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

 In a gift tax case teeming with valuation issues, one notable aspect was that, in valuing the minority shares of an S corporation, both parties’ experts applied a C corporation tax rate to the company’s earnings and the court, without ado, accepted the practice. To what extent this court’s position reflects a wider agreement among judges adjudicating tax cases and government tax specialists that tax affecting is the appropriate method for valuing nontaxable entities remains to be seen.

 Taxpayer prevails: The flashpoint was a very successful, family-owned packaging company 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. The plaintiffs chose to amend their tax returns, pay, and then sue in federal district court 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 secondary expert, who valued the company based on a combination of market and income approaches The government’s expert also used a combination but gave a different weight to each result: 60% to the market approach and 40% to the income approach. He said the market approach was most “effective at capturing the financial conditions at the time in the marketplace and industry.”

 The parties’ experts tax affected. The government’s expert also applied an S corp premium to account for perceived tax advantages to the company flowing from the S corp status. The taxpayer’s experts said the S corp status here did not add value to the gifted stock because the minority shareholders could not change the status of the corporation. The court declared itself “neutral” on the issue. If there were benefits to S corp status, it was unclear that the minority shareholders would enjoy them, the court found.

 The court credited the taxpayer’s primary expert, commending his profound understanding of the company (he had worked with the company since 1999) and his detailed examination of its unique aspects. He analyzed the company on a “‘holistic’ basis to determine a value that best fit the guideline companies,” the court noted. It only made a minor downward adjustment to the expert’s marketability discount.

 What’s the impact? In deciding how far this opinion goes toward ending the tax-affecting controversy, readers should note that this is not a U.S. Tax Court memo or a precedent-making decision from a U.S. Court of Appeals. Further, the court here does not get into a larger discussion on tax affecting (e.g., models) and does not address prior landmark decisions, including Gross v. Commissioner. At the same time, the court’s ruling and the government’s position signal a recognition that there are tax consequences to the owners of S corps and other pass-through entities that need to be accounted for in a valuation. It’s not clear whether the government will appeal the ruling.

 Stay tuned!

Tasty Tacos is near and dear to my heart.  I was distraught to learn that there is a pending trademark infringement action against Ohio-based More than Gourmet for its “Wicked Tasty Taco” seasoning.  The Des Moines Register ran an article on June 11, 2019 providing some background that you can see here.

There are several remedies available for Tasty Tacos – first and foremost is an injunction.  According to the Des Moines Register, Tasty Tacos is currently seeking injunctive relief to prevent More than Gourmet from using the “Wicked Tasty Taco” name and similar names.  Outside of injunctive relief, general damages for trademark infringement are provided in Section 35 of the Lanham Act (the Trademark Statute) and Section 36 of the Restatement of Unfair Competition Third (Restatement).

Actual damages include lost profits and corrective advertising.  Additionally, some courts may allow for a reasonably royalty analysis.  Lost profits can occur when a defendant’s infringing trademark causes the plaintiff to lose sales in the following ways:

1.       The customers purchase goods from the defendant, believing they were buying them from the plaintiff;

2.       After buying such infringing goods, the customers are disappointed with the quality and buy elsewhere; or

3.       The defendant sells the infringing brands for an amount less than the plaintiff’s customary practice, causing the plaintiff to lower its prices to maintaining its customer base.

Source: The Comprehensive Guide to Economic Damages, Fifth Edition, Nancy J. Fannon and Jonathan M. Dunitz.  To recover lost profits, the plaintiff must show lost sales as a result of the defendant’s infringement.  The Tasty Tacos action appears to be a case where a company used a name that is so similar it would tend to confuse the customers. 

Another remedy available is unjust enrichment.  With unjust enrichment, the focus is on the gain the defendant earned from the infringement.  This is a slightly different approach than lost profits as the analysis does not contemplate the plaintiff’s loss (unless both remedies are pursued).  In limited circumstances both lost profits and unjust enrichment may be pursued.  It is often beneficial for the plaintiff to pursue an unjust enrichment remedy in a trademark infringement action to shift the burden of proof.  Section 1117(a) of the Lanham Act provides “[i]n assessing profits the plaintiff shall be required to prove defendant’s sales only; the defendant must prove all elements of cost or deduction claimed.” Predominantly, in trademark infringement cases, an expert witness will calculate unjust enrichment while lost profits can be viewed as a secondary or separate damages claim.