Valuing Pass-Through Entities

Chapter 5Income Approach and Value to the Holder

Internal Revenue Service Revenue Ruling 59–60 directs business appraisers to consider the following factors when valuing the stock of closely held corporations:

1. The nature of the business and the history of the enterprise from its inception.
2. The economic outlook in general and the condition and outlook of the specific industry in particular.
3. The book value of the stock and the financial condition of the business.
4. The earning capacity of the company.
5. The dividend-paying capacity.
6. Whether or not the enterprise has goodwill or other intangible value.
7. Sales of the stock and the size of the block of stock to be valued.
8. The market price of stocks of corporations engaged in the same or similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter.¹

Factors to consider when applying the income approach are presented in Revenue Ruling 59–60, § 4.02, which states that “[p]rimary consideration should be given to the dividend-paying capacity of the company rather than to dividends actually paid in the past.”² The Revenue Ruling continues thus:

In the final analysis, goodwill is based upon earning capacity. The presence of goodwill and its value, therefore, rests upon the excess of net earnings over and above a fair return on the net tangible assets. While the element of goodwill may be based primarily on earnings, such factors as the prestige and renown of the business, ...