In prior posts, we have explained various valuation concepts, including the discounted cash flow (DCF) and comparable company analyses. In this post, we examine how those concepts can be applied for tax purposes. Like an appraisal in Delaware, when determining the fair market value of a closely held corporation or ownership interest in a corporation for tax purposes, tax courts consider a broad array of factors and methods. Pursuant to Treasury Revenue Rule 59-60, factors to consider include a company’s worth, its revenues, industry information, and, in the case of a minority interest, the degree of corporate control enjoyed by the interest. In Estate of Gallagher v. Commissioner, No. 16853-08, 2011 Tax Ct. Memo LEXIS 150 (T.C. June 28, 2011), the Tax Court was asked, by way of notice of deficiency in federal estate tax, to determine the fair market value of membership interests in a Kentucky limited liability company included in the decedent’s gross estate. The Tax Court considered both a DCF analysis and a comparable companies analysis from two competing experts. Given the lack of comparable companies, the court relied exclusively on the DCF method. The experts also debated over the projections and growth rate of the subject company and various discounts to reflect the company’s status as an S corporation, the minority interest position, and lack of marketability. The court took parts of both experts’ analyses, but calculated its own discount rate and applied both a minority discount and a lack of marketability discount. The court ultimately concluded that based on a DCF analysis, the fair value of the shares as of the valuation date was $32,601,640, or $8,212 per share.

** Lowenstein Sandler LLP thanks Anish Patel, a student at Seton Hall Law, for his contribution to this blog.