Chapter 8

Valuation of S Corporations and Other Pass-Through Tax Entities

Minority and Controlling Interests

Introduction

Valuation of Subchapter S corporations has been one of the most controversial issues the appraisal profession has faced over the last several years. It has also been one of the most difficult to resolve, as divergent and complex financial theories have surfaced and competed for attention. For the valuation practitioner, the application of reasoned financial theory has proven to be an extremely difficult undertaking, given the multitude of viewpoints and uncertainties of the IRS audit process.

The benefits of single taxation have been debated for years. With the number of S corporations increasing nearly fivefold in a fifteen-year period and surpassing the number of C corporations by the mid to late 1990s, the proper treatment of the value of S corporation status came before the tax court in Walter L. Gross, Jr., et ux, et al. v. Commissioner.1 The court in Gross rejected traditional valuation methods, and the appraisal community was quick to react, citing basic valuation principles, common sense, and unfairness to taxpayers. A multitude of theories and viewpoints have ensued, with little consensus, though the Tax Court has continued to reject the valuation community's tax-affecting of S corporation income.

The traditional valuation practice of tax affecting “is the discounting of estimated future corporate earnings on the basis of assumed future tax burdens ...

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