• March 23, 2023


The latest turn in the 25-year tax-affecting debate went in favor of the taxpayer in Cecil v. Commissioner of Internal Revenue.  The long-awaited decision pertaining to the 2010 transfers of stock in The Biltmore Company by descendants of the Vanderbilt family was rendered on February 28, 2023.  Two primary valuation issues were addressed: (i) whether it was appropriate to apply an entity level tax burden to a pass-through entity and (ii) whether it was appropriate to appraise a non-controlling interest in an asset-intensive hospitality company using an asset approach.  We first address the issue of taxes.

The tax-affecting issue first centers around whether the earnings of a pass-through entity, such as an S corporation, partnership or LLC, should be reduced by an entity level tax burden when valuing the enterprise.  Simply stated, should such entity be valued based on $100 of pre-tax, entity-level earnings or an after-tax amount.  Secondary questions on this point include the tax rate to use and to what extent the single layer of taxation stemming from the pass-through structure adds value relative to the value of an otherwise identical C corporation.  

In Cecil, it was notable that experts on both sides agreed that tax-affecting was appropriate.  The Court found itself required to agree.  The Court also highlighted an important statement made in the Jackson decision, stating “there is not a total bar against the use of tax affecting when the circumstances call for it.”  Then, seemingly in an effort to preempt those wishing to consider the tax-affecting issue now settled, the Court stated, “we are not necessarily holding that tax affecting is always, or even more often than not, a proper consideration for valuing an S corporation.”

Taxpayers and their advisers should consider the following in light of this decision:

  • The USTC made it clear that this issue will be examined on a case-by-case basis going forward, and that the Cecil decision will not close the door on this debate.
  • If you have an open audit where tax-affecting is being disallowed, the Cecil decision now replaces the Jackson case as the latest decision to address this issue, provides further insight into the USTC’s approach to this complex issue, and could provide the basis for an audit to be resolved favorably.    
  • Best practice for taxpayers that are transferring stock in closely held operating businesses structured as pass-through entities for income tax purposes is to obtain a valuation from an appraisal firm that is fully aware of the history of the tax affecting debate and the relevant cases, can articulate the reasoning for such an adjustment, applies a methodology that quantifies the differences between taxable and pass-through entities, and is prepared to discuss the issue at length in the audit setting.  

The Cecil decision was also notable in that it addressed the issue of whether an asset-intensive business ought to be valued on the basis of its underlying net asset value or on the basis of its earnings and cash flow.  Depending upon the specifics of a given matter, the application of an asset approach may yield a value that meaningfully exceeds that derived through the direct capitalization of that entity’s cash flow.  In the specific case at hand, you have The Biltmore Company that operates a world-famous entertainment, hotel and retail business centered around a former Vanderbilt family mansion and sitting on 8,000 acres.  The Court clearly viewed The Biltmore Company as a going concern, operating business.  It reasoned further that the hypothetical willing buyer and willing selling of non-controlling interests in The Biltmore Company would not consider liquidation to be a realistic, potential outcome.  Based on this fundamental view, the Court concluded that an asset-based approach was irrelevant and placed no weight on underlying net asset value, instead placing full weight upon a valuation based on The Biltmore Company’s earnings and cash flow.  

Please stay tuned for a more detailed analysis of the Cecil decision, including commentary on the topic of reliable methods to derive a discount for lack of marketability, an issue of great importance when it comes to the appraisal of closely-held business interests.  

For more information on this issue and how it may affect you or your clients, please contact us.