What Appraisers, Accountants, and Attorneys Need to Know About Business Valuation-Related Issues in Estate Planning

Transcription

1 What Appraisers, Accountants, and Attorneys Need to Know About Business Valuation-Related Issues in Estate Planning November 2,

2 DISCLAIMER The views expressed by the presenters do not necessarily represent the views, positions, or opinions of the AICPA or the presenter s respective organization. These materials, and the oral presentation accompanying them, are for educational purposes only and do not constitute accounting or legal advice or create an accountant-client or attorney-client relationship.

3 Panelists F.A. "Chip" Brown, CFA, CPA, ABV, CFF Willamette Management Associates Curtis R. Kimball, CFA, ASA Willamette Management Associates

4 Focus of Today s Presentation Best practices for estate tax valuations Appraiser s potential roles in estate planning Valuation issues in the drafting of corporation and partnership documents Recent valuation discount settlements 4

5 Best Practices for Estate Tax Valuations 5

6 8 Best Practices for Estate Tax Valuations 1. Adhere to Recognized Professional Standards 2. Meet or Exceed any Reporting or Disclosure Requirements 3. Obtain Relevant Professional Qualifications, Experience, and Education 4. Perform Adequate Due Diligence 5. Understand Subsequent Events 6. Have a General Awareness of Relevant IRS Publications 7. Apply Generally Accepted Valuation Methods 8. Perform Adequate Analyses to Support any Discounts 6

7 Best Practice #1 Adhere to Recognized Professional Standards USPAP IRS commentaries have indicated that a USPAP-compliant report will generally be regarded as a qualified appraisal. Kohler case Tax Court critical of IRS expert report that was not prepared in accordance with all USPAP standards Not that high of a hurdle to overcome SSVS No. 1 AICPA members required to follow this standard when they perform engagement to estimate value that culminate in the expression of a conclusion of value or a calculated value Other Valuation Professional Organization Standards 7

8 Best Practice #2 Meet or Exceed any Reporting or Disclosure Requirements The name of the game in gift and estate planning is adequate disclosure. The IRS s rules set forth in Treasury Regulations Section (c)-1(f)(3), published December 3, 1999, apply to all gifts made after August 5, The valuation report must contain certain items in order to meet adequate disclosure (see subsequent slide) 8

9 Adequate disclosure items related to the valuation report The date of the appraisal. The date of the transfer. The purpose of the appraisal. A description of the property. A description of the appraisal process employed, including the valuation method(s) utilized. A description of the assumptions utilized. A description of any hypothetical conditions considered. The information considered in determining the value; including all financial information in sufficient detail to allow the reader to replicate the appraisal analysis and valuation. The appraisal procedures followed, and the reasoning that supports the analysis, opinions and conclusions. The valuation method utilized, the rationale for the valuation method, and the procedure used in determining the fair market value of the asset transferred The specific basis for the valuation, such as specific comparable sales or transactions, sales of similar interests, assetbased approaches, mergeracquisition transactions, etc. Descriptions of any restrictions or other limiting conditions present. 9

10 Best Practice #3 Obtain Relevant Professional Qualifications, Experience, and Education At least one business valuation specific credential (ABV, ASA, AVA, CVA, CBA) Definition of qualified appraiser under IRC Section 170 recently modified to include earned an appraisal designation from recognized professional appraiser organization. Kohler case Tax Court commented favorably that the Estate s experts were certified appraisers Regularly perform business valuations Experience in gift/estate tax related matters Continuing education and training related to gift/estate tax matters 10

11 Best Practice #4 Perform Adequate Due Diligence Site visits (at least periodically) by the valuation analyst to the subject company location(s) Interview management Kohler case Court critical of IRS expert for limited due diligence related to site visit and interviewing management. we are convinced from his report and trial testimony that [the IRS expert] did not understand Kohler s business. He spent only 2-1/2 hours meeting with management Typical for the respective court to show a keen interest in the level of due diligence that was performed Kohler case [Estate s experts] spent sufficient time with the company and management to understand the Kohler business 11

12 Best Practice #5 Understand Subsequent Events USPAP Provides guidance regarding subsequent events for retrospective appraisals (appraisals in which the effective date of the appraisal is prior to the report date). Based on USPAP, it is reasonable for an analyst to consider data subsequent to the valuation date but only to confirm historical trends and market expectations as of the valuation date. SSVS 1 Provides guidance regarding subsequent events. Based on SSVS 1, an analyst is not required to disclose subsequent events. However, an analyst may disclose subsequent events in a separate report section for informational purposes. 12

13 Subsequent events (continued) While in theory any subsequent events should not impact valuation, the IRS often will try to use subsequent events as corroborating evidence for its position. Therefore, it may be helpful to be prepared to reconcile the valuation to subsequent events 13

14 Subsequent events (continued) A majority of the federal tax cases dealing with subsequent events have concluded that it is inappropriate to use hindsight as direct evidence of value as of the valuation date. However, the Tax Court (and other federal courts) has also opined that certain subsequent events that occur within a reasonable time after the valuation date may be appropriate to consider: Reasonably foreseeable Prove reasonableness of expectations Subsequent sale of subject interest Subsequent sale of comparable ownership interest 14

15 Subsequent events (continued) Gimbel case Subsequent event of the redemption of all estate shares by the Company. Court found that it was reasonably foreseeable as of the date of death that the company would repurchase a portion (20%) of shares, but not all the shares. Tax Court did not adopt the exact subsequent transaction price or number of shares as a basis for its decision. However, Tax Court was clearly influenced by the subsequent event. Ringgold Telephone Company case Tax Court criticized taxpayer expert for failing to consider the subsequent sale. 15

16 Best Practice #6 Have a General Awareness of Applicable IRS Publications Federal Tax Law Internal Revenue Code Code of Federal Regulation Internal Revenue Service Publications Treasury Regulations Treasury Decisions Revenue Rulings Revenue Procedures Advance Rulings and Determinations Technical Advice Memorandums Technical Memorandums 16

17 Best Practice #7 Apply Generally Accepted Valuation Methods Sounds simple, but the devil is in the details Meet Daubert standards SSVS 1 provides a good outline for generally acceptable valuation methods AICPA Practice Aid Business Valuations for Estate and Gift Tax Purposes (not yet published, but currently being worked on) 17

18 Best Practice #8 Perform Adequate Analyses to Support any Discounts Consideration of empirical models/theoretical models/regression models as part of the discount for lack of marketability discount Go beyond the studies and rules of thumb Do not use court cases as support for discounts Find applicable closed-end funds Review and understand provisions of any partnership/operating agreements that may impact control and/or marketability 18

19 An Appraiser s Role in the Estate Planning Process 19

20 Coordination Between Estate Attorney and Appraiser Appraisers should not render a legal opinion Rely on attorney in regards to the likely understanding of rights and privileges associated with subject interest A hypothetical willing buyer/seller would likely consult with attorney on similar issues Any document in the appraiser s file is subject to being discovered during the audit process or in subsequent valuation litigation. This includes written correspondence, s, notes and drafts of appraisals. Appraiser should be independent 20

21 Potential Stages of the Estate Planning Process Initial planning stage Gifting stage Gift tax audit stage Gift tax litigation stage Estate tax stage Estate tax audit stage Estate tax litigation stage 21

22 Planning Stage Appraiser potential roles Identify problem valuation situations or problem assets Identify the effects of various gift and estate planning alternatives on valuation Provide input on company/partnership documents that may impact value Determine preferred rate/yield Provide input on capital structure (voting, nonvoting, preferred, super common) 22

23 Gifting Stage Appraiser potential roles Perform periodic valuations Decide the appropriate type of report format to achieve adequate disclosure yet maintain a budget that makes sense with regard to the complexity and level of tax exposure of the client Be aware of any tax deadlines 23

24 Estate Tax Stage Appraiser potential roles Perform valuation as of the date of death Provide input on whether alternative valuation date should be considered If requested/needed, perform valuation as of alternative valuation date Sometimes more than one valuation firm is engaged to perform the valuation 24

25 Gift/Estate Tax Audit Stage Appraiser potential roles Review any IRS letters Educate the attorneys on the valuation issues that may be raised by the IRS Respond in writing on valuation questions raised by IRS Participate in call/meetings with IRS Advise client on potential impact on value Prepare for litigation in the event an agreement cannot be achieved on audit or on appeal 25

26 Estate/Gift Tax Litigation Stage Appraiser potential role Provide input on whether to prepare a formal rebuttal report to any other expert reports submitted in opposition to the original valuation position Clarify the impact of any subsequent events or newly discovered facts on the subject interest s valuation An new appraiser may be brought in during the litigation phase 26

27 Valuation Issues in the Drafting of Company and Partnership Documents 27

28 Considerations in partnership/operating agreements Attorneys drafting LLC and LP agreement documents have to deal with a certain balance between terms that provide flexibility of operation with restrictions on control and marketability State law can have a substantial influence over how interests are viewed for appraisal. Federal transfer tax laws and regulations are also important. As part of estimating the fair market value of an entity interest, the appraiser should consider the valuation impact of the terms of the agreement. This creates a unique interface between the attorney and appraiser during the planning stage of the creation of an entity. 28

29 Terms impacting lack of control Management of operations Voting rights Control over the timing and amount of distributions Control over the type of distributions Control over additional capital contributions Removal of general partner or manager Control over tax matters and tax elections 29

30 Terms impacting lack of marketability Duration of entity until dissolution Restrictions on transfers Rights of first refusal Restrictions on pledging or other forms of anticipating value Mandatory or option buy-sell requirements Admission of additional or substitute partners/members Treatment of assignees 30

31 Terms impacting other adjustments Built-in gains and the Section 754 election adjustment Built-in gains that result when a buyer of a partnership interest cannot adjust his share of the basis of the assets in a partnership to their present value has a detrimental impact on the marketability of the entity s interests. Ownership interests that cannot compel the management of the entity to enter into this election tend to have larger marketability discount adjustments to reflect the fewer number of buyers willing to take the risk that an election will be made in the future at the appropriate time. Some entity agreements make the party requesting the 754 election bear the costs of compliance. This contingent cost burden also results in an incremental additional discount. 31

32 Terms impacting other adjustments (continued) Loss of a key manager rules for successor management Some agreements have complicated successor appointment terms which could slow down the ability of the entity to respond to business opportunities or risks during a time when the entity has lost a key manager. This factor can result in an increased discount adjustment. 32

33 Terms impacting other adjustments (continued) Greater restrictions in the terms of an entity agreement may result in loss of present interest status Estate of Hackl - The judge viewed what he concluded were overly-broad provisions in the operating agreement of the LLC that had the effect of eliminating any meaningful economic benefits to the immediate use, possession, or enjoyment of the subject LLC interests transferred under the annual exclusion gift under Section 2503(b). Some commentators have suggested providing a limited (in time) right of redemption or put right for minority interests whereby the interest could be redeemed by the entity at fair market value, applying all the appropriate discount adjustments, in order to substantiate that the interest has a present economic benefit. 33

34 Recent Discount Settlements 34

35 Recent discount settlements The following data was compiled by Curtis Kimball and members of Willamette from our own case files and from materials presented by others Settlement data is interesting because it shows what the IRS and taxpayers have agreed to as fair market value in cases that are similar in nature to valuation engagements in which one may be currently involved These are out of court settlements 35

36 Recent discount settlements (cont d) Absent a comprehensive list of private transactions in non publicly registered entities, these data may be helpful in providing the appraiser with some insight into the issues that create conflicts between the IRS and taxpayers These cases, however, should not be treated as something akin to guideline transactions, but rather should be viewed in the same manner as court case decisions Please remember that these settlements do not necessarily represent arm s-length transactions, given the prospect of further litigation if a settlement is not reached Because of the differing facts and circumstances of each case, no statistical average or similar metric would be appropriate 36

37 Recent discount settlements (cont d) Settlement # 1 By: Willamette Management Associates Date: 2011 Type: Estate (2009) Interest: State Law: Limited partnership (non-controlling) Florida Assets: Publicly traded common stocks (80%); cash (20%) Other factors: None Discount settlement: 37.1% 37

38 Recent discount settlements (cont d) Settlement # 2 By: Willamette Management Associates Date: 2011 Type: Estate (2008) Interest: State Law: Assets: Common stock (controlling interest in a C corp) Delaware Municipal bond portfolio Other factors: Built-in gains tax exposure; executor sold off all the bonds during settlement negotiations. Discount settlement: 7% discount for lack of marketability and all built-in gains. 38

39 Recent discount settlements (cont d) Settlement # 3 By: Willamette Management Associates Date: 2011 Type: Estate (2007) Interest: State Law: Assets: Limited liability company (non-controlling) Delaware Diversified bond portfolio Other factors: Graegin note exposure Discount settlement: 25% (Graegin note interest allowed) 39

40 Recent discount settlements (cont d) Settlement # 4 By: Willamette Management Associates Date: 2011 Type: Estate (2007) Interest: State Law: Assets: 50% common stock interest Florida Professional medical services Other factors: Mandatory distribution agreement; interest sold by executor after settlement; Willamette brought in to rebut the IRS Appellate valuation position Discount settlement: 20% discount for lack of marketability 40

41 Recent discount settlements (cont d) Settlement # 5 By: Willamette Management Associates Date: 2011 Type: Estate (2009) Interest: State Law: Assets: Three LP and LLC interests (all 49% non-controlling interests) Florida Publicly traded diversified stock and bond portfolio Other factors: Each LLC was the general partner of one of the LPs Discount settlement: 35.5% to 36.3% 41

42 Recent discount settlements (cont d) Settlement # 6 By: Willamette Management Associates Date: 2010 Type: Estate (2007) Interest: State Law: Assets: Limited Partnership Oregon Commercial Real Estate Other factors: Some exposure on valuation of underlying real estate Discount settlement: 39% 42

43 Recent discount settlements (cont d) Settlement # 7 By: Willamette Management Associates Date: 2010 Type: Estate (2008) Interest: State Law: Limited Liability Company (non-controlling) North Carolina Assets: Timberlands, croplands, farm house (57%); public securities - mostly stock and bond funds (43%) Other factors: Real estate consisted of undivided interests Discount settlement: 31.7%, plus 40% discount for undivided interests (total discount approximately 50.6%) 43

44 Recent discount settlements (cont d) Settlement # 8 By: Willamette Management Associates Date: 2010 Type: Estate (2007) Interest: State Law: Limited Partnership Florida Assets: Stocks (50%); Bonds (50%) Other factors: Section 2036 exposure; powers of appointment Discount settlement: 23% for one LP block; 30.8% for other LP block (taxed under two different sections of the IRC; see Mellinger case) 44

45 Questions 45

46 AICPA Business Valuation Web Seminar Series: Core Competencies from the Nation s Leading Experts Upcoming Web Seminars: Valuation for Employee Stock Ownership Plans November 17, 2011 Valuations for Financial Statement Reporting Purposes December 6, 2011 Principles of Valuation for Marital Dissolution Purposes December 15, 2011 Valuations for Dissenting Stockholder & Minority Oppression Actions January 5, 2012 Pass-through Entity Valuation 2012: Research & Methods January 19, 2012 Forensic Analysis Expert Witness Testimony: Defending Your Expert Report and Expert Testimony February 2, 2012 For more information visit:

47 See You at the Event! Visit to register for the following face-to face educational opportunities: AICPA National Business Valuation Conference New in 2011 PRACTICAL APPLICATIONS TRACK! November 6-8, 2011 in Las Vegas, NV AICPA National Healthcare Industry Conference New in 2011 VALUATIONS SPECIALIZATION TRACK! November 17-18, 2011 in Baltimore, MD 47

48 For additional information, please visit: Forensic and Valuation Services (FVS) Section Accredited in Business Valuation (ABV) Credential Overview Certified in Financial Forensics (CFF) Credential Overview

49 Thank You!