Kress v. United States, 2019 U.S. Dist. LEXIS 49850; 2019 WL 1352944 (March 26, 2019)

One aspect that has valuators excited about the Kress v. United States gift tax case is that the federal court that ruled on the taxpayers’ challenge to the IRS’s gift tax assessment accepted valuations from both parties’ experts that applied a C corporation tax rate to value minority shares in an S corporation. In a rare moment of unity, the adjudicating court and both sides agreed that S corp tax affecting was an appropriate practice.

At the same time, the parties’ experts disagreed on the question of whether there was any quantifiable advantage related to S corp status that added value to the minority shareholder’s stock as well as on a range of other valuation issues.

The subject of the dispute was a successful, family-owned packaging company with headquarters in Wisconsin that was organized as an S corp. As part of their estate planning, the taxpayers gifted minority shares in the company to junior family members. The IRS claimed that, for three tax years, the taxpayers paid insufficient gift taxes.

Rather than litigate the matter in U.S. Tax Court, the taxpayers, presumably for strategic reasons, opted to amend their tax returns, pay the IRS assessed deficiencies, and then sue the federal government in federal district court (Eastern District of Wisconsin) for a refund.

At trial, both parties presented testimony from highly qualified valuation experts. The taxpayer retained two experts: a primary expert, who used the market approach, and a second expert, who valued the company based on a combination of market and income approaches. The government ‘s expert also used a combination but gave most of the weight to the market approach.

The company should also consider designating an appraiser or appraisal firm in the valuation process buy-sell agreement. Careful consideration should be made during the selection process.  You will want to ensure that the firm/appraiser will be around when a triggering event occurs.  Additionally, you will want to determine if the firm/appraiser has the appropriate qualifications and can handle the project.  This determination can be made by specifying certain requirements in the buy-sell agreement including, but not limited to, education, training, industry experience, continuing education requirements and appraisal credentials.  Some of these may not be always necessary, but it is often useful to at least consider the appropriate appraiser credentials.  

Prior to making a selection, I recommend reviewing the credentials and requirements of the following appraisal organizations:

·         American Society of Appraisers – Accredited Senior Appraiser (“ASA”)

·         American Institute of Certified Public Accountants – Accredited in Business Valuation (“ABV”)

·         National Association of Certified Valuators and Analysts – Certified Valuation Analyst (“CVA”)

I think it is helpful for the owners to make the selection prior to entering into the valuation process buy-sell agreement. If everyone agrees from the beginning, then the owners are less likely to perceive bias in the process upon a triggering event. Additionally, the selection can require the process to be carried out by credentialed appraiser(s) who will be required to follow the ethical and reporting requirements as mentioned in my previous post. Again, agreeing on the appraiser (or at least the appraiser’s credentials) at the outset is particularly helpful if the buy-sell agreement requires more than one appraiser in the process.