The
Massachusetts Medical Society (MMS) wishes to be recorded in support of S.839, An
Act Relative to the Valuation of Professional Practices in Divorce Proceedings. The MMS is grateful to Senator Michael Brady
for filing this legislation.
This
bill would ensure that professional corporations, including physician office
practices, be assessed at fair market value, as defined consistently with
federal statutes governing other transactions involving physician practices.
Traditionally, the Massachusetts
probate courts in divorce proceedings treated the value of a corporation as “the
price at which the property would change hands between a willing seller and a
willing buyer, neither being under any compulsion to buy or sell and both
having relevant knowledge of relevant facts.”
This definition is referred to as the fair market valuation standard as
defined by the Internal Revenue Service. The concept of “tax affecting” in
valuation derives from the difference in tax treatment of S and C corporations.
C corporations pay tax on earnings at the corporate level, while S corporation
earnings pass through to their shareholders on a pro rata basis and are taxed
to the shareholders when earned by the corporation, whether or not the
corporation pays dividends. When C corporations are valued using an income approach,
earnings are reduced by the applicable corporate taxes to determine an accurate
value. Valuators also reduce S corporation earnings for taxes. In some
instances, valuators base that adjustment on an assumed personal tax rate, but,
more commonly, they base the adjustment on corporate tax rates.
In Bernier v. Bernier, 449 Mass.
774 (2007), the SJC was presented with the novel question of whether to
discount the value of an S corporation by “tax affecting” income at the rate
applicable for C corporations, where one spouse would receive ownership of all
shares of the S corporation after the divorce and the other would be required
to relinquish all ownership in the business. The SJC rejected the approach of adopting
a valuation that "tax affected" the fair market value of the S
corporations at the average corporate rate of a C corporation where the parties
were not arm’s-length buyers, concluding that to do so seriously understates
the fair market value of the S corporation structure and fails to compensate
the seller for the loss of those benefits.[1] Tax and valuation professionals assert that
this outcome effectively eroded the fair market value standard for business
valuation in divorce proceedings.
This legislation would reinstate this valuation
standard for professional corporations, in particular when the professional is going to stay
with the corporation and continue to provide services.
[1]
See Berluti, McLaughlin and Kutchin, LLP, Valuation of Closely held
Corporations.
