BV204 Exam

Question 1

Definition of a pass-through entity (“PTE”)

Answer 1

A business entity that has elected to “pass through” to its owners the responsibility for payment of income taxes on the entity’s income. In other words, the PTE does not pay income taxes at the entity level. Rather, the entity’s income is attributed to its owners, who then pay taxes on that income.

Question 2

S-corp election requirements

Answer 2

i) must be a domestic corporation; ii) cannot be an ineligible corporation - partnerships, corporations, and many types of trusts may not be stockholders; iii) cannot have more than 100 stockholders; iv) no stockholder may be a nonresident alien; v) can only have one class of stock (but different voting rights are allowed)

Question 3

Gross v. Commissioner

Answer 3

minority interest valuation: Court rules earnings were after corporate taxes (since s-corps dont pay taxes), and before personal taxes. The appropriate discount rate was after-taxes too

Question 4

Wall v. Commissioner

Answer 4

minority interest valuation: The Court cited Gross and determined the income stream should not be tax-affected

Question 5

Heck v. Commissioner

Answer 5

minority interest valuation: The Court discounted pre-tax earnings with an after tax cost of capital.

Question 6

Adams v. Commissioner

Answer 6

majority interest valuation: taxpayer appraiser developed a pre-tax capitalization rate to be applied to pre-tax earnings, but the Court ruled a post-tax discount rate was appropriate.

Question 7

Dallas v. Commissioner

Answer 7

taxpayer’s appraiser tax adjusted earnings under the assumption the company would lose its s-corp status under a hypothetical sale assumption, but the Court ruled there was no evidence to support this assumption.

Question 8

S corporation structure may have little or no impact on value if:

Answer 8

(1) Determining fair market value of a controlling interest, and (2) The most probable “willing buyer” is determined (by market research into the transactional environment for the company) an ineligible stockholder, such as a C corporation (public or private).

Question 9

S corporation structure may have value if:

Answer 9

(1) Determining fair market value of a minority interest. (2) The most probable “willing buyer” is an eligible stockholder.

Question 10

Distributions for tax liability _______ provide economic value to the stockholder

Answer 10

Distributions for tax liability doesn’t provide economic value to the stockholder

Question 11

Distributions above tax liability (i.e., dividends) _______ economic value

Answer 11

Distributions above tax liability (i.e., dividends) create economic value

Question 12

Inadequate distributions are extremely ________ to the S corporation stockholder

Answer 12

Inadequate distributions are extremely unfavorable to the S corporation stockholder

Question 13

Given all other risk factors being equal, a stock that pays a dividend, causing an immediate tax consequence, is worth ______ than a stock that provides capital appreciation, which is tax deferred and then possibly taxed at more ________ rates.

Answer 13

Given all other risk factors being equal, a stock that pays a dividend, causing an immediate tax consequence, is worth less than a stock that provides capital appreciation, which is tax deferred and then possibly taxed at more favorable rates.

Question 14

What tax rates should be used when valuing an S corporation under each standard of value? (1) Fair market value (2) Investment value

Answer 14

(1) Fair market value – the income tax rates applicable to the hypothetical buyer. (2) Investment value – the tax rates applicable to the specific buyer.

Question 15

The SEAM yields an adjustment to _______, not __________.

Answer 15

The SEAM yields an adjustment to equity, not invested capital

Question 16

Dividend and capital gains tax rate changes ________ change the SEAM.

Answer 16

Dividend and capital gains tax rate changes will change the SEAM.

Question 17

re. SEAM: If the two tax rates remain equal but their amount changes, the model will also _________.

Answer 17

If the two tax rates remain equal but their amount changes, the model will also change.

Question 18

SEAM yields a __________ level of value

Answer 18

SEAM yields a minority, marketable level of value

Question 19

SEAM is applied as follows:

Answer 19

SEAM is applied as follows: ♦ Income approach: estimate the corporate income tax and deduct from projected pass-through income ♦ Market approach: Apply the GPC ‘C corporation’ multiple to the pass-through operating metric, as usual ♦ Apply the SEAM, given the payout and tax rate assumptions ♦ If an approach has been used that yields a control value, apply a discount for lack of control

Question 20

Delaware Chancery Court - S. Corp Adjustment Model

Answer 20

Question 21

Like size and illiquidity, the long-horizon cost of capital has __________ embedded in it.

Answer 21

Like size and illiquidity, the long-horizon cost of capital has tax affects
embedded in it.