mikes video with practical commentary to help you explore how you can address the valuation of an S-Corp for IRS purposes . Access to this video, which also offers 1.5 hours of CPE credit, is available through the KS Society of CPAs web site. i Michael Gregory worked for the IRS for 28 years as a specialist through executive level. In 2011 he founded Michael Gregory Consulting, LLC. His web page is www.mikegreg.com offering his 13 videos and 9 books. He can be reached at 651-633-5311 and at mg@mikegreg.com. Michael Gregory Consulting 2015 ii http://www.mikegreg.com/business-appraisals-and-irs iii http://www.mikegreg.com/valuing-interests-s-corporations iv Delaware Open MRI Radiology Associates v. Kessler, C.A. No. 275-N, April 26, 2006 v http://www.extendedarticle.com/Newsletters/MAA/2009/MAAspr09/4Tax.html