Friday, January 31, 2014
Rebecca Morrow (Wake Forest) presents Valuation in Light of Uncertainty at Kentucky today as part of its Faculty Brown Bag Workshop Series hosted by Jennifer Bird-Pollan:
Buyers and sellers of business interests, IRS officials, and courts have long faced a serious problem: they must frequently determine the present value of a future tax liability without knowing when that liability will be incurred. For example, when a corporation exists primarily to hold assets for the benefit of its owners, its value depends on the net value of the assets it holds. Such corporations are extremely common and often hold highly appreciated assets. The tax liability on the appreciation is not incurred upon the transfer of stock in the corporation; rather, it is incurred when the corporation sells its appreciated assets. Since the appreciation experienced prior to the stock transfer (referred to as “built-in gain”) will cause a future tax liability, it reduces the value of the company and therefore the value of the stock. Unfortunately, at the time when the stock is transferred, it is generally unknown when the appreciated assets will be sold. Thus, buyers and sellers attempting to arrive at appropriate stock prices and taxpayers, IRS officials, and courts attempting to calculate the estate or gift taxes due on gratuitous stock transfers must calculate the present values of future tax liabilities without knowing when those liabilities will be incurred. Courts and scholars have struggled with this problem, alternately assuming away uncertainty regarding timing or denying its importance. The result has been doctrinal inconsistency, taxpayer uncertainty, and opportunistic behavior.
This Article proposes a new valuation methodology to calculate the present value of a future tax liability when it is uncertain when that future tax liability will be incurred. Instead of ignoring uncertainties regarding timing, market participants, IRS officials, and courts can and should value future tax liabilities in a way that accounts for them by using weighted probabilities of multiple likely outcomes. This Article’s key insight is to adapt stock option valuation techniques, which account for similar uncertainties, to this problem. The resulting approach is both theoretically satisfying and eminently workable by parties, the IRS, and courts.