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Lead Article Title: AppraisalsSummary: Valuations are vital to a range of business, estate and financial planning transactions. Buyout agreements rely on valuations – either to establish a formula, or as the actual means of determining a buyout price. The price for disability, death, retirement and other buyouts from a closely held business or professional practice may all be based on different criteria. You can’t make $12,000 annual gifts of stock in the family widget company to the kiddies and not value the gift. If your valuation figures are wrong, and no gift tax return is filed, the statute of limitations for an IRS audit of those amounts never runs (tolls). The stakes however, can be huge. If you sell 40% of a family real estate business to a dynasty trust for $20 million and the IRS successfully challenges that interest as being worth $50 million, you might face a gift and generation skipping transfer (GST) tax on the $30 million excess. The following will help guide you through the process of selecting an appraiser, setting the parameters of the valuation, and getting the end product you need.SELECTING THE APPRAISER
◙ Do you need a generalist or a specialist? In medicine, you might have your family practitioner treat an ingrown toenail if it is not too serious. If it is more serious, you should go to a podiatrist. Definitely don’t have your family practitioner perform brain surgery! Generally business appraisal requires use of a higher level of mathematics and statistics than is common to accounting. A valuation of a very small business that you expect to remain small often can be done most inexpensively by a CPA who performs business appraisals during his or her slack season. However, it is impossible to be the best at audit, tax, and business valuation, or, for that matter, even two out of the three. The larger the business, the greater is the consequence of valuation error. For most midsize and large businesses, the stakes become too high to trust a valuation to a generalist CPA, and it is important to engage an appraiser (CPA or otherwise) who is a specialist in business valuation. ◙ How much experience does the appraiser have generally? ◙ Are the appraisers credentials sufficient to provide credibility? ◙ How extensive is the appraiser’s background in appraising the particular business or asset shouldn’t be relevant as good appraisers should be able to value any business, but it might impact time or cost. ◙ Does the appraiser has experience testifying in court if the matter might be litigated? What is the appraiser’s track record (an appraiser who has only testified for defendants might be viewed as biased). ◙ Is the appraiser independent? A CPA must be objective in the performance of the valuation. AICPA Code of Professional Conduct, Rule 102 . This requires impartiality and being free of both actual and perceived conflicts of interest. What other relationships does the appraiser have with the target company? Will these jeopardize independence? How is the appraiser compensated? The tax laws also include requirements for the appraiser to be independent. Treas. Reg. Sec. 25.2512-2(f); 25.2512-3.

APPRAISAL ENGAGEMENT
Agreement. A written engagement letter should be issued identifying the following: the background of the valuation assignment, a description of the business, its entity form and state (e.g., a New Jersey C or S corporation, a Delaware LLC, a New York general or limited partnership, etc.), a list of the owners and their interests, the business interest to be valued (e.g., a 30% common stock interest), the services to be performed (in descending order, the possible services are Complete Appraisal, Limited Appraisal, or Valuation Calculations), the purpose of the valuation (transaction, gift tax, estate tax, litigation, etc.), the valuation date (this is critical, as a valuation is valid only as of a certain date and a limited time period afterward—generally three months for tax purposes), the standard of value (e.g., fair market value, fair value, etc.—this is important, as it determines the valuation premiums and discounts that apply), the level of documentation (appraisal report or brief letter restricted-use report), timing of the assignment (deadlines), the client and appraiser’s responsibilities, and other factors.
Users/Confidentiality. A list of intended users of the report should be indicated. Should the data and report be confidential? Who should be privy to the data?. Should your attorney hire the appraiser to bring the appraiser under the wing of attorney client privilege? Should confidentiality and non-disclosure agreements be signed?
Scope. ◙ Establish the appraiser’s services. What will and will not be done. ◙ Is it a “calculation” engagement for which specific methodologies are agreed to, and which thus has a lower level of analysis and fewer procedures? Or is a full “valuation” engagement desired? ◙ Are there any restrictions or limitations (e.g., not to interview certain key employees when a valuation for purposes of selling the company is undertaken)? How, if at all, do these restrictions impact the appraisal? ◙ Key assumptions (no environmental violations, the business will continue to operate as a going concern, etc.). ◙ Are there restrictions on the use or persons who can access the report?
Value. Beauty is in the eye of the beholder, and so is value. There are a myriad of ways to define value. An appropriate definition must be established from the outset. Tax laws use fair market value. This is defined as the price at which a hypothetical willing buyer would pay a hypothetical willing seller, when both have knowledge of all relevant facts and neither is under compulsion to buy or sell. Treas. Reg. Sec. 20.2031-1(b). If the interest involved is 20% of a family business that would be subject to a discount for lack of control and marketability. However, if you’re a 20% partner in an accounting practice you would not want your interest discounted if you’re disabled. You would want a full payment of what your 20% interest is worth. If you’re selling your business to a suitor looking to expand to your unique market niche, a “strategic value”, which may far exceed “fair market value”.
Data. ◙ Gather information tailored to the specifics of the asset being valued, and the purpose for the valuation. ◙ Conduct site visits. ◙ Use questionnaires and interviews as appropriate. ◙ Collecting financial statements, tax returns and other reports for the business. ◙ Obtain copies of all key legal documents: shareholders’ agreement, buyout agreement, insurance policies, bylaws, certificate of incorporation, key employment agreements, customer/vendor agreements, etc.
Research. ◙ Identify relevant industry and other data and compare it to data for the target company. ◙ Identify comparable firms or assets. ◙ Assess general economic trends. ◙ For closely held businesses total compensation (salary, bonus, perquisites, etc.) is a critical issue to address. Identify industry data and/or data from similar types of businesses as a touchstone to evaluate and adjust figures for the target firm. ◙ Determine rates of return for the industry and comparable businesses. ◙ Identify industry and comparable capitalization rates. ◙ Identify recent sales of comparable businesses, or market value of public companies in similar lines of business.
Analysis. ◙ Review key provisions of the governing documents for the entity to determine if and how they impact value. ◙ Analyze financial data for 3-5 years or more, depending on the circumstances. ◙ Adjust income, expenses and other items to normalize for unusual years or events (e.g. one time events, insurance recovery, etc.). ◙ Adjust for unreasonable perquisites and inappropriate personal expenses (travel, entertainment costs, “employment” of family members, etc.). ◙ Analyze and adjust for related party transactions, loans (are the terms arm’s length? Do they suggest other issues that need to be evaluated? Do they identify related parties that affect the valuation?), etc. ◙ History of the company (review with an emphasis on identifying trends that affect future prospects, strengths and weaknesses). ◙ Products or services offered (identify industry, and nature of business). ◙ Nature of the industry (is the subject business a significant player, or a little fish in a big pond? How competitive? Future prospects for the industry as a whole will help evaluate prospects for the target company). ◙ Personnel and management (unionized or not, contract provisions, tenure, depth of management, etc.). ◙ Analysis of revenues and profits by different product or service categories. Identify trends or circumstances that might make separate analysis of lines preferable to aggregate analysis. ◙ Nature and loyalty of customers (size of average company, dependence on large customers, variation in large customers over the years, etc.). ◙ Competition (identification, strengths and weaknesses, impact on future prospects, etc.). ◙ Expenses (e.g., is production at a maximum unless a new facility is acquired requiring a substantial cost increase? What costs are fixed versus variable and how does this impact future prospects?) ◙ Regulatory environment (is the business regulated and how does that impact the future prospects of the company? Large increases in costs because of recent regulatory changes will have a very different impact that regulations serving as a barrier to larger competitors). ◙ Financing and credit sources (What sources of financing does the business use and how might this impact future growth and costs?). ◙ Other relevant factors appropriate to the valuation at hand. Every business or assets has unique nuances. No checklist or flowchart on valuation, and no rule of thumb, can be more than just a guide. While sometimes rules of thumb (2 x gross and other formulas, may be useful checks on a valuation, they are no more than that). Independent and detailed analysis of the financial and non-financial data, and circumstances, and their impact on value are always essential. Valuations for tax purposes should include an analysis of the factors in Revenue Ruling 59-60 (and successor rulings such as Rev. Rul. 68-609). Each of the factors in this Ruling should be expressly addressed in the report.
Valuation Approaches. The three most common general valuation approaches are: ◙ Market. This involves a comparison to similar entities or assets, what would it cost to acquire the asset. The guideline pubic company method, guideline company transaction method and the guideline sales of interests in the subject entity method are commonly used. ◙ Income. This involves estimates the future earning stream, capitalization of the earnings; etc. What are the expected economic benefits from owning the asset or business in the future? Another approach involves calculating an expected value of future earnings for some time period, and then a present value of the terminal value at that future date. ◙ Asset. This involves estimating the cost of constructing or replicating the asset or business interest. Another approach is to adjust each asset and liability of the business to its current fair market value.
Valuation Methodology. Evaluate all possible valuation methodologies. Accept, modify or reject each based on the particular engagement. Value the asset or business based on the appropriate methodologies. If more than one methodology is applied analyze and reconcile the findings to arrive at a single conclusion or range as to value. If different results are weighted, explain the rationale for favoring one method over another.
Discounts. Should discounts or premiums be attached to the asset or business interest involved? These could include: discounts for dependencies (key person, limited vendors, key client), excessive concentrations, lack of marketability (inability to sell in a timely manner), lack of control (e.g. for a non-voting equity interest, or minority non-controlling equity position; inability to pay distributions; inability to select management). The determination of valuation discounts should evaluate all relevant factors, which might include: prospects for growth, degree of control over operations and distributions, restrictions on transferring equity interests, prospects of the particular business, expectations for the industry, etc. A premium might be appropriate if, for example, the asset involved is a block of stock that can be the swing vote in a fractious business. Is the interest involved that of an assignee or a substitute member or partner? For tax purposes, Code Section 2703, which requires that in certain instances restrictions in the governing documents for the entity must be ignored, should be addressed.
Review. The preliminary valuation findings should be reviewed with you and all your advisers.

CONCLUSION
Appraisals are an integral part of estate, financial and business planning. The process is complex, yet those seeking to obtain values, will be better served by having an understanding of the process, assumptions and issues involved.

Checklist: Second Article 2 lines less than One Page [about 54 lines]:
Checklist Article Title: Appraisal Reports

Summary: For an appraisal to be respected by the IRS or a court the report should meet a host of requirements. Some of these are listed below. This checklist can be used to evaluate a report you intend on using in a divorce, tax plan or other matter.

Appraisal Report
• The report should comply with any appropriate standards such as USPAP which are general standards endorsed by many. Other standards of specific organizations include ASA, IBA, and AICPA standards. For example, The American Institute of Certified Public Accountants (AICPA) issued SSVS Number 1 to provide guidance and standards for CPAs performing valuations. Other standards include: The Uniform Standards of Professional Appraisal Practice (USPAP), National Association of Certified Valuation Analysis (NACVA), or the American Institute of Certified Public Accountants (AICPA), etc. This checklist focuses on SSVS 1.
• A statement as to whether the report is a “calculation report” or a “valuation report”? SSVS No. 1, §901. A valuation report contains a conclusion as to value based on the CPAs selection of methodologies deemed most appropriate. In contrast, a calculation report is the application of a valuation methodology selected by the CPA and client.
• A statement as to whether the report is a “detailed report” or a “summary report” under SSVS 1.
• Discussion of any limiting conditions.
• If the appraiser did not prepare the financial statements for the business being appraised it should state this and that it does not assume any responsibility for the financial information.
• The report details should include discussion of: ◙ Sources of information. ◙ Assumptions and facts upon which the report is based. ◙ History of the business and entity. Description of the entity (or asset). ◙ Formation of the entity, legal structure, governing legal documents. ◙ Operations of the business (customers, suppliers, personnel, competition, customers, seasonality, etc.). ◙ Analysis of non-operating assets and liabilities (e.g., loan to shareholder). ◙ Analysis of nonfinancial information relevant to the appraisal. ◙ Management. ◙ Equity interest (classes of equity, rights of different classes, etc.). ◙ Entity’s expectations. ◙ Conditions and expectations (general economic circumstances, etc.). ◙ Analysis of company financial data and other information. ◙ Valuation adjustments (e.g., normalization of earnings for unusual years, adjustment of key shareholder’s salary). ◙ Discounts. ◙ Valuation approaches and methods considered. ◙ Valuation methodologies and procedures actually used. ◙ Analysis, reasons and justification for the conclusions reached. This should include a reconciliation of the various estimates and conclusions of value (e.g., if three different valuation methodologies were applied they could be reconciled to a single figure).
• Details are vital. The report should evaluate market size and economic information and their relation to growth potential. An appraisal of a local tire shop may quote data about Goodyear and Firestone, but must also address the local situation. If market data is relevant, the report must analyze the data to show what type of growth rates are sustainable. The report should explain how the methodologies were implemented and the basis for any assumptions. Adjustments to the discount rate, historical sales growth rates, changes in profit margins, cash flow, should all be clearly explained. When market methods are used there should be a clear list of possible choices, presentation of criteria for exclusion/inclusion, support for how value drivers were determined, and specifics as to how value was actually determined based on the guideline companies. Weighting in reconciliation of value must be supported and justified. Boilerplate and unsubstantiated conclusions should be avoided.
• Representations of the appraiser.
• Calculations. The report should enable a reader to replicate the appraiser’s analysis.
• The report should reach the conclusions required to meet the stated objective.
• Specialists. If another person or firm was employed by the appraiser assuming primary responsibility for the report, that other specialist should be identified (e.g., an appraiser values 40% of an LLC owning an interest in a shopping center and relies on an independent MAI for the value of the property, the MAI must be disclosed).
• Certification of the appraiser.
• Signature of the person primarily responsible for the report.
• Appraiser’s qualifications including a curriculum vitae.
• Exhibits. These might include financial statements or tax returns for the entity, and the analysis of them. Data for comparable (guideline) businesses, or comparable data for whichever methodology was used.

Recent Developments Article 1/3 Page [about 18 lines]:

◙ Listen to your Tax Adviser: The taxpayer’s tax adviser recommended not amending tax returns. The taxpayer, instead of heading his long time advisers advice sought out another practitioner who amended the returns without researching the appropriateness of that action. The Court held that the accuracy related penalties could be assessed against the taxpayer and that the taxpayer could not avoid them by claiming reliance on the second preparer. Larry Wadsworth , TC Memo 2008-171 (Tax Ct.).

◙ Business Start up and Organization Expenses: The I RS simplified the deduction of these costs in TD 9411, 07/07/2008. After September 6, 2008 a formal election to deduct these costs will no longer be necessary, in some instances this new paradigm may be applied to expenses incurred after October 22, 2004. Instead the IRS will presume that every taxpayer would want to deduct these costs unless the taxpayer elects not to. Code Sections 195, 248, and 709.

◙ Partner Merger Rights: Section 121-1102(d) of the NY partnership law provides that a limited partner shall not have the right to attack the validity of the merger except to contest compliance with the provisions of the partnership agreement, or the notice provisions of the statute. Since these exceptions weren’t found to apply, the limited partner’s sole remedy when objecting to partnership’s merger is appraisal proceeding. Section 121-1105(b) of the Partnership Law. Appleton Acquisitions, LLC v. National Housing Partnership, 10 N.Y.3d 250, 856 N.Y.S.2d 522.

◙ Watch Will Formalities: Several recent cases have evaluated whether the formalities of signing a will were properly handled. The lesson in all is that caution and attention to formality remains advisable. In one case, the witnesses names were printed instead of signed under that of the testatrix where the formal text of the will concluded. However, both the testatrix and witnesses did sign the self-proving affidavit that followed. On appeal the court held that substantial compliance with the requirements would suffice. Hampton Road Seventh-Day Adventist Church v. Stevens, 657 SE2d 80 (2008).

Potpourri ½ Page:

◙ More Discounts: How many discounts for lack of control (DLOC) are there? Many appraisals estimate discounts for lack of control based on data from public companies. But a non-controlling minority interest of a privately held company has a greater risk than a non-controlling minority interest in a public company and warrants a greater DLOC. As but one example, the public company has SEC and other governmental oversight, the private company does not.

◙ Estate Expenses: In most estates it takes some months before a will is admitted to probate, an estate tax identification number obtained and an estate checking account opened. It is common for a family member to advance expenses personally until that time. Rather than handling this in the typical haphazard uncorroborated manner, have the estate (even if signed initially by the executor named in the will waiting to be appointed) sign a loan agreement with the family member acknowledging the estate’s liability to reimburse for expenses advanced to the estate. Since the amounts and timing are unknown, this can function akin to a line of credit, like a draw down construction loan. Prepare a schedule of the expenses with attached corroboration and treat each as a request for a further advance on the loan.

◙ Beware of Reciprocal Trusts: Dad sets up a trust naming Mom and kids as beneficiaries which owns $1M life insurance on Dad. Mom sets up a trust naming Dad and kids as beneficiaries which owns $1M life insurance on Mom. The trusts are substantially the same. The mirror image nature of the trusts could justify unwinding the two trusts as being economically equivalent to no trust having been established. U.S. v Grace, 395 U.S. 316 (1969). This would undermine the intended results. Efforts should be made to differentiate trusts established by spouses: different trustees, different assets (e.g., permanent insurance on husband, term in a different amount on wife), document different and independent planning objectives for each trust, different distribution standards, etc.. If existing trusts might face this issue consider taking corrective action at your annual trust review meeting. Have a trustee resign from one trust, use powers to appoint new trustees, contribute a different asset to one of the trusts, etc.

Back Page Announcements:

Publications:

Seminars: Sept. 9 “Divorce: Legal, Tax, Investment, Insurance Planning”. Speakers: Martin Shenkman, Esq., John Finnerty, Esq., Kalman Barson. CPA, John Canavan. Marriott Glenpoint, Teaneck, NJ. Call 201-845-8400 for info. Sept. 18, 8:30 a.m. “Health Issues in Estate Planning: HIPAA, Chronic Illness, Competency”. UJA. Marriott Marquis, 1535 Broadway, NYC. Call 212 836-1531. Sept. 18, 3 p.m., “Asset Protection Steps: LLCs, dynasty trusts, and more”. NJSSCPA. Mayfair Farms, West Orange, NJ.

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