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Business Valuation

Technical topics regarding tax preparation.
#1
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The sole shareholder of a C-Corporation died in January of 2018. His son inherited the stock. In May of 2018, a business valuation was performed. The business valuation shows a value of $900,000 for the company's stock. The Corporation operates a wrecker service.

Earlier this month, the new shareholder told me he is selling the business for $2,000,000. It is an asset sale which will result in a taxable gain of about $1.7 million.

We anticipate the shareholder will receive about $1.2 million in cash upon liquidation. This would be the cash sales proceeds of $2 million less corporate tax, sales tax, and corporate debt.

If my math is correct, the shareholder will have about a $300k capital gain personally upon distribution. $1.2 million of cash distributed in liquidation less the stock basis of $900k.

It seems the business valuation should have been closer to $2 million, rather than $900,000. The company has about $200k debt.

Is there any way we can use a value for the stock closer to the sales price of $2,000,000? Perhaps the sales price of $2,000,000 less the $200,000 of debt? Or are we stuck with this low business valuation?
 

#2
EADave  
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Hello! I can't speak to the specifics of your client's situation, but I will share a story about my client. My client's husband passed away in 2015; they were 50/50 in their S Corp. She is selling her S Corp to her son in Jan 2020. I instructed her, 4 years ago, to obtain an business valuation, which she did. The valuation came back at a price almost equal to 1X Gross Revenue, which my client thought was a bit high, but we went with it to calculate her stock basis. No harm, no foul, as her distributions never exceeded her before death cost basis; not that I was worried, but it still was in the back of my mind.

Fast forward to 2018, she obtains another, two much more thorough business valuation. One valuation represented the value at her husband's date of passing, and a more recent business valuation using current sales figures. These valuations seemed to be much more thorough, the company studied/analyzed the books from 2015 through 2018, and they came up with a value that was about $1.5MM less than the first company. And, according to my client's knowledge of the industry, probably a more realistic figure. In our case, the more realistic value was a great deal less than originally calculated, but she plans to sell the company to her son at a discount; Gift Tax ramifications and all.

My point, if you can find a business valuation company that will consider performing a retro-active appraisal, it might be worth your client's time to go this route. I can't see, after the passing of the company's founder (my assumption), the company's value increasing that much after a year. This is my conjecture, not being privy to any of your client's records, of course.
 

#3
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Is there any way we can use a value for the stock closer to the sales price of $2,000,000?

Maybe. And that way would be to get a different appraisal. Had a client one time that converted to S to C. We had a valuation done for Sec 1374 purposes. Came back at like $17m. Shortly thereafter, they entertained offers to sell the business for about $100m. There was no way the $17m valuation would hold up for BIG purposes. So they ended up selling the stock…for $100m. Sometimes these appraisals are just no good.

And is it possible that Sec 1202 might apply?
 

#4
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Jeff-Ohio wrote:

And is it possible that Sec 1202 might apply?


Good call. The stock was acquired in 1994 by the father. I believe we can exclude 50% of the gain with the 1202 exclusion on the redemption.

One other item I didn't mention. I didn't want to make overly complicated. But here is an additional fact:

$400k of the sales proceeds will be a note carried by the corporation (or shareholders if distributed in a liquidation). Is there any way to treat this as an installment sale in the corporation, distribute the cash at the time of sale, and treat that as a redemption? Or, must the corporation distribute this note to the shareholders and pay corporate tax on it in the year of the sale?
 


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