Tax Reporting

Appraisal Economics provides valuation services related to state, federal, and international tax reporting. Our clients range from large publicly traded companies to closely held family businesses. Our staff is comprised of independent valuation experts who specialize in the following tax areas:

  • Gift and estate taxes
  • International transfer pricing, such as Section 482 of the Internal Revenue Code
  • Purchase price allocations
  • Stock-based compensation, such as Section 409A of the Internal Revenue Code
  • Pass-through entities such as Subchapter S corporations, LLCs, and partnerships
  • Charitable donations

Gift and Estate Tax Planning

With experience serving as the IRS’s independent valuation experts, including as expert witnesses in U.S. Tax Court, Appraisal Economics has the qualifications and experience to meet the needs of taxpayers with complex situations. Estate planning professionals often engage us on behalf of their clients to help them plan and execute various strategies to achieve optimal tax efficiency. Often, “family limited partnerships” or other private holding companies are used to pool assets under common management. Interests in these entities are sold, gifted, or transferred through an estate. As these interests generally lack control rights and are less marketable than the underlying assets, discounts that reduce the taxable value and, therefore, taxes, may be appropriate if properly applied and supported. Additionally, we have been engaged to value promissory notes that bear interest at below-market rates and assets to be contributed to or held in grantor retained annuity trusts (GRATs).

We have been retained by the IRS to review and critique appraisal reports that were prepared by other appraisers on behalf of taxpayers. Our assignments have been to evaluate the relevance of the methodologies employed, the integrity of the analyses from a conceptual and computational perspective, the reasonableness of the underlying assumptions, compliance with generally accepted valuation standards, and the overall credibility of the other appraisers’ conclusions. We have also been called upon to reappraise certain assets in question.

In 2016, changes were proposed to Internal Revenue Code Section 2704 (“Section 2704”), which was enacted in 1990. Section 2704 disallowed the use of certain “applicable restrictions,” such as lapsing voting rights and lapsing liquidation rights, that had been used to justify reduced taxable values for intra-family transfers of interests in corporations and partnerships. Prior to Section 2704, some taxpayers structured intra-family transfers of interests in ways that had minimal economic impacts to the transferor and transferee but served to materially reduce the taxable value and, therefore, the gift and estate tax liabilities. Section 2704 was intended to curb these perceived abuses by requiring that valuations be performed as if the applicable restrictions were not in place. Since its enactment in 1990, however, a number of court cases, including Estate of Harrison v. Commissioner1 and Kerr v. Commissioner,2 changes in state statutes, and new taxpayer strategies designed to circumvent Section 2704 have collectively served to weaken the existing regulations. As a result, the U.S. Treasury Department and the Internal Revenue Service proposed additions to the regulations under Section 2704 that – if enacted and upheld – could further restrict the ability of taxpayers to apply discounts for lack of control and lack of marketability when determining the fair market value of transferred interests for estate and gift tax purposes. Several areas specifically addressed by the proposed regulations are covered entities, assignee interests, deaths within three years of the transfer, and marital and charitable deduction.3

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International Transfer Pricing

Transfer pricing is the process of determining the appropriate price for goods and services exchanged between related parties, such as a parent company and its controlled foreign corporation. International companies have an incentive to shift revenue and expenses, and therefore taxable income, among various tax jurisdictions to recognize profits in lower-tax countries such as Ireland, the Cayman Islands, and other “tax havens.” To prevent tax evasion, the IRS and other taxing authorities generally require that the prices paid between related parties be set at amounts equal to what they would be if the two parties were unrelated and negotiating at arm’s length. A thorough analysis must consider the functions performed and the value created by each entity. The correct methods, which depend on the circumstances, must be applied to determine the appropriate transfer price.

Appraisal Economics provides transfer pricing studies to help companies determine the proper transfer price between related parties located in different tax jurisdictions. We help companies comply with Internal Revenue Code Section 1.482 (“Section 482”) and the equivalent requirements of other countries’ tax authorities.

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Purchase Price Allocations

To comply with corporate tax reporting requirements, an acquisition or business combination generally requires determining and reporting the fair market values of the acquired assets. These values are included on the opening post-acquisition balance sheet and are periodically adjusted to reflect depreciation and amortization charges, which reduce the tax basis of each asset. To properly report earnings, the taxpayer must accurately compute depreciation and amortization charges based on each asset’s fair market value. The period over which depreciation and amortization of the assets’ tax bases are reported depends on the nature of each asset. The amount of depreciation and amortization affect taxable income and, therefore, income taxes. This analysis is parallel to the analysis Appraisal Economics provides to companies that are required to comply with generally accepted accounting principles (GAAP) for financial reporting purposes, although there are specific conventions that do not apply identically for tax reporting and GAAP.

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Stock-Based Compensation

Compensation has evolved from simple annual salaries, to cash bonuses, to “plain vanilla” stock options, to complex stock-based compensation awards that include a range of derivative securities, such as long-term incentive plans (LTIPs), outperformance plans (OPPs), restricted stock units (RSUs), and performance shares. Restricted shares may be earned based on the attainment of one or more time-based, performance-based, and market-based vesting conditions. Companies are generally required to treat the fair market values of these awards as expenses when reporting taxable income and after-tax earnings. Recipients of stock-based compensation are generally required to report the fair market values of the grants they receive as ordinary income on their personal tax returns.

Section 409A of the Internal Revenue Code (“Section 409A”) applies to compensation that is received after the year in which it is earned, also known as deferred compensation. Deferred compensation can be either “qualified” or “nonqualified.” Under Section 409A, an employee can delay the payment of federal income tax on qualified deferred compensation until the compensation is received if certain terms are met, including: (i) a set schedule or specified time, established prior to or when compensation is deferred, when benefits are paid; (ii) a prohibition on the acceleration of payments; and (iii) an initial election regarding the deferral of compensation and the form of payment if the compensation plan permits it.4 If an employee’s compensation does not qualify for treatment under Section 409A or another section of the Internal Revenue Code, then it is generally considered nonqualified and penalties may be assessed, including an additional 20 percent income tax.5

Section 83(b) of the Internal Revenue Code allows employees to change when taxes are paid on certain awards of stock-based compensation, such as unvested shares of stock, which may be advantageous to the employee. Companies often grant stock-based compensation to employees to incentivize the employees to remain at the company and to align their interests with the interests of shareholders. Often, employees pay tax when the awards vest, which may be several years after the awards are granted. During the period between the grant date and the vesting date, the value of the award may appreciate significantly. Although the employee benefits from delaying the payment of taxes until the awards vest, the tax liability may be much higher than if the employee had been taxed on the value of the awards when they were granted. This is particularly common for start-ups and other high-growth companies, such as technology companies with newly patented products or pharmaceutical companies that may be on the cusp of receiving approval to sell a profitable new drug.

Employees may elect, under Section 83(b), to include the fair market value of the unvested stock-based awards in their gross income for the year the award was received. As a result, the employee will pay taxes sooner than otherwise required, but no taxes are due when the awards vest, and all capital gains (including any gains between the grant date and the vesting date) are deferred until the securities are sold, potentially many years later. When the securities are sold, the capital gains will be taxed at the long-term capital gains rate. Generally, an 83(b) election may not be revoked. This means that if the value of the securities decreases between the grant date and the vesting date or the securities are sold for a loss, the employee may have paid more taxes sooner, but will not be able to receive the tax deduction for the capital losses until the securities are sold.6 Appraisal Economics performs many valuations of stock-based compensation to help employers and employees understand the fair market value of awards upon granting so that they may consult their advisors and make sound decisions.

Golden Parachute (Section 280G)

Appraisal Economics has experience in performing valuations for Sections 280G and 4999 of the Internal Revenue Code (“Section 280G” and “Section 4999,” respectively), which relate to excess parachute payments upon certain corporate events, such as a change in control. Section 280G disallows a deduction for excess parachute payments made to disqualified individuals. If an executive leaves a company and collects a parachute payment, which may consist of cash, stock, or options, and the total exceeds three times their annual compensation, then that individual may be subject to an excise tax on the excess amount. As a result, the components of the total parachute payment need to be valued to determine whether any levies under Section 280G and Section 4999 are applicable. Typically we are engaged to value the non-compete agreements, as the value of the covenant not to compete is provided by the executives to the company. Therefore, payments the executives receive in return for providing the NCAs are generally treated more favorably for tax purposes than other components of their severance packages.

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Subchapter S Corporations, LLCs, and Other “Pass-Through” Entities

Entities that are organized as Subchapter S corporations (“S-corps”) limited liability companies, or partnerships are treated as pass-through entities for income tax purposes. Owners of interests in these types of entities are taxed differently than if the entity was structured as an otherwise identical Subchapter C corporation (“C-corp”). The earnings of a C-corp are first taxed at corporate-level rates, and then any distributions to shareholders (net of corporate taxes) are taxed a second time at the individual-level rates applicable to dividends. Pass-through entities avoid most taxation at the corporate level, but owners are taxed on all earnings, whether distributed or not, at the higher individual-level rates applicable to ordinary income. Therefore, although owners of interests in pass-through entities pay higher tax rates at the individual level, they benefit from the avoidance of taxes at the corporate level, and typically receive higher after-tax income than the shareholders of a C-corp. This distinction, and the fact that owners of interests in LLCs and S-corps pay taxes on all income—even if retained in the business and not distributed to owners—means that valuing an interest in an S-corp, LLC, or partnership requires consideration of its unique tax attributes. Appraisal Economics has extensive experience valuing interests in pass-through entities.

Charitable Donation

Charitable donations can be made with a wide variety of assets, such as cash, publicly traded stocks and other marketable securities, interests in companies that are privately held, real estate, and intellectual property such as patents, trademarks, and copyrights. Typically, the donor is able to deduct the fair market value—that is, the equivalent amount of cash that the donated property is worth—from the donor’s taxable income, thereby supporting the charitable organization and also reducing taxes. The fair market values of donated assets are generally reported on IRS Form 8283. If the claimed value of noncash assets exceeds $5,000, the value must be determined in a qualified appraisal, although a fully-documented appraisal report may not necessarily have to accompany IRS Form 8283 at the time the tax return is filed. If the claimed value of noncash property exceeds $500,000, the qualified appraisal must accompany the tax return when it is filed.7 Appraisal Economics has significant experience preparing qualified appraisals to be submitted to the IRS for charitable donation tax purposes.

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Representative Engagements

Some of our valuations for tax reporting have included:

  • An international transfer pricing study for the intellectual property of a global media company.
  • Equity in a billion dollar medical device company as the Internal Revenue Service’s expert witnesses, related to a tax dispute.
  • An interest in an investment company for a former United States Secretary of the Treasury.
  • The quarterly valuation of the stock and options of a privately held company that operates a global securities trading platform.
  • Hundreds of music copyrights to value the royalty income.
  • Ownership units in a publicly traded alternative asset manager with over $200 billion of assets under management.
  • The valuation of membership interests, including discounts for lack of control and lack of marketability, in nearly three dozen holding companies with layered ownership.
  • Promissory notes held by an estate, due from entities that own large portfolios of commercial real estate.
  • Carried interests in multiple private equity funds for a jury trial in federal court.
  • A tenant-in-common interest in the equity of a seafood distributor.
  • Stock options before and after changes to the options’ terms prior to the IPO of a national apparel retailer.

In addition to tax reporting valuation services, Appraisal Economics offers a wide variety of independent valuation services to the business, financial, and legal communities around the world. To learn more about how our team of independent valuation experts can work for you, please call +1 201 265 3333 or click Contact Us.

1  Estate of Harrison v. Commissioner, T.C. Memo. 1987-8.
2  Kerr v. Commissioner, 113 T.C. 449, 473 (1999)
3  https://www.irs.gov/irb/2016-36_IRB/ar15.html
4  https://www.irs.gov/irb/2007-19_IRB/ar07.html
5  https://www.irs.gov/retirement-plans/409a-nonqualified-deferred-compensation-plans
6  https://www.irs.gov/irb/2012-28_IRB/ar12.html
7  https://www.irs.gov/taxtopics/tc506.html