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Valuing Pass-Through Entities


Praise for Valuing Pass-Through Entities

"By any metric, the valuation process is a complicated enterprise. This book, however, elucidates this exercise, making it comprehensible to the seasoned veteran and the beginner alike. Replete with examples, this invaluable resource would be useful for any practitioner in the field."
--Jay A. Soled, JD, LLM, Director, Rutgers University Masters in Tax Program

"From time to time in our field, a seasoned professional provides us with a fresh set of perspectives on a worn topic that causes us to think more deeply about what we do. Valuing Pass-Through Entities is such a book. Written in a lucid, accessible style, this book provides both a comprehensive treatment of tax rules and tax court rulings and their effect on pass-through entities and a carefully considered, clearly illustrated approach to using the Delaware MRI valuation formula. A satisfying read with a wealth of food for thought and practice!"
--Sarah von Helfenstein, Founder and CEO, Value Analytics & Design LLC

"Eric takes us on a logical journey that allows us to better understand how the specific ramifications of state and federal tax law impact the decision to tax affect pass-through entities. He takes us from the Delaware Chancery's decision in the Delaware Open MRI Radiology case to his Modified Delaware MRI Model (MDMM). This new and cogent methodology is well explained and thought out. He provides reasoning and explanations for us to follow in order to incorporate the MDMM in our valuation report. He also provides an extensive checklist to guide us through the exercise and calculations. This will enable us to form and perfect this particular 'art' to arrive at a better conclusion of value with a supportable process."
--Ronald D. Rudich, Senior Director of Business Valuation and Litigation Support, Gorfine, Schiller & Gardyn, P.A.

"Eric Barr has written an excellent book examining the valuation of pass-through entities. The book includes a detailed history of corporate and individual tax rates and presents a Modified Delaware MRI Model very useful to valuation analysts. Additionally, the book includes an insightful chapter on the value to the holder standard of value. The book also presents practical case studies beneficial to practitioners in applying the MDMM analysis."
--John E. Barrett, Jr., CPA, ABV, CBA, CVA, Barrett Valuation Services, Inc.

ERIC J. BARR is a founder and comanaging member of Fischer Barr & Wissinger LLC and is the Director of the Firm's Business Valuation and Accounting and Assurance Services departments. Barr is a nationally sought-after thought leader, lecturer and webinar presenter on accounting, forensic and valuation matters.

Foreword xi

Preface xiii

Acknowledgments xv

About the Author xvii

CHAPTER 1 Introduction 1

Definition of Value 2

Beauty and Value 2

Premise of Value 4

Approaches to Value 5

The PTE Conundrum 7

CHAPTER 2 The History of Federal Statutory Tax Rates in Maximum Income Brackets and the Evolution of Different Forms of Business Entities 11

Origins of the United States Internal Revenue Code 13

Years 1913 Through 1938 14

Years 1939 Through 1953 19

Years 1954 Through 1985 22

S Corporations 23

Tax on Unreasonable Compensation 27

General Utilities Doctrine 28

Years 1986 Through 2013 29

Limited Liability Companies 30

Summary 32

CHAPTER 3 Effective Federal Individual and Corporation Income Tax Rates 41

Effective Federal Income Taxes on $10,000 of 2012 CPI Adjusted Taxable Income, 1913-2013 42

Effective Federal Income Taxes on $100,000 of 2012 CPI Adjusted Taxable Income, 1913-2013 51

Effective Federal Income Taxes on $1 Million of 2012 CPI Adjusted Taxable Income, 1913-2013 57

Summary 67

CHAPTER 4 Comparison of Different Entity Forms 71

Business Life Cycle 71

Benefits and Limitations of PTEs 75

Financial Statements of C Corporations and PTEs 76

PTE Status and Bank Financing 78

Prevalence of PTEs 79

Change in Form of Entity 81

CHAPTER 5 Income Approach and Value to the Holder 85

Value to the Holder versus Value to the Buyer 86

Jurisdictional Issues 87

Delaware Open MRI Radiology Associates, P.A. v. Howard B. Kessler 87

Bernier v. Bernier 92

Limitations of Delaware Open MRI and Bernier 93

The Modified Delaware MRI Model 94

Flexibility of the MDMM 98

CHAPTER 6 Inputs to Modified Delaware MRI Model 101

Normalized Pretax Income 101

Entity-Level Income Taxes on Pass-Through Earnings 103

Income Retained in the Business 104

Effective Federal and State Income Tax Rates on Pass-Through Income 107

Dividend Tax Rates 111

Summary 121

CHAPTER 7 Income Approach and Investment Value 123

Measuring Investment Value 124

Deal Structure 126

CHAPTER 8 Income Approach and Fair Market Value 131

Characteristics of FMV 131

Determining FMV 134

Example of Failing to Consider Floor and Ceiling Values 135

CHAPTER 9 Fair Market Value Court Decisions 139

Number of Federal Estate and Gift Tax Returns 140

Gross v. Commissioner 141

Estate of Heck v. Commissioner 145

Wall v. Commissioner 146

Estate of Adams v. Commissioner 149

Robert Dallas v. Commissioner 151

Gallagher v. Commissioner 153

Analysis of Cases 154

CHAPTER 10 The Market Approach 157

Revenue Ruling 59-60 157

Appraisal Standards Board Standards 159

AICPA Statement on Standards for Valuation Services 160

Guideline Public Company Method 161

Guideline Public Company Method and PTE Value to the Holder 163

Guideline Public Company Method and PTE Investment Value 168

Guideline Public Company Method and PTE Fair Market Value 169

Guideline TransactionsMethod 171

CHAPTER 11 Individual State Income Taxes 175

Statutory Individual State Income Tax Rates 175

Effective Individual State Income Tax Rates 176

CHAPTER 12 Discounts, Premiums, Bylaws, and State Laws 181

PTE Agreements 181

State Law 183

Nevada Senate Bill 350 183

CHAPTER 13 Valuing Complex PTE Ownership Interests 187

Reasons for Complex Capital Structures 187

Option-Pricing Method 188

Example 1: Preferred-Member Units 190

Example 2: Joint Venture 193

Example 3: S Corporation with Unreasonable Officer/Stockholder Compensation 196

Appendix A: Checklist 199

Appendix B: Case Study: Bob's Cruises 215