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Business Valuation and Federal Taxes: Procedure, Law and Perspective, 2nd Edition by Shannon P. Pratt, David Laro

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Chapter 18

Entity-Level Discounts

Summary

Entity-level discounts are those that apply to the company as a whole. That is, they apply to the values of the stock held by all the shareholders alike, regardless of their respective circumstances. As such, they should be deducted from value indicated by the basic approach or approaches used. Since they apply to the company as a whole, regardless of individual shareholder circumstances, the entity-level discounts should be deducted before considering shareholder-level discounts or premiums.

There are four primary categories of entity-level discounts:

1. Trapped-in capital gains discount

2. Key person discount

3. Portfolio (nonhomogeneous assets) discount

4. Contingent liabilities discount

Trapped-In Capital Gains Discount

The concept of the trapped-in capital gains tax discount is that a company holding an appreciated asset would have to pay capital gains tax on the sale of the asset. If ownership in the company were to change, the cost basis in the appreciated asset(s) would not change. Thus, the built-in liability for the tax on the sale of the asset would not disappear, but would remain with the corporation under the new ownership.

Logic Underlying Trapped-In Capital Gains Tax Discount

Under the standard of fair market value, the premise for this discount seems very simple. Suppose that a privately held corporation owns a single asset (e.g., a piece of land) with a fair market value of $1 million and a cost basis of $100,000. Would ...

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