Remember , a court is a “ trier ” of fact , not a “ creator ” of fact . And if experts from both sides agree that tax affecting is appropriate , why would a court decide otherwise ? standard of value explicitly stated in that state ’ s Corporations Code or precedent case law .
Tax Affecting
When I say tax benefits that pass through , I am referring to , among others , accelerated depreciation and various tax credits that will have a significant beneficial effect on the owners ’ income tax situation .
Many appraisers are ignoring the benefits of pass-through entity tax status . Simply put , owners of passthrough entities pay less in taxes , the earnings of a business based on a hypothetical C corporation tax rate of 21 percent or a combined rate in California ranging between 21 percent and 30 percent .
Some practitioners have even taken the approach of tax impacting the capitalization rate in what I would argue is an effort to bury the issue .
I have had the opportunity to discuss
Remember , a court is a “ trier ” of fact , not a “ creator ” of fact . And if experts from both sides agree that tax affecting is appropriate , why would a court decide otherwise ? standard of value explicitly stated in that state ’ s Corporations Code or precedent case law .
A hypothetical tax rate which will never be paid by a party in litigation should not be applied when using an investment value or marital standard of value in California or else it will artificially lower the value .
You should state your support for any imputed tax rate within your report . And if you cannot factually support the tax rate , rethink using it .
Jared Tonks , CPA , ABV , CFF is managing director at CBIZ Forensic Consulting Group , LLC and chair of the Business Valuation Section of the CalCPA Forensic Services Section . You can reach him at JTonks @ CBIZ . com . particularly due to the double taxation which exists in California .
Consider the examples on the previous page . If we assume that an individual is at the highest marginal tax rates , an S corporation would still pay less in taxes than a C corporation .
This is worth repeating : Regardless of the case , the pass-through entity pays less in taxes .
Now , if we remove the California state income tax impact , then there is still a benefit , but it is a reduced benefit . Does this preferential tax treatment make the pass-through entity more valuable than a C corporation ?
If the after-tax net cash flow is the driver , then yes !
We also cannot ignore the fact that many C corporations pay little to no tax each year . Based on the most recent data published by the IRS ( from 2013 ), 99.7 percent of business entities pay less than $ 20,000 in taxes each year , including C corporations .
The number of businesses paying less than $ 20,000 in taxes has likely increased since the passage of the Tax Cuts and Jobs Act , which lowered the corporate income tax to 21 percent from 35 percent .
However , despite all this , there are still many valuation practitioners who reduce this approach with many practitioners and they will often cite the number of practitioners who employ tax affect . They will cite unscientific webinar polls or past experiences to reduce the earnings stream by as much as a third . Very few have any support for the hypothetical tax rate applied in their reports .
What is clear after Cecil is that tax affecting may be appropriate when the facts and circumstances dictate . Review the Estate of Jackson v . Commissioner ( T . C . Memorandum . 2021-48 ) for a comprehensive discussion on the issue . The Court outlines in seven pages ( beginning at Page 75 ) the history and rationale for and against tax impacting pass-through entities .
A logical and well-reasoned approach is necessary to be successful . Successful tax affecting has required a detailed analysis in many cases . Consider the Delaware Chancery Model , Treharne Model and Van Vleet SEAM . Note that models present different results based on the underlying assumptions of the model .
Further , proper consideration should be given to the standard of value . Tax affecting has crept into litigation with a known buyer and seller . These cases often require a specific wantmore ?
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CalCPA ’ s Forensic Services Section provides an expanded forum to facilitate education , participation , and the exchange and dissemination of ideas and resources , identify relevant current events and trends , and to analyze technical issues and interpret applicable standards .
The Forensic Services Section ’ s four sections ( Business Valuation , Economic Damages , Family Law and Fraud and Financial Investigations ) allow member CPAs to interact on concerns specific to their area of practice .
Find more information at calcpa . org / membership / committees-and-sections / forensic-services . www . calcpa . org MARCH / APRIL 2024 CALIFORNIA CPA 19