Could New Section 2704 Regulations Eliminate Discounts Applicable to Transferred Interests in Family Owned Entities?

Posted on June 30 2015 by admin

Section 2704(b)

Internal Revenue Code Section 2704(b) provides that certain “applicable restrictions” that would typically justify the application of lack of control and/or lack of marketability discounts to transferred interests in closely-held family entities such as limited partnerships or limited liability companies are to be ignored for the purpose of valuation, if those interests are transferred either by gift or upon death to or for the benefit of other family members.

Applicable Restrictions

An applicable restriction is one that restricts the ability of an entity to liquidate with terms that are more restrictive than under applicable default state law and that either disappears after the transfer to a family member or when the family collectively is vested with the authority to eliminate it.

To preclude a restriction from being applicable, statutes have been changed to ensure that the default rules under state law restrict the ability of the entity to liquidate.

Statutory Proposal and Regulations

There has been a proposal to amend Section 2704 to create an additional category of restrictions that would be disregarded when valuing an interest in a family controlled entity. It would apply to a transfer of an interest to a family member, if after the transfer the restriction will lapse or may be removed by the transferor or the transferor’s family. These disregarded restrictions would essentially include limitations on a holder’s right to liquidate its interest, which are more restrictive than a specified standard to be identified in the regulations.

Status of Proposed Amendment to Section 2704

On May 10, 2015 Cathy Hughes of the U.S. Treasury’s Office of Tax Policy spoke at the ABA’s Tax Section Meeting. She commented on proposed Section 2704 regulation which might have a dramatic impact on the valuation of interests in closely-held limited partnerships and limited liability companies transferred to family members.

Ms. Hughes suggested that the 2704 regulations might be issued later this summer or fall prior to the ABA Tax Section meeting which is September 17-19.

Treasury regulations are typically effective on the date final regulations are issued. At least several years typically lapse from the time proposed regulations are issued until the regulations are finalized. In very limited situations, proposed regulations provide they will be effective when finalized retroactive back to the date of the proposed regulations.

Possible Responses to the Proposed Amendment

Many practitioners believe that if enacted, an amendment to Section 2704 would ultimately be rejected by the Tax Court in a manner analogous to Kerr v. Commissioner in 1999. In that case, as well as Jones v. Commissioner, Knight v. Commissioner, and Harper v. Commissioner, the IRS argued that the term “applicable restriction” in Code § 2704(b) includes any restriction that limits the ability of a partner/member to liquidate his interest in the partnership/LLC that is more restrictive than state law. In support of its argument, the IRS cited Regulation § 25.2704-2(b), which provides that an “applicable restriction” includes any restriction to liquidate the entity “in whole or in part”. In all four cases, the Tax Court rejected the IRS’s argument.

Another important consideration is whether the elimination of lack of control and lack of marketability discounts will ultimately squash the Treasury’s plan to amend Section 2704 because the instructions to Form 706 (United States Estate Tax Return) and Form 709 (United States Gift Tax Return) instruct the preparer to determine the fair market value of the decedent’s assets or the gifted assets.

Since fair market value is defined as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts, it is our opinion that the business valuator must take lack of control and lack of marketability discounts into consideration unless the instructions to the forms are revised.

By Gary Ringel, CGREA

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Divorce Business Valuations: The “Double Dip” and Reasonable Compensation Conundrums

Posted on June 17 2015 by admin

DFamily Law Court magistrates often face two dilemmas regarding what monthly spousal maintenance payments should be when a business is owned by the divorcing couple and is an asset to be distributed in the property settlement part of the divorce.

For purposes of discussion, let us assume that the spouse who runs the couple’s business is Husband and that he will pay Wife for her 50% equity interest and he will continue to operate the business as his own; and, that Wife does not work in the business. Let us also assume that the only compensation going to the marital community is the compensation Husband earns out of the family business.

The dilemmas faced by the judge are these: 1. If Wife gets her 50% interest in the business bought out by Husband, should she also get spousal maintenance payments; and, 2. if Wife gets paid for her 50% business interest by Husband, should the amount of Husband’s compensation used to calculate the spousal maintenance payments be the same compensation deemed as a reasonable expense in valuing the business under an income approach?

Dilemma 1

Dilemma 1 is frequently protested in divorce by Husband who has to purchase Wife’s 50% business interest and also has to make monthly spousal maintenance payments. Husband will often cry “foul” and contend that this is a case of “double dipping”. That is, Wife already receives her interest in all future compensation of Husband because it is already contemplated in the business valuation. Some business appraisal experts do not agree with this thought process. The reason is this: The value of the business is the value of a marital asset, usually done at some date near the date of service of notice of divorce. This is no different than determining the value of a home, a marital asset which is also to be considered for property settlement purposes.

The value of the business is calculated on the amount of earnings or cash flows remaining after reasonable compensation has been deducted. It is this remainder or “excess,” generally after an estimate for income taxes has been removed, that will be valued in arriving at the portion of the value of the business asset to be distributed to Wife. There is, therefore, no double dip involved if spousal maintenance is to be paid by Husband. On the other hand, if no compensation expense is considered by the business appraiser in arriving at a value for the business, some appraisers then believe double dipping is occurring; that is, that the same compensation is being, in effect, considered twice: 1. by its exclusion in the valuation of the business thus overvaluing Wife’s interest; and 2. by it also being used in the spousal maintenance calculations.
Dilemma 2

Dilemma 2 may also bring opposition by Husband, who operates the couple’s business, and who also has to pay spousal maintenance. Husband, however, may find himself in his own dilemma. For example, in the valuation of an interest in a professional practice, say a medical one, reasonable compensation may be researched by the business appraiser to be $400,000, when the Husband/Doctor actually averages about $700,000 annually, and has done so for the last five years and likely will, for the next five. Husband will argue that his compensation for spousal maintenance purposes should be based on the $400,000 number and not the $700,000 amount.

One school of thought by business appraisal experts is that using the $400,000 as the benchmark for basing future spousal maintenance payments would be a mistake. The reason is this: The $400,000 is used for business valuation purposes as reasonable compensation to be paid to Husband/Doctor solely to arrive at a value under the standard of fair market value (*) . It is what the “market” at large would consider as reasonable compensation. Another way of thinking about this is to imagine what an absentee owner would pay to a physician to take the place of Husband to be involved in the practice: $700,000, or the market rate of $400,000 annually. If spousal maintenance is based on only the $400,000 amount, Wife will be losing out on an average of $300,000 per year on which her spousal maintenance payments would also be based.

Another school of thought is that only the $400,000 amount should be used for determining spousal maintenance in order to avoid, or lessen the effect of, the “double-dip” scenario mentioned previously.

Concluding Thought

If you are thinking these dilemmas have to be something that gives judges gray hair in trying to determine what is equitable to the divorcing spouses, my impression is that you are… absolutely right!

Writer’s note: The foregoing comments are reflective of issues involving divorce cases occurring in Maricopa County, Arizona and may not be what happens in divorce matters in other jurisdictions. Other states, for example, may treat these two dilemmas entirely different than what has been depicted in this article.

By Don R. Bays CPA, ABV, CVA, CFF

(*) Fair Market Value is defined in the Statement on Standards for Valuation Services, No. 1, of the American Institute of CPAs as: (T)he price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.

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Did You Just Try to Scam a Forensic Accountant?

Posted on June 9 2015 by admin

As a forensic accountant, I know that telephone scams are becoming increasingly more common. However, I was surprised when I actually received a phone call recently with an automated message stating that I needed to call back regarding a serious tax liability. Although I knew it was bogus, I called back and spoke to a gentleman with a foreign accent, purporting to be an IRS representative, who claimed that I owed back taxes which needed to be taken care of immediately. When I explained to the caller that I am a CPA and that I know that the caller was committing fraud, he hung up immediately.

This particular scam is typically prevalent around tax filing deadlines, and I did receive the call just prior to April 15th. Last year, the U.S. Treasury Inspector General for Taxpayer Administration (TIGTA) issued a warning to taxpayers to be alert for phone calls from cybercriminals, purporting to be from the IRS, claiming that the taxpayer owes taxes and must pay immediately with a prepaid debit card or wire transfer. In January 2015, the TIGTA issued a press release reminding taxpayers to be wary and stated that “This scam, which is international in nature, has proven to be the largest scam of its kind that we have ever seen. The callers are aggressive, they are relentless and they are ruthless. Once they have your attention, they will say anything to con you out of your hard-earned cash.” (*)

TIGTA has received reports of roughly 290,000 contacts since October 2013 and has become aware of nearly 3,000 victims who have collectively paid over $14 million as a result of the scam. The fraudsters may threaten the victim with arrest, deportation, loss of business or driver’s license.

How to know the call is bogus? The TIGTA explains that the IRS usually contacts people by mail first, rather than by phone regarding unpaid taxes. In addition, the IRS would never ask for payment using a pre-paid debt card or wire transfer or ask for a credit card number over the phone. Furthermore, the IRS would never use email, texting or any social media to contact a taxpayer. Finally, an IRS representative would not use threatening language.

According to the TIGTA, these phone fraudsters often:

  • Utilize an automated robocall machine.
  • Use common names and fake IRS badge numbers.
  • May know the last four digits of the victim’s Social Security Number.
  • Make caller ID information appear as if the IRS is calling.
  • Send bogus IRS e-mails to support their scam.
  • Call a second or third time claiming to be the police or department of motor vehicles, and the caller ID again supports their claim.

The TIGTA offers advice if you receive a phone call like mine:

  • If you owe Federal taxes, or think you might owe taxes, hang up and call the IRS at 800-829-1040. IRS workers can help you with your payment questions.
  • If you don’t owe taxes, fill out the “IRS Impersonation scam” form on TIGTA’s website, or call TIGTA at 800-366-4484.
  • You can also file a complaint with the Federal Trade Commission at Add “IRS Telephone Scam” to the comments in your complaint.

By Julia Allen Miessner, CPA, CFF, CGMA


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Shareholder Debt or Equity – Does it Effect Value?

Posted on June 2 2015 by admin

Shareholders of a small business sometimes will infuse cash into their Companies when needed. This cash is often recorded as a loan to the business. The shareholder and the Company may or may not have documented the “loan” setting forth the terms including interest rate, payback period, etc.

When developing an equity value of a business, an appraiser will subtract interest bearing debt from the value determined using an income approach when a weighted average cost of capital has been used. Interest bearing debt is also subtracted from the value determined under a market approach. The use of an asset approach calls for all liabilities to be subtracted from total assets.

Below are basic examples of the effect on value determined by the treatment of cash infusions by the shareholder(s). In the top example, $200,000 has been treated as debt. In the bottom example, the $200,000 has been treated as equity (additional paid in capital).


Now, imagine this on a much larger scale. In a case in Illinois Family Court (*) , a husband and wife argued over the treatment of $5.8 million contributed by the family trust to their business. The Wife’s business valuation expert treated the $5.8 million as additional paid in capital while the Husband’s expert treated it as interest bearing debt. The valuations of the business did vary substantially prior to the treatment of debt. Wife’s expert concluded a value of $16.1 million less debt of $4.9 million for an equity value of $11.2 million. Husband’s expert determined a value of under $10 million less debt of $9.5 million concluding an equity value of $310,000.

The Illinois Court, without explanation, determined a value of $10.6 million, less debt. Per the court, there was “clear, convincing, and overwhelming evidence that these were business loans.” The court therefore subtracted $9.5 million of debt to arrive at a value of $1.1 million for the business.

While it is not clear to what evidence the court was referring to with regards to the existence of the loans, it would seem that promissory notes with stated interest rates and terms of payback as well as proof of payments to the trust pursuant to the promissory notes would be considered convincing evidence.

By Melissa E. Loughlin-Sines, CPA, CFE, CVA, CFF, ABV

(*) Freihage v. Freihage, State of Illinois Family Court

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Exploding Growth in Crowdfunding

Posted on May 27 2015 by admin

Crowdfunding is the practice of funding a project or venture by raising monetary contributions from a large number of people, typically via the internet. Crowdfunding has grown dramatically over the last few years. As shown in the chart below, crowdfunding websites helped companies and individuals worldwide raise $89 million from members of the public in 2010, growing to $5.1 billion in 2013. The overall crowdfunding industry is estimated to grow to nearly $10.9 billion in 2015.


The growth in crowdfunding is due in part to the Jumpstart Our Business Startups Act (JOBS Act) which was passed with bipartisan support by Congress and signed into law by President Obama in April 2012. Following on the success of donation-based crowdfunding, the JOBS Act now enables businesses to solicit securities-based funding from the general public – also known as Business Crowdfunding.

Unlike the Donation Model of crowdfunding on sites like Kickstarter, where people donate to creative projects and do not receive any return on funds invested, securities-based crowdfunding allows investors to receive a financial return through the purchase of equity, debt or revenue-based securities.

The JOBS Act also expands investment opportunities to “non-accredited” investors (those with a net worth of less than $1 million or an annual income lower than $200,000), who have been historically excluded from this process. Although the JOBS Act was passed in 2012, the Securities and Exchange Commission did not have rules and regulations in place in order to implement the new legislation.

It wasn’t until September 2013 that Title II of the JOBS Act was implemented by the SEC. This allowed companies to publicly advertise that they were looking to raise money. However, only the wealthy, accredited investors could participate in the offerings. Shortly after issuing Title II, the SEC came out with a proposal for Title III which would allow non-accredited investors to participate. The final rules for Title III have still not been issued. However, on March 25, 2015 the SEC issued final rules for Title IV which allows non-accredited investors to invest up to 10% of their annual income or net worth in each deal by way of Regulation A+ offerings. Regulation A is an existing exemption from registration for small issuers of securities. The updated exemption will enable smaller companies to offer and sell up to $50 million of securities in a 12-month period, subject to eligibility, disclosure and reporting requirements.

As crowdfunding becomes mainstream it will be interesting to follow new rules and regulations adopted by the SEC and keep an eye on potential fraud that could occur in such a fast growing investment environment.

By Cindy Andresen, ASA

SEC Adopts Rules to Facilitate Smaller Companies’ Access to Capital: New Rules Provide Investors with More Investment Choices”, Washington D.C., March 25, 2015,

Crowdfunding Investors Rejoice!”, by Louis Basenese, April 8, 2015, Wall St. Daily

Global Crowdfunding Volumes Rise 81% in 2012”, by Kylie MacLellan, April 8, 2013, The Huffington Post

SEC Democratizes Equity Crowdfunding with JOBS Act Title IV”, by Chance Barnett, March 26, 2015 & “10 Top Equity Crowdfunding Campaigns from 2014”, by Chance Barnett, December 17, 2014, Forbes

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99.7% of Estates Are Not Subject to Federal Tax

Posted on May 19 2015 by admin

The American Taxpayer Relief Act of 2012 (“Act”) increased tax exemptions for federal estates, gifting and generation skipping trusts (GST). The Act also escalated the aforesaid exemptions each year for inflation. Below is a summary of the 2015 status of the three exclusions along with the ceiling for the federal estate tax rate applicable to each exemption:

  • $5,430,000 federal estate tax exemption (increased from $5,340,000 in 2014) and a 40% top federal estate tax rate.
  • $5,430,000 GST tax exemption (increased from $5,340,000 in 2014) and a 40% top federal GST tax rate.
  • $5,430,000 lifetime gift tax exemption (increased from $5,340,000 in 2014) and a 40% top federal gift tax rate.

Many estate planners, accountants, wealth managers and other professionals who represent high net worth clients are taking advantage of the increased exemptions imposed by the Act to make larger lifetime gifts; to leverage more assets through a variety of estate planning techniques (such as a sale to a grantor trust); and to shift income producing assets to individuals such as children or grandchildren who may be in lower income tax brackets and/or reside in states with a low income tax rate or no state income tax.

As you would presume, only a handful of American taxpayers are able to benefit from these tax planning opportunities. For instance in 2012, the most recent year in which both Internal Revenue Service and national death statistics are available, approximately 2.543 million Americans passed away. Of that group, just 8,423 estates exceeded the $5.12 million threshold for estate exemptions that year. These figures indicate that 99.7% of decedents in 2012 were not subject to federal tax.

If you have significant wealth, it is well worth your time to sit down with your professional advisers this year to discuss estate planning techniques that might benefit you and your beneficiaries.

By Gary Ringel, Managing Director of Henry & Horne, LLP’s Business Valuation & Litigation Support Services Group


March 2015 edition of Trust & Estates written by Robert F. Sharpe, Jr. titled “Making Gifts Sooner Than Later … Accelerating Charitable Bequests.”

Proskauer Rose LLP’s December 2014 newsletter titled “2015 Estate, Gift and GST Tax Update: What This Means for Your Current Will, Revocable Trust and Estate Plan.”

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Telephone Fraud: Beware of the Big Prize Promise

Posted on May 5 2015 by admin

wheelI know an elderly lady who is disabled and in early stages of dementia. Her name is Doris. Doris was the recent victim of a telephone scam.

Doris’ four adult children recently told me that two months ago their mother received a telephone call, out of the blue, from Jamaica. It was from a slick talking guy who said his name was Jack Holiday. Jack proceeded to tell Doris that she was the winner of a $2.2 million sweepstakes prize. He said her name was chosen from a few hundred thousand participants in a magazine contest. Doris could not recall entering the contest but was elated to hear the good news.

Jack said he and the rest of his company’s award team would personally be coming to Doris’ home in Phoenix, Arizona to deliver the prize money. Jack told Doris to keep the matter quiet and to not report it to her family and friends. He said it would make the award to Doris more of a wonderful surprise if they did not know about it until Jack came to Phoenix.

Jack told Doris that before he could process the award, Doris would have to send him funds as a down payment on the income taxes Doris would have to pay to the U.S. Internal Revenue Service because of her receipt of the $2.2 million.

Doris’ daughter became aware that her mother had run up a bill with her cell phone service provider of $1,200. Upon further inquiry the daughter found that most of the charges were due to her mother making calls to Jamaica. Doris’ daughter had a talk with her and Doris finally ‘fessed up to what she was doing. Unfortunately, by this time, Doris’ daughter found that Doris had wired Jack, via Western Union, about $4,000 to apply to her “taxes” on her award.

Doris’ daughter and one of Doris’ sons immediately took her to the police station where they filed a complaint about Jack Holiday and his evil deed. The children explained to their mother that Jack was a scammer, a crook and a very bad person. Doris said she understood. It turned out she understood but didn’t care.

The children had Doris change her telephone number so that Jack could no longer telephone her. Doris then called Jack and gave him her new number. She subsequently gave Jack another $6,000 before the children realized she was still involved with Jack. Her cell phone bill had grown to $1,400.

Doris’ oldest son always prepared her federal and state income tax returns. A few weeks ago he excitedly told Doris that she had a $2,200 federal tax refund coming. Doris was happy. So happy that she tried to wire Jack $1,700 of her refund when it arrived. Fortunately, the funds were returned to Doris’ bank account because of a wire transfer error. Doris’ son, who was also a signer on her checking account, quickly put the tax refund money into another account he established under his and Doris’ daughter’s name. The funds were now protected from Slick Talking Jack Holiday.

In the meantime, the children have turned the matter over to the FBI. The children have told me that the FTC, who is investigating other telephone scam cases, will be given the information about Doris’ plight as well.

As of this writing, Doris is still communicating with Jack. Jack is still trying to get money from Doris. Just last week Doris gave him another $435. Her cell phone bill has ballooned to $1,700 and the cell phone service provider wants Doris to pay immediately.

The children have asked Doris why she keeps trying to give Jack money.“Because he is a nice man,” she replies.


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Protecting Your Inventory and Customers from Employees

Posted on April 28 2015 by admin

During the last year, I have received more phone calls than usual from business owners who believe employees are stealing inventory from them. Many of the concerns I hear from small business owners fall into two categories. The first scenario is the extremely popular and growing internet business, in which entrepreneurs keep inventory in warehouses, garages, and other storage spaces to fulfill orders. Often, they find that tracking and managing their inventory is difficult. As a result, they may not have the expected inventory on hand to fulfil orders, resulting in customer dissatisfaction and lower profits.

The second scenario is not a new problem; however, due to the economic impact on the construction and service trades, business owners are taking a stronger stance relating to their employees and subcontractors performing side jobs for their customers, and possibly using company inventory and resources. Companies invest funds and resources into getting leads and customers. Employees and subcontractors who go out on calls and have customer contact may cut the business out of the loop and perform the job for less on the side.

Following are some suggestions of policies and controls that may reduce employee theft of inventory and the occurrence of employees using company resources to perform side jobs:

  • Show your employees that you treat your inventory like money. Employees may not realize the value of your stock inventory. Often, employees who would never think of taking money out of the cash register have no qualms about “borrowing” inventory. By installing proper controls, you can help your employees appreciate the true value of inventory.
  • Security cameras and other theft-deterrent devices are not as expensive and difficult to install as they once were. Although, an employee who is truly a thief can often get around these systems, it is an effective deterrence for many employees.
  • Physically counting inventory on hand and comparing it to internal inventory records is extremely important. Nowadays, many small companies rely on electronic systems to manage their inventory. However, while computer software programs to manage inventory are efficient and useful, they can also be manipulated to hide fraud. Nothing can replace physical inventory counts. In addition, these counts will act as a psychological deterrent, especially if you conduct them on a random basis.
  • Reduce the people who have access to your warehouse and inventory storage areas. Oftentimes, salespeople, vendors, drivers, and subcontractors all have access, which can lead to more inventory shortage.
  • Oftentimes, inventory is removed, which is not invoiced (or sold), in order to make a sales call, provide samples or for an emergency situation. Implement a tool that allows salespeople and drivers to easily record material they remove, which could be as simple as a clip-board hanging on the door. Management/owners should review these regularly. It is often surprising how many “samples” are removed and never returned.
  • Pay your employees fairly and create a work environment where employees feel valued to reduce the incentive to steal or take side jobs. Communicate to your employees that inventory generates revenues and increases the bottom line, which will result in better pay and benefits.
  • Your employee manual should clearly explain the company’s policy on performing side work. For example, it may state that any request by a client for the employee to work on any job other than those contracted for by the company must be reported to the company immediately, or it may be a termination offense.
  • Your subcontractor agreement should also state that the subcontractor should not talk to the customer about any other work. Again, they should report all such requests directly to you immediately. It should be a termination offense if they are caught doing such work.
  • Many employees have use of a company truck and cell phone during work and non-work hours. GPS vehicle and cell phone tracking systems are becoming more popular to determine whether employees are performing work for customers during non-work hours, and to match up locations with time billing sheets. However, due to concerns over employee privacy, employers need to ensure that any tracking or electronic surveillance is legal.
  • Review the corporation commission websites to determine if employees have set up companies with a similar name or offering the same services.
  • Follow up with customers or sales leads to potentially uncover instances of employees performing side work. Sometimes, the customer is under the impression that the company is performing the work, and is surprised to hear that the work will not be covered or warrantied, because the employee actually performed the work on the side.

By Julia Allen Miessner, CPA, CFF, CGMA

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Can You Apply a Discount to a Promissory Note?

Posted on April 13 2015 by admin

Hoffman v. Commissioner: Tax Court Accepts 12.5% Discount Rate

Treasury Regulation 20.2031-4 states that the fair market value of promissory notes, secured or unsecured, is presumed to be the amount of unpaid principal, plus accrued interest at the date of valuation, unless the taxpayer provides sufficient evidence to the Internal Revenue Service which supports a lower value.

In the Estate of Marcia P. Hoffman v. Commissioner, T.C. Mem. 2001-109; Mark Mitchell was retained by the Internal Revenue Service to value two unsecured promissory notes. In order to quantify a discount rate to apply to the future cash flows of each note, Mr. Mitchell took the following interest rates, or yields, into consideration when contemplating a rate of return that would be acceptable to a hypothetical buyer of the debt instruments:

  1.  Interest rates of various debt securities;
  2.  Corporate bonds of various ratings;
  3.  Interest rates for conventional mortgages; and
  4.  Venture capital returns.

After analyzing the risk attributes associated with each of the four types of interest rate proxies, Mitchell formed an initial opinion of the rate of return expected by a hypothetical buyer of the promissory notes and then made adjustments to his rate based on specific criteria such as the:

  1.  Creditworthiness of the borrower;
  2.  The payment history of the borrower;
  3.  The absence of security provisions in the notes such as covenants related to late and prepayment penalties;
  4.  The omission of collateral assignments should the borrower default; and
  5.  The lack of marketability for the notes attributable to the fact that a formal secondary market is nonexistent for private debt.

Mr. Mitchell determined that discount rates ranging from 10% to 15% would adequately account for the level of risk associated with the promissory notes and concluded that 12.5% was a reasonable rate to apply to both notes’ future cash flows in order to calculate their present (fair market) values.

The Court was not persuaded by the report and testimony of the Estate’s expert, rejected his value conclusion, and concluded that a discount rate of 12.5% appropriately reflected a hypothetical buyer’s anticipated internal rate of return between the date of death and the maturity dates of the notes.

By Gary Ringel, CGREA

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Why CPA Testifying Experts Can’t Accept Contingent Fee Engagements

Posted on March 24 2015 by admin

StopAttorneys are often asked to take on a litigation assignment where there is a potential for a large monetary amount to be awarded to their clients by the court. They may take on the work solely based on a contingent fee arrangement with their client. What this usually means is that if the attorney wins the case for their client, they will get paid. If they don’t win, they don’t get paid. CPAs who are retained by clients to be testifying expert witnesses cannot similarly accept a litigation support engagement on a contingent fee arrangement.

The American Institute of CPAs (AICPA) indicates in its rules that a contingent fee is a fee established for the performance of any service pursuant to an arrangement in which no fee will be charged unless a specified finding or result is attained or in which the amount of the fee is otherwise dependent upon the finding or result of such service. The AICPA also states for purposes of this rule, fees are not regarded as being contingent if fixed by courts or other public authorities or, in tax matters, if determined based on the results of judicial proceedings or the findings of governmental agencies. (*)

The AICPA is pretty explicit regarding the prohibition of its CPA members from taking contingent fees when the member performs: I) an audit or review of a financial statement; or II) a compilation of a financial statement when the member expects, or reasonably might expect, that a third party will use the financial statement and the member’s compilation report does not disclose a lack of independence; or III) an examination of prospective financial information; or IV) prepares an original or amended tax return or claim for a tax refund for a contingent fee for any client. (**)

But, what about a CPA providing expert witness services in a litigation case? The AICPA’s 2009 publication, Special Report 09-1, FVS Section, Introduction to Civil Litigation Services, states the following in footnote 39 on page 19 in reference to the paragraph, Timekeeping, Fees and Billings:

“Contingent fees arrangements are almost never acceptable for an expert witness. Laws in many jurisdictions preclude expert contingent fees, as do the ethics rules of many bar associations, including rules of the American Bar Association. Even if an expert witness was in a situation that did not preclude a contingent fee by law or rule, a contingent fee creates the appearance that the expert witness lacks objectivity because fees are potentially dependent on the favorable testimony of the expert, or perhaps the successful outcome for the practitioner’s client. Regardless of the fee arrangements, it is advisable for the practitioner to collect any outstanding balances prior to expert testimony to avoid unintentionally creating a contingent fee arrangement, or the perception of one.”

By Don R. Bays, CPA/ABV/CFF, CVA

(*) AICPA Code of Professional Conduct, effective December 15, 2014; Section 1.510.001 Contingent Fees Rule, par. .03. The Arizona State Board of Accountancy’s Rule R4-1-455 Professional Conduct: Independence, Integrity, and Objectivity, par. B.1, contains similar language.

(**) Ibid; par. .01 (AICPA)

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