Income Tax Valuation Issues Insights Editors for This Issue: Robert F. Reilly, CPA, and Seth Palatnik, CPA
Overcoming Obstacles in the Intellectual Property Transfer Price Analysis
Aaron M. Rotkowski and Scott R. Miller
When a multinational corporation develops and owns intellectual property that is used by its controlled foreign subsidiaries, a reasonable intercompany transfer price should be established as a charge for the use of the intellectual property. The purpose of such an intercompany transfer price is to ensure that the appropriate amount of taxable income is recognized—and the appropriate amount of income tax is paid—in each national taxing jurisdiction. The intercompany transfer price should reflect an arm’s-length price (ALP) that unrelated parties would agree to for the use of similar intellectual property. The Internal Revenue Service provides guidance on the procedures to estimate the intellectual property intercompany transfer price in such a situation. However, the analyst is likely to encounter unique circumstances in each individual case. This discussion addresses issues that the analyst may encounter when applying the procedural guidance provided by Internal Revenue Code Section 482 (and the corresponding Regulations) with regard to the calculation of a fair, arm’s-length royalty rate for the intercompany transfer of intellectual property.
Valuation Issues in the C
S Corporation Conversion
David M. Chiang
Income Tax Valuation Insights This discussion addresses the valuation issues related to the federal income tax conversion from C corporation status to S corporation status. These valuation issues include (1) the eligibility requirements for a C corporation taxpayer to convert to S corporation status, (2) the application of a valuation discount for lack of marketability, (3) the valuation consideration of the built-in gains tax liability, and (4) the appropriate standard of value to apply in the C corporation to S corporation conversion valuation.
Buyers and Sellers of an S
Should Consider the Section 338 Election
Robert P. Schweihs
There are a variety of factors that buyers and sellers consider when deciding whether the acquisition of a 100 percent ownership interest in the target company should be structured as an acquisition of target company equity or as the purchase of target company assets. If the target company is an S corporation for federal income tax purposes, there is a federal income tax opportunity to achieve the best of both worlds—that is, the acquisition of the target company equity treated as a purchase of the target company assets. That federal income tax structure could have a favorable impact (1) on the transaction’s after-tax sale proceeds to the seller and (2) on the transaction’s after-tax cost to the buyer.
Sale of the Closely Held
Personal Intangible Assets versus
Company Intangible Assets
Chip Brown, CPA
Prior to the sale of a closely held C corporation, the seller corporation’s financial advisers should consider any personal intangible assets that may be operated by the corporation. A “personal intangible asset” is an intangible asset that is created and owned by the corporation owner—but is used by the subject corporation. Personal intangible assets may exist when a shareholder’s personal reputation, industry expertise, and/or business relationships contribute significantly to the company business value and expected future cash flow. This discussion summarizes what the closely held corporation owner should consider regarding the identification and documentation of personal intangible assets, particularly with respect to structuring the sale of the closely held C corporation
Implications of the America
for Income Tax Patent Valuations
Ashley L. Reilly
On September 16, 2011, President Obama signed into law the America Invents Act (the “AIA”). The AIA represents the result of many years of patent reform efforts. And, in fact, the AIA provisions do provide significant changes related to (1) the patent application process, (2) the process for challenging pre-issuance and post-issuance patents, and (3) litigation related to various types of patent claims. Taxpayer patents (and other taxpayer intellectual property) are frequently the subject of valuation for a variety of federal income tax purposes. This discussion lists several of these tax-related valuation purposes. The principal question considered in this discussion is: Will the AIA patent reform affect the valuation of taxpayer patents for federal income tax purposes?
The Dangers of the New
David Abbott, Esq., Brian Kittle, Esq., and Andrew Steigleder, Esq.
Within the ever-evolving standards and judicial doctrines applied by the courts to assess the validity of tax-advantaged transactions, there has been an increasing trend to supplement, or even abandon, a traditional risk analysis. Rather, the trend is to perform an analysis that examines not only whether a risk exists, but also the probability that such risk will manifest itself. This new analysis can lead to the application of entirely subjective standards. Such subjectivity can create additional uncertainty for taxpayers in structuring and defending taxadvantaged transactions.
Tax Considerations of Close
Robert F. Reilly, CPA
Valuation analysts are often involved in designing the valuation pricing formula included in close corporation and professional practice buy/sell agreements. In addition, valuation analysts are often asked to interpret or implement buy/sell agreements that call for a “fair market value” price or a price to be determined by “an independent appraiser.” In addition to quantifying the pricing aspects of close corporation buy/sell agreements, valuation analysts should be generally familiar with the taxation aspects of the common types of buy/ sell agreements. This discussion summarizes the income tax implications of the common types of buy/sell agreements.
Reasonable Compensation Analysis for C Corporations and S Corporations
John C. Ramirez
The reasonableness of shareholder/employee compensation is often a highly controversial issue in the context of federal income taxation. This is because what is considered reasonable compensation by the shareholder/employee taxpayer is often considered unreasonable by the Internal Revenue Service (“Service”). According to Internal Revenue Code Section 162, in order to be deductible for federal income tax purposes, executive compensation must be (1) “reasonable in amount” and (2) “based on services actually rendered.” The income tax–related consequences associated with unreasonable shareholder/ employee compensation can be significant (and include payroll taxes, late payments, and tax return filing penalties). For this reason, it is important that valuation analysts and other financial advisers understand the factors that the Service and the federal courts consider when analyzing the reasonableness of shareholder/employee compensation. This discussion focuses on the generally accepted factors and methods used to analyze the reasonableness of shareholder/employee compensation.
Data Sources for Reasonable
Victoria A. Platt
One important component to meeting the Internal Revenue Service standards for proving the reasonableness of shareholder/employee compensation is relying on credible empirical data. This discussion introduces the reasonable compensation analytical procedures that were developed by statutory authority and legal precedent. This discussion also identifies reliable sources of empirical data for the analyst to use in applying the generally accepted reasonableness of compensation methods and procedures.
Section 409A Considerations
Corporation Stock Option Valuations
Katherine A. Gilbert and C. Ryan Stewart
Internal Revenue Code Section (“Section”) 409A involves the taxation of deferred compensation such as stock options and stock appreciation rights. Compliance with Section 409A can be challenging for the management of a closely held taxpayer corporation. Such compliance requires an understanding of the specific Section 409A requirements as they apply to the valuation of the closely held corporation. This discussion focuses on the Section 409A provisions that stipulate the (1) circumstances that require a valuation, (2) appropriate methods to use when performing the valuation, and (3) selection of qualified individuals to perform the valuation of the closely held taxpayer corporation common stock.
Insolvency Procedures under
Irina Borushko and Urmi Sampat
In the current prolonged recession, many industrial and commercial entities have had to restructure their outstanding debt. Many debtor entities have had to restructure their public bonds as well as their private mortgages and notes. In particular, many real estateintensive debtor entities have had to restructure their commercial real estate mortgages. When any amount of debt repayment is forgiven in such a debt restructuring, that event causes the debtor entity to recognize cancellation of debt (COD) income for federal income tax purposes. However, the debtor taxpayer can exclude some, or all, of this COD income to the extent that the debtor entity is insolvent. This discussion summarizes the federal income tax requirements related to the debtor entity recognition of COD income. And, this discussion summarizes the federal income tax requirements for the exclusion of COD income recognition related to debtor entity insolvency. In particular, this discussion focuses on the generally accepted methods and procedures that the valuation analyst may use to measure debtor entity insolvency for COD income exclusion purposes.
Some Thoughts Regarding
Bankruptcy Tax Planning
Roger J. Higgins, Esq.
Planning for when a business faces the prospect of an insolvency restructuring, whether as a bankruptcy case, a state law proceeding, or an out-of-court workout, can be very complicated. And, the landscape can be as charged as a minefield. Throw in income tax considerations, and matters become even more interesting. This discussion provides an overview of some of the more fraught income tax issues that often arise within a restructuring or insolvency context.
Definition of “Readily
Securities for ESOPs
Robert F. Reilly, CPA
When an employee stock ownership plan (ESOP) owns sponsor company stock that is not readily tradable, the sponsor company must provide a number of rights to the ESOP participants (e.g., pass-through voting rights, annual independent appraisals, the retiree “put option,” etc.). When an ESOP owns sponsor company stock that is readily tradable, the sponsor company does not need to provide these rights to the plan participants. For most ESOPs, it is fairly obvious as to whether the ESOP owns private company stock or public corporation stock. However, for some sponsor companies (e.g., a company with stock that trades on the OTC Bulletin Board or on a foreign stock exchange), the determination of “readily tradable” is not always so obvious. Therefore, the Internal Revenue Service has issued final rules as to the definition of the term “readily tradable” with regard to employee benefit plans.
Lightning Strikes Twice, MRI
Wins Big Again—Halloween Verdict Proves
to Be Frightening to Regional Health System
Charles A. Wilhoite, CPA
On October 31, 2011, MRI Associates, Inc. (MRIA) was awarded $52 million in economic damages by an Idaho jury for claims relating to a variety of alleged breaches on the part of Saint Alphonsus Diversified Care, Inc., and Saint Alphonsus Regional Medical Center (collectively, “SARMC”). The breaches related to a magnetic imaging joint venture. The verdict represented the second time in four years that an Idaho jury ruled in favor of MRIA regarding substantially the same complaint. This discussion presents the key facts and circumstances regarding the case, with an emphasis on the damages models and related opinions offered by the financial experts retained by each party.