Estate and gift tax. The IRS has provided guidelines for valuing closely held corporations. Revenue Ruling 59-60 (1959-1, C.B. 237) and Section 2031 of the Internal Revenue Code. These guidelines, used by the IRS in estate and gift tax cases, have been used by courts in equitable distribution cases.

Section 1 states: "The purpose of this Revenue Ruling is to outline and review in general the approach, methods and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift tax purposes."

Section 2 defines fair market value in effect as "the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to sell, both parties having reasonable knowledge of the relevant facts."

Section 4 sets forth factors that are "fundamental and should be considered in each case: (a) the nature of the business and the history of the enterprise from its inception; (b) the economic outlook in general and the condition and outlook of the specific industry in particular; (c) the book value of the stock and the financial condition of the business, (d) the earning capacity of the company, (e) the dividend paying capacity, (f) whether or not the enterprise has goodwill or other intangible value, (g) sale of the stock and the size of the block of stock to be valued, (h) the market price of stocks of corporations engaged in same or similar line of business having their stocks actively traded in a free and open market, either on exchange or over the counter."

Section 5 states, concerning the weight to be accorded various factors, that: "(a) Earnings may be the most important criterion of value in some cases whereas asset value would receive primary consideration in others. In general, the appraiser will accord primary consideration to earnings when valuing stocks of companies which sell products or services to the public; conversely, in the investment or holding type of company, the appraiser may accord the greatest weight to the assets underlying the security to be valued. (b) The value of the stock of a closely held investment or real estate holding company, whether or not family owned, is closely related to the value of the assets underlying the stock. For companies of this type, the appraiser should determine the fair market values of the assets of the company. Operating expenses of such company and the cost of liquidating, if any, merit consideration when appraising the relative values of the stock and the underlying assets. The market values of the underlying assets give due weight to potential earnings and dividends of the particular items of property underlying the stock, capitalized at rates being proffered by the investing public at the date of appraisal. A current appraisal of the investing public should be superior to the retrospect opinion of an individual. For these reasons, adjusted net worth should be accorded greater weight in valuing the stock of a closely held investment or real estate holding company, whether or not family owned, than any other customary yardsticks of appraisal, such as earnings and dividend payout capacity."

Section 6 refers to capitalization rates as "one of the most difficult problems in a valuation…among the important factors to be taken into consideration in deciding upon a capitalization rate in a particular case are: (1) the nature of the business; (2) the risk involved; and (3) the stability or irregularity of earnings."

Section 7 indicates that weighted averages would serve no useful purpose since "such a process excludes active consideration of other pertinent factors, and the end result cannot be supported by a realistic application of the significant facts in the case except by mere chance." However, in the case of Sharp v. Sharp, 116 N.C. App. 513, 449 S.E.2d 39 (1994), review denied, 338 N.C.669, 453 S.E.2d 181 (1994). the court rejected this provision and stated: "In support of her argument, defendant cites Revenue Ruling 59-60. We do not find this Revenue Ruling persuasive in this case. Defendant has not argued, and we have not found any cases in North Carolina holding that valuation of a law partnership based on an averaging of methodologies approach is erroneous."

Section 8 states that "restrictive agreements are a factor to be considered, with other relevant factors in determining the fair market value."

Excerpted from A. Doyle Early, Valuation of A Small Business, Equitable Distribution 1997, Wake Forest University School of Law CLE Seminar.