In Estate of Jones, TC Memo 2019-101, the Tax Court addressed the valuation of various limited partnership interests for gift tax purposes.
The opinion summarized the approaches considered as follows:
Three generally accepted approaches are used to value equity interests in closely held businesses: the income approach, the market approach, and the asset- based approach. Exelon Corp. v. Commissioner, 147 T.C. 230, 244 (2016), aff’d, 906 F.3d 513 (7th Cir. 2018); Estate of Noble v. Commissioner, T.C. Memo. 2005-2, 2005 WL 23303, at *7. The income approach uses either the direct capitalization method or the DCF method to convert the anticipated economic benefits that the holder of the interest would stand to realize into a single present- valued amount. Estate of Noble v. Commissioner, 2005 WL 23303, at *7. The market approach values the interest by comparing it to a comparable interest that was sold at arm’s length in the same timeframe, accounting for differences between the companies by making adjustments to the sale price. Id. And the asset-based approach values the interest by reference to the company’s assets net of its liabilities. Id. When valuing an operating company that sells products or services to the public, the company’s income receives the most weight. See Estate of Andrews v. Commissioner, 79 T.C. 938, 944-945 (1982). When valuing a holding or investment company, which receives most of its income from holding debt, securities, or other property, the value of the company’s assets will receive the most weight. Id. at 945.
The primary dispute between the parties is whether SJTC should be valued using an income approach or an asset-based approach. The parties have several other points of dispute: (1) the reliability of the 2009 revised projections, (2) the propriety of “tax-affecting”, (3) the proper treatment of intercompany loans from SSC to SJTC, (4) the proper treatment of SSC’s 10% general partner interest in SJTC, and (5) the appropriate discount for lack of marketability. We consider these in detail below.
Posted by Lewis J. Saret, Co-General Editor, Wealth Strategies Journal.