Page 54 - Business Valuation for Estates & Gift Taxes

Chapter 9

Miscellaneous Issues

Following is a brief discussion of some less common issues that may come up in valuations for estate
and gift tax purposes. The valuation analyst should research these topics more fully as needed as this
discussion is not intended to be all inclusive.

Built-in Gains Discount

A built-in gains discount is a discount or reduction in the value of an interest in an entity, typically a C
corporation, which has a built-in capital gains tax liability. A buyer of a C corporation interest would
typically discount the price paid for an equity position to account for the fact that upon liquidation, cer-
tain appreciated assets the entity holds would be subject to capital gains taxes. The valuation analyst can
help develop an appropriate discount that would be applied to the stock’s purchase price to offset the
impact of capital gains taxes paid on the appreciated assets at some future liquidation event.

Prior to the Tax Reform Act of 1986 (TRA), taxpayers were allowed an election to treat the acquisition
of the equity in a C corporation as if it was an acquisition of the assets of the C corporation. The asset-
acquisition tax treatment allowed the C corporation buyer to depreciate the fair market value (that is, the
"stepped-up basis") of the acquired assets. In addition, the asset-acquisition tax treatment allowed the
seller to recognize the gain on the sale of the C corporation assets at the amount of the purchase price for
the transaction.

This federal income tax treatment was referred to as the General Utilities doctrine, named after a land-
mark tax case and allowed the selling shareholders to avoid the payment of double taxation on the
"deemed" liquidation of the C corporation assets. With the passage of the TRA, this tax treatment be-
came obsolete and instead of the step-up in basis, the income tax bases of the acquired assets are carried
forward and no step-ups are recognized by the buyer of the company.

When an asset with unrecognized appreciation is held by a C corporation, a built-in gain (BIG) tax obli-
gation exists which is not paid by the C corporation until that asset is sold. A BIG tax obligation can ex-
ist whether the subject C corporation is either an operating company, an investment, or a holding com-
pany and can be a material variable in determining fair market value.

In federal estate tax matters, the BIG tax issue has been and continues to be the subject of litigation.
Federal courts have allowed a valuation adjustment to reflect the BIG tax obligation when determining
the business value of a C corporation; however, some courts have limited the magnitude of valuation ad-
justments related to built-in gains tax liability.

In 1998, the Tax Court recognized the valuation implications of the liability represented by the built-in
capital gains tax associated with appreciated capital assets held in a C corporation. The Estate of Davis
was the first judicial decision to recognize the BIG tax valuation impact following the repeal of the Gen-

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