For over 15 years, the IRS has discriminated against S Corporations when it comes to estate taxes and other matters where business valuation plays a role and, for 15 years, S Corp has been fighting them on it.
Our S-Corp advisor Nancy Fannon has written extensively on the subject. In 2007, we told you about her book, The Comprehensive Guide to S Corporation Valuation, which did a great job of laying out the entire issue.
Now, Nancy has followed up with Taxes and Value: The Ongoing Research and Analysis Relating to the S Corporation Valuation Puzzle. You can purchase the book here and you can register here for a special May 20th webinar workshop Nancy is hosting.
For those new to the issue, the challenge is whether the courts take taxes into account when they value S corporations as part of an estate or other legal proceeding. In many cases, the courts ignore the taxes S corporations pay, resulting in them being subject to 60 percent or higher premium over similar C corporations. As you can imagine, premiums that large have been noticed by the S corporation community.
The discrimination stems from the Gross v. Commissioner case decided in 1999 where the court ruled against “tax affecting” the projected income of the S corporation – that is, adjusting the income down to reflect taxes paid – because S corporations are not subject to the corporate tax.
The tax community will recognize that the court was effectively asserting a distinction without a difference. The lack of an entity level tax on S corporations is one of form, not substance. S corporation shareholders are required to pay tax on their business income when it is earned (just like C corporations), regardless of whether the income is distributed (just like C corporations), and often at higher rates than C corporations are subject to. This reality is lost in the Gross decision.
The effect of that decision is that, in many cases, the IRS fails to adjust the fair market value of an S corporation to reflect the business’s overall tax liability, as they do when assessing the fair market value of a C corporation. Congress should be aware of this on-going discrimination on the part of the IRS against S corporations.
S corporations pay taxes – lots of them — through their shareholders. As our 2012 Quantria made clear, the average tax burden on S corporations is actually higher than the corresponding burden on C corporations, and this tax burden should be reflected in their fair market value when they are part of an estate.
If S corporation valuation is important to you, read Nancy’s book and watch her seminar. And know that with the ongoing debate over the estate tax, S-CORP will continue to fight the good fight and ensure family-owned businesses are valued fairly.