One of the most highly debated topics in business valuation is the treatment of income taxes in valuing S corporations.
There are two extreme positions on this point. The first is to include no income taxes at all in S appraisals. The second is to fully tax the income stream of S corporations and, in effect, to treat them as C corporations. This article discusses the treatment of income taxes in the valuation of S corporations and recommends a treatment different from both of these approaches. It describes a methodology that takes into account the tax advantage of S corporations and demonstrates an economically appropriate and supportable tax effect.
The Tax Advantage of S Corporations
The market values post-corporate tax, pre-personal tax cash flow. The cash flow that is valued in publicly held companies is dividends expected to actually be paid. In privately held companies, the cash flow that is valued is the free cash flow that is available to be paid to equity holders for their unrestricted use, whether it is actually paid or not. This available cash flow is what Revenue Ruling 59-60 calls “dividend paying capacity.”