How B.I.G. is your valuation discount?

The Notorious B.I.G.

by Michael E. Stover, CPA/ABV

No, I’m not talking about the well-known American rapper and hip-hop artist. I’m talking about the calculation of the Built-In Gains (BIG) discount as it applies in business valuation cases. After the repeal of the General Utilities Doctrine in 1986, the income tax basis of assets held by the target in a stock acquisition is carried forward with no increase in value. When an asset with unrecognized appreciation is held by a C corporation, then a built-in gains tax obligation exists. The BIG tax is not paid by the corporation until that asset is sold. It’s this future liability that gives rise to the valuation discount.

How to calculate this discount, however, is the BIG question. There are two schools of thought, (1) a dollar-for-dollar discount and (2) a present value approach.

Dollar-for-dollar Discount

Estate of Dunn and Estate of Jelke are well-known cases that have allowed dollar-for-dollar discounts for the BIG tax. Students of this school believe that a hypothetical buyer of a corporation’s stock would demand a full reduction in the purchase price for this future tax liability. The Fifth Circuit, in Dunn, reasoned that when calculating the asset-based value of a company, it is a foregone conclusion that the assets will be sold. In Jelke, the Eleventh Circuit reversed the Tax Court’s use of a present value approach following the argument in Dunn.

Present Value Approach

Estate of Litchfield and Estate of Jensen are well-known cases for the other school. These students believe that a corporation’s assets will be sold over a sometimes lengthy period of time, and the resulting future tax payments should be discounted to their present value. This approach is more difficult to put into practice, however, because one must forecast when the assets will be sold, as well as consider the future appreciation of the asset’s value.

B.I.G. Discount’s Uncertainty

Outside of the Fifth and Eleventh Circuits, you’ll find little certainty over this issue. The trend, however, seems to be favoring the present value approach with consideration of the future anticipated appreciation of the assets. You should consider historical data, as well as management’s plans, when determining the estimated holding period. Although, one well-known expert has published an article in which he calculates the difference between buying a corporation’s stock and buying the underlying assets and concludes that buying the stock is not as attractive as buying the assets even after recognizing 100% of the BIG tax liability.

One thing’s for sure. As this issue draws more attention, more analysis will be required. If you need help in determining the fair market value of a closely held business interest, give one of our accredited valuation experts a call.

Our Valuation Group is ready to help you and your clients determine the values of family limited partnerships and closely held business interests.

Michael Stover
– or 937-223-5247

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