I look forward to working with Pluris again and highly recommend their services to other trust & estate practitioners.
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Justia Inc.

Tax Valuation

What securities does Pluris typically value for tax purposes?

Pluris specializes in valuing securities or interests where the key valuation issue is the discount for lack of marketability. Pluris has particular depth of expertise in the valuation of the restricted securities of publicly traded companies — where the only valuation issue is the discount for lack of marketability. That means restricted stock and, also, non-statutory (non-qual) stock options.

What other assets can Pluris value for tax purposes?

Pluris can value any other illiquid security, asset or fractional interest where the discount for lack of marketability has an impact on the valuation. This includes fractional interests in real estate and family entities (FLPs or LLCs) that hold real estate or marketable securities, but also standard operating businesses. Another very important focus area is general partner interests (“carried” interests) in hedge funds and private equity funds.

Why is it particularly important to have access to the LiquiStat data for tax valuations?

First, because marketability discounts remain the most contentious issue between the IRS and taxpayers: in audit and in Tax Court. Second, because all the traditional methods for determining the discount have been criticized by the Tax Court in recent years. In particular, in the McCord case, both the traditional pre-IPO discount studies and restricted stock private placement studies were found to be inadequate by the Tax Court. The pre-IPO studies are considered inherently biased. Private placements are considered subject to too many factors other than the illiquidity of the stock sold to be pure illiquidity measures.

The LiquiStat database is different. Because the transactions in the database are sales of restricted stock, they reflect the difference in price of illiquid versus liquid securities. Yet, because the transactions are not private placements by the issuer, the other factors do not come into play and muddy up the liquidity discount measure. For more information on the differences between the LiquiStat data and the traditional forms of illiquidity discount data, please see our Press Room.

Please explain the implications of the McClatchy case to “control” stock.

In the McClatchy case, the decedent died holding a very significant block of stock in McClatchy Newspapers, Inc., worth approximately $36 million at prevailing market prices. The decedent, however, was chairman, CEO and editor of the company at the time of his death. In other words, he was an “affiliate” under the definition of that term in Rule 144. This fact alone caused his “control” stock to be considered restricted and, therefore, discountable. After litigation between the estate and the IRS, and a decision for the IRS in Tax Court, the 9th Circuit Court of Appeals reversed and held for the estate. McClatchy indicates that estates of affiliates, or control persons, as that term is defined in the securities regulations, should value their stock at substantial discounts for lack of marketability to account for the restricted nature of such control stock.

How does Pluris value restricted stock?

Pluris uses traditional methods, theoretical models and data from its ongoing LiquiStat study to value restricted stock. Because the inherent problems with the pre-IPO studies are worse than the problems with the restricted stock private placement studies, and certain of the restricted stock studies are very well established as benchmarks for the discount, an indication from the restricted stock studies is developed as a starting point. This discount indication is then further developed by an analysis of the LiquiStat data. In addition, the analysis can be supplemented with theoretical models and an analysis of the cost to borrow the subject securities. For more information, or for a quote, please e-mail us.

Why do so many tax advisors suggest transferring non-quals to GRATs?

Non-statutory, or non-qualified, stock options (non-quals) are highly leveraged investments. This means they can be expected to show explosive increases in value, should the underlying stock increase in value during the term of the trust. In a simplified example, assume you could transfer only a certain dollar-amount to the GRAT — say $10 million, based on today’s values. If the choice is between transferring at-the-money options worth $1 per option and shares worth $10 per share, many advisors would opt to transfer the options. This is because 10 million options could be transferred under these conditions, while only 1 million shares could be transferred. At almost any scenario of stock price appreciation, the wealth transfer from the GRAT to the remaindermen would be greater if the GRAT held options.

How does Pluris value stock options?

In the estate and gift tax arena, the options valued are typically vested, non-qualified stock options. These options are long-term options issued by the issuer of the underlying stock, so they are almost indistinguishable from illiquid warrants.

Ignoring Revenue Procedure 98-34, the starting point should be the theoretical model (usually, the Black-Scholes model) price for the option. However, this model price does not factor in the illiquidity of the option. For non-traded options, therefore, a discount must be taken.

To the best of our knowledge, there is no model or empirical study other than the LiquiStat database available for determining such discounts. Therefore, the proper method is to use the LiquiStat data to determine the appropriate discount for the warrant.

However, Revenue Procedure 98-34 establishes a “safe harbor” for option valuations. Some tax advisors advise their clients to adopt this method, rather than opting for methods that can more accurately reflect the “true” fair market value of the options. If Pluris is retained to value your client’s options, we may provide both the Revenue Procedure 98-34 value and the fair market value in our report.

Would my client benefit from the LiquiStat database for option valuations, too?

Almost certainly, yes. The appropriate discounts for non-traded warrants and options are very significant. Ignoring such discounts would severely overstate the value of the gifted amounts and the client’s gift-tax liability. We are aware of no empirical data or model that can explain and determine discounts for non-traded warrants and options, other than the LiquiStat data. For more information, or for a quote, please e-mail us.

My client is a General Partner in a private equity fund. Can you explain how Pluris values such interests?

Pluris uses two methods to value the “carry,” which usually comprises the bulk of the value of a General Partner’s interest. The first method is a standard discounted cash-flow method, discounting the projected investment earnings for the fund to their present values. The second method uses options pricing methods to determine the value of the fund, recognizing that the “carry” is the equivalent of a call option on a portion of the fund.

If my client is making a gift, are Pluris’ valuation reports designed to constitute “adequate disclosure” under the applicable regulations?

All of our tax valuation reports are designed to constitute adequate disclosure, and contain statements reflecting that the report includes all information necessary to satisfy the adequate disclosure requirements.

How do you charge for your tax valuations?

We charge fixed fees, rather than hourly charges, providing the client with more upfront visibility on what the cost of the valuation will be. The fees vary based on the size and risk of the engagement and the complexity of the analysis. For a quote on a specific tax valuation matter, please e-mail us.

What kind of assistance can you offer in the case of an audit?

We offer all necessary assistance to support our conclusions, whether answering correspondence or phone calls from the IRS, meeting with agents during the audit process, or testifying in court. The fees for such additional services are based on professional hours spent.

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