A Fine Tasting Opinion: The Art of Reviewing an Appraisal, Ethically Protecting Privileges and Popping the Cork off of Kovel

Continuing with our reports from the 2016 Heckerling Institute on Estate Planning

Stephanie Loomis-Price of Winstead, PC and Louis S. Harrison of Harrison, Held, Carroll and Wall, LLP provided guidance to advisors in reading and commenting on valuation reports. The emphasis was on the defensibility of preparing transfer tax returns and privileges in hiring appraisers. The focus was on business appraisal reports used to support values used in transfer tax returns.

Ms. Loomis-Price suggests selecting a qualified independent appraiser; look for credentials. Some of the credentialing organizations include the American Society of Appraisers, the Institute of Business Appraisers and the National Association of Certified Valuation Analysts. Without valuation credentials, the appraisal report may be disregarded by the courts. Have a methodology as to how to review the appraisal report. Ask questions rather than making edits to report in order to preserve the appraiser’s independent opinion. Details are important! Review grammar and look for typos. Be sure to check quotes and cites. Checking math may seem basic but is necessary. Ask yourself, does the valuation opinion pass the smell test? Is the conclusion logical and are the facts correct? Courts look for thoroughness, integrity and logic. Be sure that the appraisal takes into account Revenue Ruling 59-60 which sets forth the factors to consider in the valuation of a small closely-held company.

Mr. Harrison talked about the many methods of valuing a business. The basics are that all methodologies will fall into one of three approaches: income, market or asset. Income approaches that are based on projected income or cash flows involve determining a discount rate. Generally, income streams or cash flow streams used in the income approach will be tax-effected for C corporations. There is some debate as to whether such income streams or cash flow streams should be tax-effected for S corporations. Recently, the courts have taken the position that S corporation income should not be tax-effected. This results in a higher value. Many appraisers disagree with not tax-effecting the income or cash flows.

Market approaches involve determining a multiple. A favored methodology which is a market approach is a multiple of EBITDA (Earnings Before Income Taxes, Depreciation and Amortization). Determining the market multiple of EBITDA starts with a search for comparable or guideline public companies. Calculations are performed to determine the price to earnings or EBITDA. Typically, the mean or median is selected. Mr. Harrison warned to be careful in enumerating the reasons for the selection of the multiple to support the multiple selected to apply to the company being valued. Such factors may include competition, number of customers, quality of workforce, compressed margins and size of company. Mr. Harrison favors the market approach and in particular the multiple of EBITDA method for S corporations because tax effects are very subtle. 

The asset approach is typically used to value family limited partnership interests. The assets of the family limited partnership such as marketable securities are valued as if they are being liquidated. This approach is less complex than the income and market approaches and is not often used for operating entities.

Appraisals can be very complex and detailed so it is important to review them carefully yet allow the appraiser to maintain his or her objectivity. Ms. Loomis-Price and Mr. Harrison warn that the client should review the report before it is finalized to be sure that the facts are correct and the appropriate comparable companies have been selected. All of the points discussed will help to refine the appraisal and make sure that transfer tax returns are prepared most defensibly!

For more content stemming from the 2016 Heckerling Institute on Estate Planning, please click here