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Summing It Up

Keeping you ahead of the curve with timely news & updates.


Ron Soluri Jr.

Recent Posts

Understanding Standards of Value

Lawyers aren’t expected to be valuation experts. That’s why they choose to hire professional appraisers when their clients need a company or business interest valued for tax, litigation or other purposes. But having a basic understanding of the various standards of value allows you to work more effectively with your expert — and better serve your client.

The ins and outs of FMV

Did you know that the most widely recognized standard of value is fair market value (FMV)? It’s almost always used for valuing business interests for estate and gift tax purposes. The IRS defines FMV as “the price at which the property would change hands between a hypothetical buyer and seller who have reasonable knowledge of the relevant facts and are under no compulsion to enter into the transaction.”

Fair market value reflects the price at which a transaction would occur under the conditions that existed as of the valuation date. For many standard-setting bodies, FMV represents the highest and best use that the property could be put to on the valuation date, taking into account special uses realistically available. It doesn’t matter if the owner has actually chosen that use for the property.

Understanding “Fair Value”

According to the Financial Accounting Standards Board (otherwise known as FASB), fair value is the price it would take (in an orderly transaction between market participants) to transfer a liability or sell an asset in the market where the reporting entity would typically transact for the asset or liability.

The fair value standard is often applied for financial reporting purposes. But it’s also used in shareholder or divorce litigation, and is typically defined by state law in such cases. In many states, fair value for litigation involving dissenting shareholders is considered to be the pro rata share of a controlling level of value. So, control and/or marketability discounts generally aren’t applied.

Understanding Investment Value

Investment value (also known as “strategic value”) represents the value of an asset to a specific investor. For real estate purposes, it’s often defined as the value of an investment to a particular investor or class of investors based on their investment requirements. Value is determined by discounting an anticipated income stream while also considering potential benefits from synergies such as lower expenses or revenue enhancement.

Investment value varies from FMV for a couple of reasons, such as contrasting estimates of future income and different perceptions of risk. There may also be income status differences and synergies with other operations that are owned or controlled by the investor.

When it comes to shareholder litigation, investment value carries a different meaning, however. Here, investment value is based on earning power, but the appropriate capitalization rate or discount is typically a consensus rate that isn’t specific to any investor.

Understanding Intrinsic Value

Intrinsic value is usually employed when valuing an equity share to determine its “real worth.” Intrinsic value (also known as fundamental value) is calculated by looking at an asset’s primary value factors. Relevant factors include:

  • The value of the company’s physical assets,
  • Expected future earnings,
  • Expected dividends payable and future interest, and
  • Expected future growth rate.

It’s true: Defining intrinsic value can be rather tricky. Many appraisers use the term to refer to investment value, while others use it to describe the independent analysis of an investment analyst, banker or financial manager. Trouble is: Courts don’t always clearly define the term, either. So, appraisers are challenged to establish an upfront, clear definition with their clients and attorneys.

Understanding the options

So, with so many options to choose from, how do valuation experts decide which standard to apply when performing a business valuation? The appropriate standard is often determined by specific court orders, state or federal statute, or case or administrative law. Corporate documents, such as articles of incorporation or buy-sell agreements, also might dictate the applicable standard.

A valuator’s professional judgment factors into the decision, as well. For this reason, it’s important that you work with an experienced and qualified appraiser. It might just mean the difference between testimony that’s accepted in court or that which is rejected.

© 2014

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How a Company’s Value Can Change When an Executive Leaves

What to Do When One Employee Holds the Key to Business Value

Author: Ron Soluri Jr.


A company’s earnings and cash flows can suffer significantly when an executive or other critical employee leaves. Small and service-oriented businesses and professional practices are particularly vulnerable to such financial losses.

To account for this risk, professional valuators may apply a key-person discount. These discounts don’t apply to all business appraisals and they’re rarely one-size-fits-all. Thus, a valuator must ask several questions specific to the subject company and its key employees.

Which appraisals are affected?

Choosing when a key-person discount is appropriate can be tricky. Smaller closely held businesses are likely to depend on one or more critical employees, but such risk is often accounted for in a separate “size premium.” Larger closely held companies or public companies usually are able to replace key management personnel and thus minimize potential losses.

In general, businesses that sell products are better able to withstand the loss of a key person than service businesses, which depend to a greater extent on key employees’ knowledge, reputation and relationships. However, a product-based company that relies heavily on technology or intellectual property may be at risk if a key person possesses specialized technical knowledge.

Who are the key people?

Key people provide value in different ways, depending on the roles they play in their companies. For example, a key person might:

  • Drive the company’s strategic vision,
  • Handle day-to-day management responsibilities,
  • Offer technical expertise,
  • Lend his or her excellent reputation, or
  • Provide access to an extensive network of contacts.

Personal relationships are a critical factor in identifying key employees. If clients, customers and vendors deal primarily with one person, they may decide to do business with another company if that person is gone. On the other hand, it’s easier for a company to retain customer relationships when they’re spread among several people within the company.

A key person may also have a financial impact on the business. It’s not unusual for the CEO or another executive in a closely held business to personally guarantee the company’s debts. Lenders may call in such debts if the key person is no longer with the company.

How deep is the bench?

When determining key-person discounts, valuators must assess the ability of others to fill key employees’ shoes. To survive without a key person, existing management must have the knowledge, skills and business acumen to continue normal operations without interruption.

Another key factor is whether there exists a comprehensive succession plan that formally outlines which individuals assume control after key people leave. In the absence of a plan, the departure of one key person could trigger power struggles or require the company to bring in a replacement who isn’t familiar with the organization.

What’s the impact?

Identifying risks associated with key persons is one thing; estimating the impact of those risks on business value is quite another. Valuators generally use one of three methods to incorporate key-person discounts into their calculations: 1) Adjust future earnings to reflect the risk of losing a key person (typically used when a key person’s departure is imminent), 2) adjust the discount or capitalization rate, or 3) discount calculated value by a certain percentage (similar to a marketability or minority interest discount).

Quantifying the discount can be challenging because little empirical support for across-the-board key-person discounts exists. However, research has shown that, in cases where a discount was appropriate and a departure was reasonably certain, the applicable decrease in value associated with a key person’s loss ranged between 4% and 6%.

Best outcomes 

Among the many legal contexts in which key-person discounts can arise are marital dissolutions, shareholder disputes, mergers and acquisitions, and tax court challenges. To ensure the best outcome for your client, work with a valuator who has experience estimating such discounts and is capable of defending his or her appraisal methodology in court.

If you have any questions about valuations or any other issue, give us a call at 716.847.2651, or you may contact us here.

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Litigation Support: The Gift Tax Exclusion

Court Determines the Gift Tax Exclusion Applies to FLP

Author: Ron Soluri Jr.

litigation supportRecently, we discussed a case where the U.S. Tax Court held that gifts of interests in a family limited partnership (FLP) qualified for the federal annual gift tax exclusion. The decision in Estate of Wimmer v. Commissioner came as a surprise to some because, in three previous cases, the same court held that the exclusion didn’t apply to gifts of limited partnership interests.

Keeping it in the family

A married couple formed an FLP in 1996, funding it with publicly traded and dividend-paying stock. The FLP was established in part to restrict nonfamily rights to acquire family assets. The husband and wife made gifts of limited partnership interests in the FLP to various family members.

In 1996, the FLP began receiving quarterly dividends from the stock. To allow the limited partners to pay federal income tax, the FLP made distributions from 1996 through 1998. Beginning in 1999, the FLP continuously distributed all dividends — net of partnership expenses — to the partners when they were received. These were made in proportion to partnership interests. Limited partners were also given access to capital account withdrawals and they used such withdrawals for, among other things, paying portions of their residential mortgages.

After the husband died and his estate filed an estate tax return, the IRS returned a tax deficiency of $263,711. The estate asked the Tax Court to find that the gifts of limited partnership interests qualified for the annual gift tax exclusion.

Present benefits

Annual gift tax exclusions are available for “present interest gifts” only, not to gifts of future interests in property. As the court clarified, a gift in the form of a transfer of an equity interest in a business or property, such as limited partnership interests, isn’t necessarily a present interest gift.

To qualify as a present interest gift, the gift must confer on the recipient a substantial present economic benefit by reason of use, possession or enjoyment of either the property or income from the property. In this case the court decided that, because of the significant transfer restrictions in the FLP’s partnership agreement, the donees didn’t receive the rights to immediately use, possess or enjoy the limited partnership interests themselves.

3 requirements

However, the court found that the estate satisfied three requirements for income from the limited partnership interests to qualify the gifts of the interests as present interest gifts: 1) the partnership would generate income; 2) some portion of that income would flow steadily to the limited partners; and 3) that portion of income could readily be ascertained. The court concluded that the limited partners received a substantial present economic benefit.

Wimmer provides an example of the right way to administer an FLP. It’s possible to put restrictions — which often are used to create valuation discounts — on gifted limited partnership interests while still satisfying the requirements for the gifts to qualify for the annual gift tax exclusion. To ensure your clients’ FLP operating agreements walk this fine line, work with an experienced financial advisor.

If you have any questions about the gift tax exclusion or any other litigation support issue, give us a call at 716.847.2651, or you may contact us here.

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Tax Court Allows Gift Tax Exclusion for FLP Interests

Court Previously Held that the Exclusion Didn’t Apply

Author: Ron Soluri Jr.

Reversing its own recent trend, the U.S. Tax Court in Estate of Wimmer v. Commissioner held that gifts of interests in a family limited partnership (FLP) qualified for the federal annual gift tax exclusion. In three previous cases, the same court held that the exclusion didn’t apply to gifts of limited partnership interests.

Keeping it in the family

A husband and wife formed an FLP in 1996 and funded it entirely with publicly traded and dividend-paying stock. The FLP was intended in part to restrict nonfamily rights to acquire family assets. The couple made gifts of limited partnership interests in the FLP to various family members.

business interruptionIn 1996, the FLP received dividends from the stock and continued to receive them quarterly. It made distributions to the limited partners from 1996 through 1998 for payment of federal income tax. Beginning in 1999, the FLP continuously distributed all dividends — net of partnership expenses — to the partners when they were received, in proportion to partnership interests. In addition, limited partners had access to capital account withdrawals and used such withdrawals for, among other things, paying portions of their residential mortgages.

After the husband died and his estate filed an estate tax return, the IRS returned a tax deficiency of $263,711. The estate asked the Tax Court to find that the gifts of limited partnership interests qualified for the annual gift tax exclusion.

Siding with the estate

The annual gift tax exclusion is available only for “present interest gifts,” as opposed to gifts of future interests in property. As the court explained, a gift in the form of a transfer of an equity interest in a business or property, such as limited partnership interests, isn’t necessarily a present interest gift.

A present interest gift must confer on the recipient a substantial present economic benefit by reason of use, possession or enjoyment of either the property itself or income from the property. In Wimmer, the court easily found that the donees didn’t receive the rights to immediately use, possess or enjoy the limited partnership interests themselves because of the significant transfer restrictions in the FLP’s partnership agreement.

But the court also found that the estate satisfied the three requirements for income from the limited partnership interests to qualify the gifts of the interests as present interest gifts:

  1. The partnership would generate income.
  2. Some portion of that income would flow steadily to the limited partners.
  3. That portion of income could readily be ascertained.

The court therefore concluded that the limited partners received a substantial present economic benefit.

Learning Wimmer’s lesson

Wimmer shows how an FLP can be administered in such a way that it can put restrictions — which often are used to create valuation discounts — on gifted limited partnership interests while still satisfying the requirements for the gifts to qualify for the annual gift tax exclusion. A qualified financial professional can help you draft an appropriate operating agreement.

If you have any questions about the gift tax exclusion or any other litigation support issue, give us a call at 716.847.2651, or you may contact us here.

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Litigation Support: Transferring Assets to Family Members

Wandry v. Commissioner offers guidance on defined-value clauses

Author: Ron Soluri Jr.

The U.S. Tax Court recently provided valuable guidance on using defined-value clauses in gift documents — guidance that should have significant estate planning implications. In fact, the court’s ruling in Wandry v. Commissioner can help taxpayers who want to transfer assets to family members before Jan. 1, 2013, when the lifetime gift tax exemption is scheduled to be reduced from $5.12 million to $1 million unless Congress acts.

Arrangement is challenged

In 2004, a married couple executed gift documents that provided they were giving membership units in a family-owned limited liability company (LLC) to their children and grandchildren. The documents identified the gifts in specific dollar amounts, rather than in percentages.

The documents included a defined-value clause stating that the number of units was based on their fair market value, “which cannot be known on the date of the gift but must be determined after such date.” The clause also stated that, if it were ultimately determined (including by the IRS or a court) that the value of the gifted units differed from the dollar amounts specified, the units would be adjusted to gift the intended amounts. The couple’s intent was to give units that were of dollar amounts equal to their available federal gift tax exemptions and annual exclusions.

On their 2004 gift tax returns, the couple reported the amount of the gifts detailed in the gift documents — $261,000 for each child and $11,000 for each grandchild. Their CPA relied on an independent appraisal of the LLC to conclude that each 1% interest was worth $109,000. He therefore described the gifts in the returns as gifts of 2.39% interests to the children and 0.101% to the grandchildren, rather than as dollar amounts.

Based on these percentages, the IRS valued the interests at $366,000 and $15,400, respectively, and challenged the gift tax returns. Among other things, it asserted that the defined-value clause didn’t save the couple from taxes because it created a condition (a valuation) subsequent to completed gifts.

Court upholds the clause

The Tax Court considered the IRS’s contention regarding the couple’s defined-value clause. It described the issue as an old one “that has evolved through a series of cases where the Commissioner has challenged a taxpayer’s attempt to use a formula to transfer assets with uncertain value at the time of the transfer.”

Some federal courts have upheld formulas used to limit the value of a completed transfer. But the Tax Court has invalidated previous attempts to reverse completed gifts in excess of gift tax exemptions and exclusions. However, the Tax Court has drawn a distinction between a savings clause, which a taxpayer can’t use to avoid gift tax, and a formula clause, which is valid. Savings clauses are void because the taxpayer essentially tries “to take property back.” Formula clauses merely transfer a “fixed set of rights with uncertain value.” The pivotal question is just what the donor is trying to gift.

In this case, the court concluded that the couple’s defined-value clause was a valid formula clause. On Jan. 1, 2004, each donee was entitled to a predefined LLC percentage interest expressed through a formula. The formula included an unknown — the value of the LLC as of Jan. 1, 2004 — but that value was constant. The gift documents didn’t allow the Wandrys to take property back but merely corrected the allocation of the units.

Another takeaway

business interruptionNotably, previous cases that upheld formula clauses generally involved clauses that reallocated interests among the donees, with any transfers in excess of the specified dollar amount going to a charity. According to the Tax Court, though, it’s “inconsequential” that a clause doesn’t reallocate the units to a charity if the reallocations don’t alter the transfers.

For any questions on estate planning or any other litigation support issue, contact us here or give us a call at 716.847.2651.

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IRS Proposes Alternate Estate Valuation Dates

Adjustments in Valuation Dates No Longer Straightforward

Author: Ron Soluri, Jr.

The IRS has proposed regulations on the election of alternate valuation dates for estates. Currently, it’s unclear whether they will be implemented, but the proposed regs could significantly affect the availability of alternate valuation dates when the value of an estate decreases after death.
According to Internal Revenue Code Section 2032(a), executors can elect to value an estate six months after the date of death. But any estate property that’s distributed, sold, exchanged or otherwise disposed of during the six months is valued as of the date of disposition. What’s more, any interest whose value changes due merely to the lapse of time is valued as of the date of death. Adjustments are allowed for any difference in value attributable to factors other than the lapse of time.

The proposed regulations include two exceptions to Sec. 2032(a)’s rule:

  1. Transactions in which an interest in a corporation, partnership or other entity includible in the decedent’s gross estate is exchanged for a different interest in the same entity or an acquiring entity, such as a reorganization, recapitalization or merger, and
  2. When the estate receives a distribution from a business entity, bank account or retirement trust and an interest in that entity is includible in the decedent’s gross estate. An estate may be able to use the six-month date to value, respectively, the interest received or the property held in the estate if certain conditions are met.

In its proposal, the IRS also introduces an aggregation rule for calculating the fair market value (FMV) of each portion of property that’s disposed of during the alternate valuation period but that remains in the gross estate on the six-month date. And it proposes a special rule for determining the portion of a trust that can be included in the gross estate as of the alternate valuation date by reason of a retained interest.

Further, the proposal clarifies when property is deemed to be disposed of where its title passes by contract or operation of law. It also lists the types of factors, including economic or market conditions during the alternate valuation period, that affect the FMV of property on the alternate valuation date.

business interruptionThe proposal’s future is yet uncertain. But your financial advisor can keep you abreast of any developments likely to affect your clients. You can read more about the proposal here.

For any questions regarding this proposal or other estate management issues, contact us here or give us a call at 716.847.2651.

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Litigation Support: Calculating Lost Profits

Courts Disagree About Post-Breach Conditions

Author: Ron Soluri, Jr.

Are plaintiffs’ claims for lost profits undermined by poor market conditions subsequent to an alleged breach of contract? Recently, some defendants have argued just that. But one defendant in a Maryland case, CR-RSC Tower I, LLC v. RSC Tower I, LLC, learned the hard way that courts don’t always agree.

A cooperative development

CR-RSC owns a 53-acre tract of land in Maryland. It entered into two 90-year ground leases with RSC (which is partially owned and controlled by a real estate development company), for a total of about five acres. The expectation was that RSC would develop the portion of the land that wasn’t subject to the ground leases.

According to the ground leases, RSC would construct Towers I and II, apartment buildings that it would sell after construction and initial rental. Construction on Tower II was projected to begin about two years after Tower I was constructed. The leases obligated the parties to cooperate with each other in developing the apartment buildings, as well as the rest of the tract.

Plans change — and change again

business interruptionAfter executing the leases, the parties modified their agreements to permit development of condominium buildings, a hotel and a spa, rather than apartments. In late 2004 and early 2005 they executed several agreements in furtherance of this project. But in September 2006 the parties abandoned these plans and entered into a termination agreement. RSC then obtained county approval to revert to its original development plan to build apartments. It arranged financing with Northwestern Mutual Life Insurance Company to construct Tower I.

But CR-RSC failed to provide the estoppel certificates required to secure the financing; the leases required RSC to provide such certificates. CR-RSC also initiated proceedings to challenge the county’s approval of RSC’s site plans and building permits.

Trial court issues order

In November 2006, RSC sued CR-RSC, alleging breach of contract and seeking declaratory and injunctive relief that would require appellants to perform their obligations under the leases. The trial court issued a preliminary injunction in early 2007 that ordered CR-RSC to deliver executed estoppel certificates.

CR-RSC delivered the certificates as ordered. Nevertheless, RSC claimed that the certificates didn’t comply with the terms of the leases, and no one could or would rely on them. It subsequently alleged that CR-RSC’s continued refusal to execute proper estoppel certificates and its efforts to hinder governmental approval of the apartment project constituted continuing or successive breaches.

RSC sought about $28 million in lost profits. It claimed that the real estate and credit markets had deteriorated after April 4, making it impossible for RSC to obtain financing for the apartment project. It also alleged that the county no longer considered its prior approvals of the project to be valid. The jury found for RSC and awarded it about $36 million. CR-RSC appealed.

Appellate court weighs in

RSC based its lost profits claim on market projections at the time of the initial breach of contract in December 2006. CR-RSC argued that, at that time, the Towers weren’t projected to be fully leased until 2010 and 2012, and that actual market conditions in that time frame were relevant. CR-RSC contended that RSC wouldn’t have profited under those conditions. However, the trial court had excluded evidence of post-breach actual market conditions.

In analyzing the facts and circumstances, the Maryland Court of Special Appeals noted the “traditional rule” that lost profits damages are measured at the time of the breach. Further, later events, such as post-breach fluctuations in value, often are irrelevant when determining damages.

The court cited decisions in other jurisdictions that reached the same conclusion about the irrelevance of post-breach events in construction cases. However, some courts have considered such evidence. In the end, the appellate court held that, under Maryland law, the traditional rule was appropriate. Therefore, the trial court did not err in barring evidence of post-breach market conditions.Collateral Damage

Constructing a case

Calculating lost profits can be a complicated process. Regardless of the law on post-breach conditions in your jurisdiction, it’s important to work closely with a qualified and experienced damages expert.

If you have any questions regarding lost profits or are in need of litigation support, please contact our experts or call us at 716.847.2651.

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