Fall 2002

Facts and Circumstances Also Drive the Issue

The reason an S corporation valuation is being conducted, as well as the size and circumstances of the entity being valued, also influence the issue of how to discount earnings and whether tax-affecting is appropriate.

In Gross, for example, the interests being valued were very small (about 1 percent) and the shareholders were subject to a buy-sell agreement that prevented them from selling their interests to anyone that would jeopardize the S corporation election. This made the most likely buyer of the minority interest another individual.

Even when the entire company is being valued, the idea that the most common buyer for an S corporation is a C corporation may be less accurate for smaller entities. One factor to consider is that smaller entities with fewer shareholders are less likely than larger S corporations to run afoul of IRS limits on the number and kind of shareholders allowed.

In addition, the reason driving the valuation should be considered. If a company is being valued for sale, then the tax liability of a potential buyer is an obvious concern.

Suppose, however, that the company is being valued in order to divide marital assets in connection with a divorce. There’s no imminent change in ownership to raise many of the arguments for a tax-based discount to earnings. The appropriate treatment, however, will be based on the appropriate law and the standard of value (e.g., fair market value or investment value).

As with all valuations, the specific facts and circumstances of each case remain a vital issue. It’s important to retain a valuation professional with a thorough understanding of the practical and theoretical underpinnings of the income approach.

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The articles in this newsletter are general in nature and are not a substitute for accounting, legal, or other professional services. We assume no liability for the reader's reliance on this information. Before implementing any of the ideas contained in this publication, consult a professional advisor to determine whether they apply to your unique circumstances.

© 2002