Tax-affecting Can Influence the Development of Judicial Precedent

I may have mentioned this before on this blog, but it is striking to me how many accountants and valuational professionals regard court decisions as monolithic. At NACVA chapter meetings, I have heard CPAs say that “you must do this” or “you can’t do that” because of some court decision or IRS position. But we must not forget that all court decisions are, to some extent, fact-sensitive and case-specific. The job of a lawyer as an advocate is to cite facts and cases that support one’s position and to distinguish/minimize facts and cases that do not. It is also important to realize that intermediate appellate decision carry less weight than supreme court decisions, and trial court decisions carry little or no precedential weight (except to the extent that their logic may be persuasive).

So I was pleased to read, in the latest BVWire blast email from BVResources.com, a report from the New York State Society of CPAs describing a lecture given at their 2008 Business Valuation Conference. BVWire reports:

IRS agents and auditors may tell you that the Internal Revenue Service does not have an official position on tax affecting Subchapter S corporations—but “don’t believe it,” Dan Van Vleet (Duff & Phelps) told the NYSSCPA gathering. The “official” IRS position “is to assess the reasonableness of the analysis and make a determination,” he said. The problem: The Service may presume that tax affecting is not reasonable—a position based in large part on prior Tax Court Memorandum decisions (Gross, Heck, Adams, Wall, Dallas – all are available to subscribers of BVLaw in which neither the IRS nor the taxpayer’s expert presented a good model for tax affecting the subject interests. But only one of these—Gross, which concerned an “extreme” set of facts—has been affirmed by a federal court of appeals (6th Cir.). The rest are not binding. “The current reality is that the IRS has audited—and accepted—numerous reports involving substantial matters” that Van Vleet and his colleagues have prepared using his S Corporation Economic Adjustment Model (SEAM). “If you use a model that explains [tax affecting] reasonably,” he said, “they’ll accept it.”

“I’ve never been challenged,” agreed Chris Treharne (Gibraltar Business Appraisals, Inc.), who presented his S Corp model to attendees. “If you’ve got an S Corp that’s distributing enough to cover [shareholder] tax liability, then for heaven’s sake, tax affect. If you can explain it in your report with sound economic reasoning,” he said, “you will win.” The economic issues that lie at the heart of the valuation of any pass-through entity are “absurdly simple,” said Nancy Fannon, the third expert on the topic—but they have been wrapped in “deceptively complex” models. She reminded conference attendees that her article comparing the various models—including those used by the Tax Court and the Delaware Chancery Court—is available as a Free Download at BVResources (fifth on the current list) along with her book, Fannon’s Guide to the Valuation of Subchapter S Corporations).

They are right! Many valuation professionals believe that tax-affecting is appropriate and justifiable in certain situations, and if they express their views to the lawyers who are advocating their positions, they can as a team convince factfinders and influence the development of judicial precedent. Soon we will look at the recent decision in Bernier, a marital dissolution decision arising from Massachusetts, which may not have as pervasive an influence as has been described in some reports.