The United States District Court’s March 2019 court decision in Kress v. United States1 created a lot of buzz in the valuation community. The case involved plaintiffs James and Julie Kress disputing gift taxes they paid related to their gifts of minority ownership interests in Green Bay Packaging, Inc. (“GBP”), a Subchapter S Corporation, to their children and grandchildren. In order to resolve the case, the court needed to determine the fair market value of the GBP stock at the time of the gifts.
The Court reviewed three different valuation reports (two submitted by the plaintiffs’ experts, one submitted by a government expert). While the case addressed a number of key valuation issues, the part of the case that has received the most attention was related to GBP’s S Corporation (“S Corp”) status, as all three experts (including the IRS expert) tax-affected GBP’s earnings as if it were a C Corporation (“C Corp”). Many business valuation experts have been advocating for this type of treatment of S Corps and other pass-through entities for years, but the IRS and tax courts have generally rejected this approach, arguing that S Corps are not subject to taxes at the corporate level. However, valuation experts claim that not tax-affecting can inappropriately ignore the tax burden that individual S Corp owners face.
In addition, the Court considered whether there was any additional value to GBP being organized as an S Corp instead of a C Corp. The plaintiffs’ experts did not add any “S Corp premium” while the government’s expert did. However, the Court sided with the plaintiffs’ experts, stating that, “GBP’s subchapter S status is a neutral consideration with respect to the valuation of its stock. Notwithstanding the tax advantages associated with the subchapter S status, there are noted disadvantages, including the limited ability to reinvest in the company and the limited access to credit markets. It is therefore unclear if a minority shareholder enjoys those benefits.”
While this is not a U.S. Tax Court memo or a precedent-making decision from the U.S. Court of Appeals, it does provide support for tax-affecting S Corps. Further, while the Court did not allow an “S Corp premium” in this case, we believe it is necessary to consider the appropriateness of this premium on a case-by-case basis.
Schneider Downs has significant experience in preparing business valuations for gift and estate tax, financial reporting, buying/selling and a range of other purposes. Please contact Steve Thimons (412-697-5281; firstname.lastname@example.org) or Thomas D. Pratt (412-697-5615; email@example.com) for more information about our business valuation services.
1James F. Kress and Julie Ann Kress, Plaintiffs, v. United States of America, Defendant. 1:16-C-795. United States District Court, Eastern District of Wisconsin
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