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Dan John, ISTC
Kent Absec, ISBA
When is the last time you looked at your client's Buy-Sell (DIS)agreement?
IRS Updates
Profession's Quick Bites
Spangler Offers Perspectives on Four Decades with Idaho, MTC
Thought to Ponder
Why is it that when you're driving and looking for an address, you turn down the volume on the radio?
Congratulations Dan John
Congratulations and Best Wishes to Dan John. Dan served 40 years with the Idaho State Tax Commission. Most of those years he held the title of Tax Policy Manager. Many of us know Dan as the face of the Idaho State Tax Commission. Dan retired effective March 31, 2012. We will miss him. The Idaho Society of CPAs has made a contribution to the ISCPA Scholarship fund in Dan's honor.
Congratulations Kent Absec
Congratulations to Kent Absec, the new Executive Director, Idaho State Board of Accountancy.
When is the last time you looked at your client's Buy-Sell (DIS)agreement?
Written by Peter J. Butler, CFA, ASA, MBA
The title of this article doesn't sound right, does it? The purpose of a buy-sell agreement is to provide peace-of-mind. In theory, these "agreements" should provide relatively easy business transitions from one shareholder to another in highly emotional times (death, divorce, disability, retirement, etc.). Often, however, these well-intentioned documents fail business owners in highly emotional times and provide anything but peace. Unfortunately, these agreements frequently contain incorrect and/or confusing language and/or outdated formulas. Given these problems, there is little wonder that some of these transactions end up in litigation where business transitions are never easy and peace-of-mind is rarely attained.
There are generally three types of buy-sell "agreements:"
- Fixed price agreements
- Formula agreements, and
- Process agreements
Fixed price is simple enough. Upon a triggering event (such as retirement), "Mr. Shareholder will be bought out at $250,000" is an example of a fixed price agreement. Its big advantage is its simplicity, and the fact that it eliminates uncertainty in highly emotional times. However, the fixed price probably becomes out-of-date shortly after it was written. Therefore, when a triggering event occurs, either the buyer or the seller will be happy, but probably not both.
A formula agreement may be written as "Ms. Shareholder will be bought out at 4 times earnings times the appropriate ownership percentage." Not as simple as the fixed price agreement, but simple enough. Or is it?
How do you define earnings? Is it after-tax or pre-tax net income, earnings before interest and taxes (EBIT), earnings before interest taxes depreciation and amortization (EBITDA), or operating earnings? Should the earnings be normalized? Is it the latest twelve months earnings, the last fiscal year's earnings or the last calendar year's earnings?
In times of stress isn't it likely that two shareholders (the buyer and the seller) may view the earnings a little bit differently? You bet! I have seen far too many buy-sell "agreements" morph into buy-litigate-sell disagreements.
Moreover, even if 4 times earnings represents market value today, will it represent market value a year from now when a triggering event occurs? Probably not.
It is crucial for corporate attorneys and business owners to consult with business appraisers/CPAs in drafting these "formulas" to eliminate as much of the surrounding subjectivity as possible. Appraisers must carefully assess each word individually, and in aggregate, to ensure the agreement is well-crafted, explicit, detailed, and irrefutable – to the extent that it is possible in business valuation to avoid costly unintended consequences.
The last type of agreement is the process agreement. The following is an example of a process agreement, "Mr. Shareholder will be bought out at the fair market value of his shares as determined by a credentialed business valuation appraiser." Fair market value (FMV) implies discounts for lack of control and lack of marketability, if appropriate. If shareholders would rather not take discounts, this can also be stated in the agreement.
What are the disadvantages of this type of agreement? There is no known take-out price or even a known formula. We have uncertainty. Uncertainty, as previously discussed, is not a good thing.
What are the benefits? The FMV should keep up with changing market conditions. Theoretically, both buyer and seller should be happy as the price is fair. Recognizing that valuation is part art and part science, sometimes these process agreements are written where the buyer has an appraiser and the seller has a different appraiser to perform the valuation. This is OK too, but more expensive for all involved. The agreement may then call for an average of the two conclusions, or possibly to bring in a third appraiser to settle the score if the first two appraisals are materially different. Does the third appraiser settle the score so to speak or does his/her conclusion then also get averaged in? As you can see if companies are not careful, this process can get incredibly unwieldy and expensive.
Can a firm eliminate some (but not all) of the uncertainty related to the scenario described above? You bet! A firm could obtain a valuation at the end of every year, for example (Although we all know that this is frequently written into these agreements but rarely followed-up on). If a triggering event occurs in the next year, then the valuation conclusion would be the take-out price. If valuations were obtained every year, it would create a nice historical record of progress that all shareholders could see. If perchance, anyone had an issue or did not agree with the valuation conclusion, then shareholders could discuss it before the emotion of a triggering event is facing them.
With these issues in mind, it might be time to assist your clients as their trusted advisor and dust off the spider-webs on the old buy-sell (dis)agreement or assist in creating a new buy-sell agreement.
Peter J. Butler, CFA, ASA, MBA is a principal with Valtrend, LLC, an independent business valuation, litigation
support and mergers and acquisitions advisory company. He can be reached at (208) 371-7267 or pete@valtrend.com.
IRS Updates
- Which Form? Chart Explains Foreign Asset Reporting
The new Form 8938, Statement of Specified Foreign Financial Assets, does not eliminate a taxpayer's obligation to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). Some taxpayers are required to file both. A new
comparison chart explains the filing requirements for both Form 8938 and Form TD F 90-22.1.
- IRS Releases Fiscal Year 2011 Data Book
The Internal Revenue Service released the
2011 IRS Data Book, a snapshot of agency activities for fiscal year 2011 – Oct. 1, 2010, to Sept. 30, 2011. During the year, the IRS collected $2.4 trillion and processed more than 234 million tax returns.
- Have questions about payment cards or Forms 1099-K?
Payment Card and Third Party Network Payment
FAQs will answer many questions about payment card reporting, payment settlement entities and Forms 1099-K.
Headliner 328, Form 1099-K Reporting Information for Tax Years 2011.
- IRS Seeks Applications for Information Reporting Advisory Committee; Deadline Is May 31
The Internal Revenue Service officially opened the
nomination season for the Information Reporting Program Advisory Committee (IRPAC), a federal advisory group that provides recommendations to the IRS on information reporting issues of concern to both the private sector and the federal government.
- New COBRA Audit Technique Guide
A new
Audit Technique Guide covers tax examinations involving the continuation of employee health care coverage.
-
FOIA Awareness for PTIN Holders
- IRS Updates the Allowable Living Expense Standards for 2012
The Internal Revenue Service released the 2012 updates to the Allowable Living Expense Standards on April 2. The ALE standards are used to reduce subjectivity in determining what a taxpayer may claim as basic living expenses necessary to avoid undue hardship when the taxpayer must delay full payment of a delinquent tax. The standard allowances provide consistency and fairness in collection determinations by incorporating average expenditures for basic necessities for citizens in similar geographic areas. Collection Financial Standards
- IRS Revises Publication 1771
The IRS has released
Publication 1771 (rev. September 2011), Charitable Contributions - Substantiation and Disclosure Requirements, which explains general rules and specifications for documenting charitable deductions and explains new guidelines that allow charities to electronically mail documentation to donors.
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Notice 2012-29 announces that the IRS and the Treasury Department anticipate issuing guidance relating to the applicability of the normal retirement age rules to governmental plans. The guidance under consideration would clarify that governmental plans that do not provide for in-service distributions before age 62 do not need to have a definition of normal retirement age. The guidance would also modify the age-50 safe harbor for qualified public safety employees. In addition, the notice announces that the IRS and the Treasury Department intend to extend the effective date of the normal retirement age regulations for governmental plans. The notice includes a request for public comment.
- IRS Creates Online Search Tool for Easier Check On Information About Exempt Organizations - users can now go to
one location on IRS.gov
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Revenue Procedure 2012-23, which contains tables showing the limits of depreciation deductions under section 280F for automobiles placed in service in 2012
- Small employers that provide health insurance coverage to their employees encouraged to check out the small business health care tax credit -
Small Business Health Care Tax Credit for Small Employers
- What is a "provisional PTIN" and who receives a "provisional PTIN?" -
Get the details
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ISCPA IRS Insights - "FBAR/FATCA" - June 12 @ 10:00am Mountain Time
Profession's Quick Bites
Spangler Offers Perspectives on Four Decades with Idaho, MTC
Introduction Written by John McGown, Jr., Hawley Troxell
Article Written by Doug Sheppard, State Tax Notes
Ted Spangler, now retired as the Idaho State Tax Commission's Deputy Attorney General, knows more about Idaho taxes than any other person. He was recently recognized for his nationwide contributions to the state tax area. The award was named in honor of Paull Mines, who I had the good fortune to meet. Paull was a guest lecturer (as was Ted) for me when I taught State Taxation at the BSU Graduate Tax Program.
The recognition was followed by an interview of Ted in State Tax Notes. I found the article very interesting for its historical perspective on how the state tax field has evolved over time-both in Idaho and nationally.
Read the Article
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