to this belief when they merely split the difference between appraisals and do not make the ef- fort to arrive at precise values. If valuation is nothing more than a good guess, there is nothing to prevent appraisers from providing lawyers or clients whatever appraisal they need to justify their transaction. After all, who can dispute that the guess is not legitimate? Although it is true that the valuation of a business involves using common sense to make sound judgments, valuation is not merely a guess as to value. Certainly, valuation is a judg- ment; but it is a studied judgment, and should be withheld by ethical business appraisers until all reasonable and relevant facts are analyzed in the context of established financial and ap- praisal principles. To discourage mere valuation guesses, and to deter those who would perform a valuation with the purpose of accommodating a client who needs a certain result, the tax law has a series of penalties, nondeductible from taxes, that apply to valuations done for tax purposes. These penalties are designed to inhibit over- and undervaluations, as well as negligent or fraudulent valuations. Penalties are important to both the Service and the taxpayer. To the Service, penalties are a meaningful deterrent against abusive valuation misstatement. To taxpayers, penalties are real dollars that they would not pay the government but for a valuation misstatement. If a taxpayer underpays taxes as a result of a substantial valuation misstatement, the Ser- vice can collect three types of monetary remedies: the actual back taxes owed, interest on the amount owed, and penalties. Excluding potential criminal liability, in business terms the first two remedies would be analogous to repaying a loan—the taxpayer repays the principal, plus the interest that she denied the government. Penalties are how the Service financially discour- ages underpayment of taxes, and they are far from trivial. 1 For the aggressive taxpayer assessed with a deficiency due to a valuation misstatement, this multitude of penalties can add up to significant amounts of money. The statutory penalty expressly designed for valuation cases is in two subsections within Code section 6662, but other penalties may be applied by the Service in special cases. WHAT YOU NEED TO KNOW Five sections in the Internal Revenue Code provide for penalties that may be applied in cases of valuation misstatement. To avoid confusion, remember that some sections contain multiple penalties. For instance, section 6662 contains both valuation and general penalties. For this reason, it is highly recom- mended that you read I.R.C. §§ 6662, 6663, 6700(a)(2)(B), 6701, and 6673 before reading the rest of the chapter. 64 PENALTIES AND SANCTIONS 1 Additions to tax under sections 6651(a)(1) (failure to file a tax return) and 6651(a)(2) (failure to pay taxes) are not penalties and are not discussed in this chapter. They are, however, another way in which the Service may penalize certain valuation misstatements. See, e.g., Estate of Young v. Comm’r, 110 T.C. 297 (1998) and Estate of Campbell v. Comm’r, T.C. Memo 1991-615. VALUATION PENALTIES The penalty directly applicable to valuation misstatement is contained in Code sections 6662(b)(3) and (b)(5). Generally, where a taxpayer “substantially” misstates value for income or estate tax purposes, she will be liable for a penalty equal to 20 percent of the resulting un- derpayment, after the back taxes are paid with interest. Section 6662: Imposition of Accuracy-Related Penalty provides in relevant part: (a) Imposition of Penalty. If this section applies to any portion of an underpayment of tax required to be shown on a return, there shall be added to the tax an amount equal to 20 percent of the portion of the under- payment to which this section applies. (b) Portion of Underpayment to Which Section Applies. This section shall apply to the portion of any un- derpayment which is attributable to one or more of the following: (1) Negligence or disregard of rules or regulations. (2) Any substantial understatement of income tax. (3) Any substantial valuation misstatement under chapter 1. (4) Any substantial overstatement of pension liabilities. (5) Any substantial estate or gift tax valuation understatement. . . . (e) Substantial valuation misstatement under chapter 1. (1) In general. For purposes of this section, there is a substantial valuation misstatement under chapter 1 if— (A) the value of any property (or the adjusted basis of any property) claimed on any return of tax imposed by chapter l is 200 percent or more of the amount determined to be the correct amount of such valuation or ad- justed basis (as the case may be), or (B) (i) the price for any property or services (or for the use of property) claimed on any such return in con- nection with any transaction between persons described in section 482 is 200 percent or more (or 50 percent or less) of the amount determined under section 482 to be the correct amount of such price, or (ii) the net section 482 transfer price adjustment for the taxable year exceeds the lesser of $5,000,000 or 10 percent of the taxpayer’s gross receipts. (2) Limitation. No penalty shall be imposed by reason of subsection (b)(3) unless the portion of the under- payment for the taxable year attributable to substantial valuation misstatements under chapter 1 exceeds $5,000 ($10,000 in the case of a corporation other than an S corporation or a personal holding company (as defined in section 542)). . . . (g) Substantial estate or gift tax valuation understatement. (1) In general. For purposes of this section, there is a substantial estate or gift tax valuation understatement if the value of any property claimed on any return of tax imposed by subtitle B is 50 percent or less of the amount determined to be the correct amount of such valuation. (2) Limitation. No penalty shall be imposed by reason of subsection (b)(5) unless the portion of the under- payment attributable to substantial estate or gift tax valuation understatements for the taxable period (or, in the case of the tax imposed by chapter 11, with respect to the estate of the decedent) exceeds $5,000. Valuation Penalties 65 Key aspects of section 6662 include: • The penalty for any violation of the section is 20 percent of the underpayment—not the misstatement, but the amount by which taxes were underpaid. • The penalty applies for both income and transfer taxes. In other words, you cannot escape the penalty by moving from the income to the transfer tax regime. • No penalty will be imposed for overstating property values for income-tax purposes unless the overstatement is 200 percent of the correct value. • No penalty will be imposed for understating property values for transfer tax purposes un- less the understatement is 50 percent of the correct value and the resulting underpayment exceeds $5,000. Consider a routine court case involving a valuation penalty. In Estate of Reiner v. Com- missioner, 2 the court had to decide whether the estate is liable for an addition to tax under sec- tion 6662(a) for a substantial estate or gift tax valuation understatement. The Reiner family owned a 7,200-square-foot strip mall in Dubuque, Iowa, selling con- sumer electronics. At the time of his death, the father owned 22,100 private shares of the com- pany, which the estate reported as worth $33.02 each. After lengthy analysis, the court found the fair market value of those shares to equal $952,000, for a price per share of $43.08. The estate reported the shares as worth $33.02 per share. The Commissioner sought to impose a penalty under section 6662(b)(5). The court stated: [The Commissioner] also determined that the estate was liable for an addition to tax under section 6662(a), which imposes a 20-percent addition for certain underpayments of tax. The addition is imposed where there is an underpayment of estate tax resulting from a substantial estate tax valuation understatement. See sec. 6662(b)(5). A substantial tax estate valuation understatement occurs if the value of any property claimed on an estate tax return is 50 percent or less of the amount determined to be correct. See sec. 6662(g)(1). In the instant case, the estate reported Reiner’s stock on its return as having a value of $33.02 per share. As we have found that the correct value is $43.08 per share, no substantial estate or gift tax valuation understate- ment has occurred. Given our conclusion, we need not address whether the estate qualifies for the reason- able cause exception contained in section 6664(c)(1). As this case reflects, application of valuation penalties is fairly mechanical. The court merely compares the amount of the value claimed by the taxpayer with what it determines is the (correct) fair market value. Within these doctrinal confines, however, is an enormous un- certainty for the taxpayer: What will the court determine fair market value to be? Without be- ing able to predict what measure of value the court will use or how it will apply the measure used, the taxpayer cannot be certain whether he or she will face penalties if the Service as- sesses a deficiency. Section 6662 “shall” apply in the case of underpayment due to substantial misstatement of value. Section 6664(c) provides for a reasonable cause and/or good faith exception to section 6662, but this requires the taxpayer to establish that she either had reasonable cause to believe the valuation was reasonable, or that she acted in good faith. Neither of these is easy to estab- 66 PENALTIES AND SANCTIONS 2 T.C. Memo 2000-298, 80 T.C.M. (CCH) 401, T.C.M. (RIA) 54054. lish, given the uncertain nature of valuation, but having a recognized valuation expert (and preferably several of them) value the property using several different valuation techniques will strengthen the taxpayer’s argument. 3 There is another clause in section 6662(d)(2)(B), which waives the penalty where the un- derpayment was due to: (a) items supportable with “substantial authority,” or (b) items that are “adequately disclosed” on the return. However, neither of these exceptions is available where the underpayment was the result of investment in a tax shelter. Since many valuation cases arise from use of tax shelters, section 6662(d)(2)(B) may be of limited usefulness. Whether the taxpayer faces the stiff 20 percent penalty will thus hinge largely on what the fair market value of the property is determined to be. As we have repeatedly noted, determin- ing fair market value is a factual matter about which there may be a difference of opinion. GENERAL PENALTIES General penalties are applicable to all cases, but can be, and often are, applied to valuation cases. There are four relevant general penalties: 1. Negligence—section 6662(b)(1) 2. Fraud—section 6663 3. Promoting abusive shelters by making, or encouraging another to make, a gross valuation overstatement—section 6700(a)(2)(B) 4. Aiding and abetting understatement of tax liability—section 6701 We will discuss only the negligence and fraud penalties, as they are the most likely to be applied in a valuation case. Negligence Consider section 6662(c): (c) Negligence. For purposes of this section, the term negligence includes any failure to make a reasonable attempt to comply with the provisions of this title, and the term disregard includes any careless, reckless, or intentional disregard. The statute states: “failure to make a reasonable attempt to comply.” If one thinks of lev- els of neglect on a continuum, careless disregard is the least egregious and is typified by just being sloppy. Reckless disregard is the next level of misbehavior and may include things like not observing the tax law at all. Intentional disregard is the highest form of negligence and may occur where one read and understood the law, but did not follow the law. General Penalties 67 3 There is, however, no guarantee the court will accept either the taxpayer’s or government’s experts. See, e.g., Pul- sar Components v. Comm’r, T.C. Memo 1996-129, 71 T.C.M. (CCH) 2436 (1996) (dismissing the taxpayer’s ex- pert as “unconvincing” and having “difficulty” accepting the government’s expert, the court concluded, “we are not persuaded by either of the experts,” and proceeded to conduct its own valuation.) Where a taxpayer is justified in relying on a tax advisor and continues to monitor the sta- tus of an investment, he or she may not be liable for the negligence penalty. Negligence penal- ties are not excused where the taxpayer’s reliance on another was unjustified. Fraud Imposition of Fraud Penalty is rarely applicable to valuation cases. It is applied, as the name would suggest, to cases of willful abuse, and the penalties are stiff. Section 6663 states: (a) IMPOSITION OF PENALTY. If any part of any underpayment of tax required to be shown on the re- turn is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the un- derpayment which is attributable to fraud. (b) DETERMINATION OF PORTION ATTRIBUTABLE TO FRAUD. If the Secretary establishes that any portion of an underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud, except with respect to any portion of the underpayment which the taxpayer establishes (by a pre- ponderance of the evidence) is not attributable to fraud. DISCRETIONARY SANCTIONS Discretionary sanctions are those that may be awarded against taxpayers when a court feels they are justified. Under section 6673, discretionary sanctions may be awarded in one of three instances: when the court feels the taxpayer (1) is litigating the case solely for delay, (2) is tak- ing a frivolous position, or (3) unreasonably failed to pursue administrative remedies. Section 6673 provides: (a) Tax court proceedings. (1) Procedures instituted primarily for delay, etc. Whenever it appears to the Tax Court that— (A) proceedings before it have been instituted or maintained by the taxpayer primarily for delay, (B) the tax- payer’s position in such proceeding is frivolous or groundless, or (C) the taxpayer unreasonably failed to pursue available administrative remedies, the Tax Court, in its decision, may require the taxpayer to pay to the United States a penalty not in excess of $ 25,000. (2) Counsel’s liability for excessive costs. Whenever it appears to the Tax Court that any attorney or other person admitted to practice before the Tax Court has multiplied the proceedings in any case unreasonably and vexatiously, the Tax Court may require— (A) that such attorney or other person pay personally the excess costs, expenses, and attorneys’ fees reason- ably incurred because of such conduct, or (B) if such attorney is appearing on behalf of the Commissioner of Internal Revenue, that the United States pay such excess costs, expenses, and attorneys’ fees in the same manner as such an award by a district court. (b) Proceedings in other courts. (1) Claims under section 7433. Whenever it appears to the court that the taxpayer’s position in the proceed- ings before the court instituted or maintained by such taxpayer under section 7433 is frivolous or ground- less, the court may require the taxpayer to pay to the United States a penalty not in excess of $ 10,000. (2) Collection of sanctions and costs. In any civil proceeding before any court (other than the Tax Court) which 68 PENALTIES AND SANCTIONS is brought by or against the United States in connection with the determination, collection, or refund of any tax, interest, or penalty under this title, any monetary sanctions, penalties, or costs awarded by the court to the United States may be assessed by the Secretary and, upon notice and demand, may be collected in the same manner as a tax. (3) Sanctions and costs awarded by a court of appeals. In connection with any appeal from a proceeding in the Tax Court or a civil proceeding described in paragraph (2), an order of a United States Court of Appeals or the Supreme Court awarding monetary sanctions, penalties or court costs to the United States may be registered in a district court upon filing a certified copy of such order and shall be en- forceable as other district court judgments. Any such sanctions, penalties, or costs may be assessed by the Secretary and, upon notice and demand, may be collected in the same manner as a tax. Discretionary Sanctions 69 Chapter 7 Valuation and Choice of Entity Summary Introduction Corporations Limited Liability Companies General Partnerships Limited Partnerships Sole Proprietorships Valuation Considerations Choice of Jurisdiction Conclusion SUMMARY This chapter explores five different types of business entities and then examines some of their unique characteristics to see what relationship, if any, these varying characteristics may have with valuation. The five types of entities considered are: 1. Corporations 2. Limited liability companies 3. Partnerships 4. Limited partnerships 5. Sole proprietorships Corporations (C or S corporations) are distinguished by their centralized management, difficulty of formation, limited liability for owners, perpetual existence, centralized manage- ment, and free transferability of ownership. Their primary disadvantages are cost of formation and, for C corporations, double taxation, with income being taxed when earned by the corpo- ration and when distributed to shareholders. Limited liability companies (LLCs) share many corporate attributes, including limited lia- bility. LLC members may participate in management (if accorded that right) without destroy- ing limited liability. Unlike corporations, however, they are not taxed twice on their earnings; all earnings pass through to the owners. 70 Partnerships can exist any time two or more people or entities act in a joint activity for profit. They are easily formed and permit each partner full participation in the business. How- ever, they impose unlimited joint and several liability on each partner, allowing creditors to come after the partners’ personal assets to satisfy partnership debts. They also have a limited life, terminating, in the case of a two-member partnership, on the death of either partner. Limited partnerships (LPs) are similar to LLCs in many ways, affording limited liability to limited partners and pass-through tax treatment to all partners. LPs differ in several impor- tant ways, however. First, there must be a general partner in an LP who takes unlimited liabil- ity for the LPs debts, unlike an LLC. Second, unlike LLC members, limited partners must not participate in management of the LP or they may be treated as a general partner and lose lim- ited liability. Sole proprietorships exist whenever one person engages in business. They are limited in duration to the life of the proprietor, who has unlimited liability. Some of these inherent differences among the entities can lead to significant differences in value when exploited by sophisticated tax planners. INTRODUCTION We now turn to the role that the choice of business organization may have on valuation. A brief example will be helpful to our discussion. Assume that Rachel has been in the business of selling computers for the last several years, operating as a sole proprietor. Busi- ness has been good and so she decides to expand. She needs additional investment capital and decides to solicit a few investors. Assume that she has the choice of incorporating her business or organizing as a limited partnership. Will the choice of organization alter value? Would it make any difference to the value of the business if Rachel incorporated and then her corporation elected to be taxed as an S corporation? In essence, does the form of the organization affect its valuation for federal tax purposes? Among the major organizational choices or forms are: • Corporations • Limited liability companies • Partnerships • Limited partnerships • Sole proprietorships There are approximately 4.6 million corporations, 1.7 million partnerships, and 17 million unincorporated proprietorships in the United States. Although corporations repre- sent only about one-fifth of all business entities, they account for roughly 90 percent of all business income. 1 Introduction 71 1 U.S. Census Bureau, Statistical Abstract of the United States 545 (1999). A complete analysis of each business organization, examining each organization and comparing one to another in great detail, is beyond the scope of this book. The focus of this chapter is the importance, if any, of the form of business entity to valuation. We begin with the corporation. CORPORATIONS A corporation is an artificial person or legal entity created under the laws of a state; it has six major attributes: 1. A corporation is created by filing articles of incorporation. The articles of incorporation contain information about authorized shares and possible restrictions on the shares. The bylaws of the corporation come into existence at about this time and may also address re- strictions applicable to the shares. For instance, the corporation may decide to restrict the number of shares to be issued, establish rules for voting control, or define how directors are elected. Restrictive provisions may inhibit transferability of shares and thus nega- tively impact the value of the shares in the corporation. 2. The corporation is a separate legal entity. The corporation does business in its own name and on its own behalf, rather than in the name of its shareholders. The corporation may contract in its own name, similar to a person doing business; it has powers to do all things necessary to conduct business. 3. A corporation has centralized management that is distinct from the owners of the corpo- ration. A corporation is run by its board of directors. Each director is elected by the share- holders. The board, in turn, appoints management to conduct the daily affairs of the corporation. This means that investors may remain passive. Valuers pay careful attention to management, as they want to know if management is talented and capable enough to create a successful business. Valuers must also look at management’s compensation to en- sure that it is structured to reward successful management, and thereby ensure the contin- ued vitality of the business. 4. A corporation has perpetual life. The corporation endures by law until merger, dissolu- tion, or some other matter causes it to terminate. It is never destroyed by a person’s death. Valuers may consider perpetual life to be an advantage over a form of organization with a finite life, such as ten years or the life of the owner. 5. Corporate ownership is freely transferable. Absent restrictions adopted by shareholders or the corporation itself, shareholders are free to sell, gift, or transfer their shares. When, however, the transferability of the shares is restricted, either by law or agreement, the re- strictions are likely to reduce the value of the shares. This reduction in value is sometimes desirable. For instance, family members may want to have a buy-sell agreement that de- fines and restricts the sale of shares to only family members. Such restrictions may inhibit value, but the Service closely scrutinizes such agreements out of concern that values may be artificially reduced. 6. Limited liability. Shareholders, management, and board members do not become person- ally liable for corporate obligations. This alone is a strong attraction of the corporation. Members of limited liability companies, and limited partners in a limited partnership, also 72 VALUATION AND CHOICE OF ENTITY enjoy some aspects of limited liability. However, partners in a general partnership are per- sonally liable for the obligations of the partnership. Valuers must take into consideration exposure to liabilities as an element of value. Since the corporate form limits the liability of the shareholders, the corporate form itself has added value. Quantifying that value de- pends on the facts and circumstances of the particular business being valued. The biggest downside of traditional corporations is double-taxation. C corporations, gov- erned by Subchapter C of the Code, which are taxed as legal entities separate from their share- holders. Income, taxed at the corporate level, is taxed again, either as ordinary income when distributed as a dividend, or as capital gains when shareholders sell their shares. To avoid this, a corporation may elect to become a pass-through entity under Subchapter S of the Code. 2 The virtue of this election is that the taxable income of the corporation is passed through to the shareholders without first being taxed at the corporate level. At the same time, the shareholders continue to enjoy the benefits of limited liability. It can be difficult to qualify as an S corporation, however—the Code specifies several requirements that must be met before a corporation can elect S status. For a further discussion, see Chapter 8. LIMITED LIABILITY COMPANIES A limited liability company is a hybrid, unincorporated business organization that shares some aspects of corporations and partnerships. The Service has ruled that the LLC can be taxed as a partnership, if the taxpayers so elect. Gains and losses are not taxed at the entity level, but are passed through to its members. LLC members may actively participate in management. The LLC nominally offers limited liability to its members similar to that of a corporation. And it is not as hard to qualify as an LLC as it is to qualify for S corporation status. All states have statutes governing LLCs, but the provisions vary from state to state. There is one down- side: LLCs are relatively new (the first LLC statute was enacted in 1977), and it is too early to know with certainty how courts will treat them on the issue of limited liability. GENERAL PARTNERSHIPS A general partnership is an association of two or more people or entities engaged in an activ- ity for profit. The partnership is not taxed; the gains and losses are passed through to the part- ners, who are taxed on their share of partnership gains. Each partner is jointly and severally liable for the partnership obligations, for the acts of the other partners, and for acts of the part- nership’s agents in furtherance of partnership business. Potential liability is unlimited, and partners can be pursued personally for partnership debts. General Partnerships 73 2 Though it is beyond the scope of the book, readers should be aware that if a corporation was formerly organized as a C corporation, certain types of profits may be subject to double taxation for a period of 10 years. [...]... (29) × (30 ) 261,549 238 ,806 218,040 199,080 Σ (31 ) 917,474 S Corporation Minority Interest Appraisals Exhibit 8.4 93 (Continued) Projected Fiscal Year 1 (33 ) S corp net income 2 3 4 Table G -3, Line 12 Table G -3, Line 16 (33 ) – (34 ) Σ (35 ) (36 ) × 20% 615,625 646,406 678,727 712,6 63 491,815 516,406 542,227 569 ,33 8 1 23, 810 533 , 635 106,727 130 ,000 136 ,500 1 43, 325 (37 ) / (1 – 20%) (39 ) Present value factor... Year 1 2 3 4 Stabilized as if C Corp 5,000,000 5,250,000 5,512,500 5,788,125 6,077, 531 625,000 656,250 689,0 63 7 23, 516 759,691 40.0% 40.0% 40.0% 40.0% 40.0% (250,000) (262,500) (275,625) (289,406) (30 3,877) 37 5,000 39 3,750 4 13, 438 434 ,109 455,815 200,000 210,000 220,500 231 ,525 2 43, 101 (30 0,000) (31 5,000) (33 0,750) (34 7,288) (36 4,652) ( 23, 810) (25,000) (26,250) (27,5 63) (28,941) 251,190 0.8696 2 63, 750... 1 2 3 4 Stabilized as if C Corp (8) × (9) 5,000,000 5,250,000 5,512,500 5,788,125 6,077, 531 625,000 656,250 689,0 63 7 23, 516 759,691 40.0% 40.0% 40.0% 40.0% 40.0% (250,000) (262,500) (275,625) (289,406) (30 3,877) (8) – (10) (3) × (7) (4) × (12) 37 5,000 39 3,750 4 13, 438 434 ,109 455,815 200,000 210,000 220,500 231 ,525 2 43, 101 (30 0,000) (31 5,000) (33 0,750) (34 7,288) (36 4,652) (2) × (7) (5) × D (7) ( 23, 810)... Fiscal Year 1 2 3 4 Stabilized as if C Corp (9) × (10) 5,000,000 5,250,000 5,512,500 5,788,125 6,077, 531 625,000 656,250 689,0 63 7 23, 516 759,691 1.5% 1.5% 1.5% 1.5% 40.0% (9 ,37 5) (9,844) (10 ,33 6) (10,8 53) (30 3,877) (9) – (11) (3) × (8) (4) × ( 13) (5) × D (8) 615,625 646,406 678,727 712,6 63 455,815 200,000 210,000 220,500 231 ,525 2 43, 101 (30 0,000) (31 5,000) (33 0,750) (34 7,288) (36 4,652) ( 23, 810) (25,000)... (9 ,37 5) (9,844) (10 ,33 6) 4 (10,8 53) (250,000) (262,500) (275,625) (289,406) (28) Difference in entity-level taxes (29) Pretax equivalent (ownerlevel dividend tax rate) (30 ) Present value factor (26) – (27) (28) / (1 – 20%) (16) 240,625 30 0,781 252,656 31 5,820 265,289 33 1,611 278,554 34 8,192 8696 7561 6525 5718 (31 ) Discounted tax savings of S corp election (32 ) Tax savings of S corp election (29) × (30 )... Discounted tax adjustment (52) Tax increase due to tax rate differential (15) × 20% (34 ) × 41.5% (46) – (47) (48) / (1 – 20%) (16) (49) × (50) Σ (51) 2 3 4 50, 238 204,1 03 1 53, 865 192 ,33 2 52,750 214 ,30 9 161,559 201,948 55 ,38 8 225,024 169, 637 212,046 58,157 236 ,275 178,118 222,648 8696 167,245 586,670 7561 152,702 6575 139 ,4 23 5718 127 ,30 0 paying the hypothetical income tax for the first four years, using a C corporation,... carefully consider the various features of each business organization when performing a business valuation An organization’s characteristics affect valuation because they define and influence such things as cash flow and transferability of the business interest Federal and state laws determine many parameters of the entity, but counsel can also 78 VALUATION AND CHOICE OF ENTITY Exhibit 7.2 Differences in... 2 43, 101 (30 0,000) (31 5,000) (33 0,750) (34 7,288) (36 4,652) ( 23, 810) (25,000) (26,250) (27,5 63) (28,941) (2) × (8) Σ (12) to (15) 15.0% (16) × (17) Σ (18) See Box A (19) + (20) + (21) 491,815 0.8696 516,406 0.7561 542,227 0.6575 569 ,33 8 0.5718 427,666 1,500,187 1,745,698 39 0,477 35 6,5 23 325,521 161,849 3, 407, 733 Box A Terminal value before benefit Estimated % of intangible assets Intangible assets Step-up... (40) Pass-through-basis adjustment (38 ) × (39 ) 133 ,409 (34 ) S corp free cash flow (35 ) Net income less free cash flow (36 ) Sum of cash flow differential (37 ) Tax benefit of 20% (capital gains rate) (38 ) Pretax equivalent cash flow 5718 76,277 Projected Fiscal Year 1 (41) Tax on income in excess of free cash flow (42) Pretax equivalent (ownerlevel dividend tax rate) ( 43) Present value factor (44) Discounted... increasing depreciation and amortization and lowering entity income taxes in future periods The indicated value is $3, 407, 733 for 100 percent of the equity multiplied by five percent equals $170 ,38 7 (before application of any discount for lack of control and/ or reduced marketability) This example addresses the assumed investment holding period and the effect on value if it is assumed that the business will be . aff’d. 272 F.3d 33 3 (6th Cir. 2001). community was quick to react, citing the violations of basic valuation principles, common sense, and unfairness to taxpayers. A multitude of theories and viewpoints. features of each business organization when performing a business valuation. An organization’s characteristics affect valuation because they define and influence such things as cash flow and transferability. Interest Appraisals 83 3 Roger J. Grabowski, “S Corporation Valuation in the Post-Gross World—Updated,” Business Valuation Review (September 2004). 4 In the case of REITs the law generally requires