Research in Taxation (TAXN 728)
Project Three
Memorandum on Expert Witnesses
To: Partner-in-Charge for Taxation Consulting, ABC Accounting Firm
From: Senior Tax Manager (SSN 429-85-9407)
Date: April 7, 1997
Subject: Expert Witnesses: Selection, Instructions, and Guidelines
Outline
1. Introduction
2. List of Authorities
3. Selection of Expert Witnesses
4. Instruction for Expert Witnesses
5. Guidelines for Expert Witnesses
6. Summary
Appendix: List of References
1. Introduction
Success or failure in tax litigation can depend on the strength of an expert's report
and his involvement in pretrial proceedings. In whatever capacity the expert is appointed,
the objective must be to offer constructive opinions to help minimize time, cost, and risk in
legal proceedings, while achieving practical and early settlements.
ABC Accounting Firm provides tax litigation support to our clients. Our forensic
accountants as experts will assist clients in establishing facts and presenting opinions and
conclusions, particularly in matters which require the skills and experience of an
accountant in, for example, assessing the quantum of claims and interpreting professional
standards.
Our litigation support team should have a complete policy in selecting new
members and assigning experts to clients. In addition, we should have instructions and
guidelines for our forensic accountants when they serve as expert witnesses for out clients.
Experience and a thorough technical knowledge of the subject matter are vital for
an expert witness. In addition, the expert witnesses are required to be independent,
analytical, objective, tactful, patient, realistic, good communicators and persons who will
politely hold their soundly based opinions, no matter how rigorous the cross-examination.
Our team will acquire these qualities by working extensively with solicitors and counsel,
and through frequent court appearances as expert witnesses.
The job of the expert witness is to present and clarify the facts in a court battle.
Federal Rules of Evidence for United States Courts and Magistrates provide the rules of
evidence for the federal courts. Rule 143(a) provides that trials before the Tax Court will
be conducted in accordance with the rules of evidence applicable in trials without a jury in
the United States District Court for the District of Columbia.
In all cases handled, we should conduct our own inquiries, review of evidence and
interviews with plaintiffs or defendants and other witnesses, where agreed with the
instructing solicitor. While keeping the instructing solicitor fully informed, we should not
constantly ask for additional instructions or expect the solicitor to carry out research
which should be performed by the expert accountants.
Our business philosophy should be: our forensic accountants (with the appropriate
analytical skills, communication skills, and courtroom experience) have a great deal to
offer litigation lawyers. We should be ready to review any case, without cost or
obligation, and to report to clients on the work which we think is required. Our report
would be in a form suitable for presentation to the court or a client.
Our team should prefer to be involved in cases at an early stage, wherever
possible. A careful review of evidence will lead to either a confidential report to
instructing solicitors, pointing out the weaknesses of a case, or an impartial report when a
case is strong, thus reducing the time spent in prosecuting hopeless cases and increasing
the time available for pursuing cases which will enhance the client's reputation.
The following items illustrate the scope of our expert witness services:
Valuations of businesses, in connection with:
partnership disputes;
tax planning, tax mitigation and negotiations with the tax authorities;
separation or divorce;
assessing the financial strength of an opposing party for orders for security for costs.
Professional negligence claims for alleged deficiency of service in:
property and information technology matters;
due diligence in business acquisitions or disputes;
taxation advice;
auditing and reports to lenders.
Actions against directors in connection with:
insolvency (alleged failure to keep proper records, trading whilst insolvent);
aggrieved minority shareholders.
2. List of Authorities
1. IRC section 7430
2. TRS Regulation Sec. 20.2031-6
3. IRS Action on Decision CC-1987-023 (1987)
4. IRS Revenue Procedure 96-53
5. IRS Publication 561
6. Federal Rule of Evidence 702, and 704 (a)
7. Tax Court Rule 143(f)
8. Citrus Valley Estates v. Commissioner (99 T.C. No. 21, 1992)
9. Hudspeth Pine v. Commissioner (T.C. Memo. 1985-628, 1985)
10. Snap-Drape v. Commissioner (Docket No. 95-60699, 1996)
11. Estate of Freeman v. Commissioner (T.C. Memo. 1996-372, 1996)
12. Keogh v. Commissioner (Docket No. 92-4133, 1995)
13. Donald Palmer Co. v. Commissioner (Docket No. 95-60381, 1996)
14. Hospital Corporation of America v. Commissioner (T.C. Memo. 1996-559, 1996)
15. Republic Plaza Properties Partnership v. Commissioner (107 T.C. No. 7, 1996)
3. Selection of Expert Witnesses
The expert witnesses should have the following expertise:
specialist knowledge within a given discipline;
highly developed investigative and analytical skills;
a broad perspective of the issues affecting a dispute;
experience in handling disputes and contentious problems;
an understanding of the legal process;
an ability to present findings and opinions with clarity and authority.
The criteria should include:
education/degrees;
industry experience (scope and scale);
certification/license;
professional association;
academic activities and credibility;
litigation experience.
Rule 702 of the Federal Rules of Evidence provides that "if scientific, technical, or
other specialized knowledge will assist the party in a trial of fact to understand the
evidence or determine a fact in issue, a witness qualified as an expert by knowledge, skill,
experience, training, or education, may testify thereto in the form of an opinion or
otherwise."
Our team members should fully understand the role of an expert witness, the
procedure for testifying, how the cross-examining attorney prepares, goals of the cross-
examining attorney, techniques used by counsel, and the ethical considerations for the
expert witnesses. The most important factors are: credibility, independence, and
experience.
Certifications
To become a qualified forensic accountant there are several degrees, certifications,
and positions that serve as to qualify the accountant as an 'expert' in this field. Forensic
accountants, who are usually involved in litigation support or investigative accounting,
must have some form of credentials to deem them capable of the work or career they are
pursuing. After completion of the basic requirements for an undergraduate degree, there
are two main professionals certifications that are now available. They are the Certified
Fraud Examiner (CFE) and the Certified Insolvency and Reorganization Accountant
(CIRA).
Like many other certifications with the exception of the CPA, the CFE and the
CIRA are not licenses to practice but rather a certification or evidence that a qualifying
knowledge base is present. Most people that are successful with a career in forensic
accounting have already passed and received their CPA license. Once certified, forensic
accountants can seek many different positions including that of fraud auditor and
investigator, loss prevention professional, or litigation support specialist. The big six
accounting firms are also adding these specialists to their ranks in order to address the
needs of their clients.
Experience requirements for expert witnesses
The need for an expert witness generally arises when there is a dispute involving
the area of accounting expertise. He may be called upon to perform economic fact
finding, prepare a tax analysis, help take the deposition of the other party's expert witness,
suggest avenues of inquiry, help interpret documentation, and assist in eliciting
information from other witnesses.
Previous experience as an expert witness is preferred but not required. The most
important factor is the experience in a specific industry (specialty) related to the litigation
case. Even though only a short amount of time is spent in the courtroom, it is the most
critical because reputations are made and broken in the witness box (de Lorenzo,
Australian Accountant). Therefore, it is imperative that the expert witness be more than
just an accountant. The accountant must also be an educator and possess other necessary
skills. Once in the courtroom, the accountant must treat the judge and jury as if they had
no understanding of any accounting terms. For example, he needs to explain that net
income does not necessarily equal cash in the bank. Also, several other hints for expert
witness are to speak up and talk slowly. This enables the judge and jury to take notes, as
well as simply understand what the witness is saying. He needs to keep statements short
and simple, if possible, and avoid rambling. Also, the witness should avoid moving about
too much as this gives a shifty impression. The expert witness should pause when needed
and, if another look at a document is needed, request time to do so to ensure that precise
information is being given. Some common sense approaches are not to argue with the
lawyers or the judge while on the stand. The witness should look towards the jury when
giving evidence, as well as attempt to build a rapport with the judge. Above all, the
witness should try not to irritate the judge.
Entertaining the jury is also a positive attribute of a good expert witness because
the jury's perception of his or her credibility could determine the client's case. The expert
witness must know what to say, when to say it, and how to say it. He must know when to
add humor and when to speak with authority (Jarnigan, New Accountant). As Lorenzo
stated, the key to becoming a good expert witness is the Three P's - Preparation!
Preparation! Preparation!
Another task of being an expert witness is that while he needs to actually do most
of the research, he must definitely write the entire report. If the accountant delegates this
work to someone else, he could be ripped apart under cross examination for not being
totally familiar with the material. As a result of this, professional reputation and future
opportunities could be destroyed.
IRS Publication 561 (Determining the Value of Donated Property) on "What Is
Fair Market Value (FMV)" states that generally, the weight given to an expert's opinion
on matters such as the authenticity of a coin or a work of art, or the most profitable and
best use of a piece of real estate, depends on the knowledge and competence of the expert
and the thoroughness with which the opinion is supported by experience and facts. For an
expert's opinion to deserve much weight, the facts must support the opinion. The expert
must be knowledgeable and competent, and the opinion must be thorough and supported
by facts and experience.
Many tax court cases demonstrate the importance of training and experience to
expert witnesses. In Donald Palmer Co. v. Commissioner (Docket No. 95-60381,
1996), petitioner insists that the Tax Court's decision not to qualify Harold Mollere as an
expert witness is manifest error. Petitioner maintains that Mollere is qualified to be an
expert in this case, given his experience as a practicing certified public accountant for
thirty-eight years, during which time he reviewed hundreds of federal income tax returns
annually for businesses and corporations, and advised clients on their compensation in
connection with their year-end planning. Petitioner goes further, suggesting that the Tax
Court disqualified Mollere because the IRS had no expert of its own rather than because
of Mollere's qualifications. The judges are not persuaded. During voir dire, Mollere
admitted that he had not had any specific training in the field of executive compensation,
and that he had never been retained to evaluate a company's executive compensation
policy. In addition, the Tax Court noted that Mollere's report was unhelpful as it merely
summarized his view of the evidence and did not provide sufficient information to make an
intelligent evaluation of his conclusion that all of Palmer's compensation is reasonable.
Furthermore, Petitioner has absolutely no support for its speculation that the Tax Court's
ruling was based on the fact that the IRS had no expert witness of its own. Under these
circumstances, the judges conclude that the Tax Court did not commit manifest error by
deciding not to qualify Mollere as an expert.
IRS Announcement 89-156 (1989-50 I.R.B. 17) stated that it would establish the
Expert Witness Library to assist IRS attorneys in locating and hiring expert witnesses for
litigation. The Service said that the library will enhance its ability to effectively litigate
cases by aiding in the selection of expert witnesses. The Expert Witness Library will
contain the names of individuals who have acted as expert witnesses for the government
and against the government in various tax cases. The records, which will be organized by
individuals' names and areas of expertise, will contain evaluations of the effectiveness of
the experts in prior cases. We should establish out reputation by carefully selecting and
assigning expert witnesses to clients, so that when cases arise in the future, our experts'
names will be on the candidate lists for both private clients and IRS.
4. Instructions for Expert Witnesses
Our experts should take the following items as instructions: avoiding legal
conclusions and advocacy statements; respecting court's procedures and deadlines;
ensuring independence as an expert witness; respecting court authority and discretionary
judgments; collecting reasonable fees for the expert witness service.
Avoiding Legal conclusions and advocacy statements
In Snap-Drape v. Commissioner (Docket No. 95-60699, 1996), both of the two
expert witness reports offered by Taxpayer, which the Tax Court refused to admit into
evidence, are in the form of letters from certified public accountants and contain analyses
that lead to the conclusion that section 404(k) dividends are deductible for purposes of
computing ACE. Each report also concludes that the position taken by the Treasury
Department in Regulation section 1.56(g)-1(d)(3)(iii)(E) was not reasonably foreseeable
before it was published in proposed form on May 3, 1990.
In refusing to admit these expert witness reports into evidence, the Tax Court
determined that they improperly contain legal conclusions and statements of mere
advocacy. The Tax Court further concluded that the reports would be of no assistance in
making findings of fact.
Taxpayer asserts on appeal that the two expert witness reports should have been
admitted as they show (1) the proper treatment of 404(k) dividends for tax accounting
purposes and (2) the reasonable reliance by Taxpayer on its tax advisors at the time that it
entered into the ESOP transaction, months before publication of the proposed regulation.
Taxpayer further asserts that, as Federal Rule of Evidence 704(a) supports the admission
of these reports, the Tax Court abused its discretion in refusing to admit them into
evidence. Judges disagree.
The Tax Court accurately described the expert witness reports at issue as
consisting of nothing more than legal arguments. The judges conclude that Taxpayer's
reliance on Rule 704(a) is misplaced. The judges have repeatedly held that this rule does
not allow an expert to render conclusions of law. In any event, the judges conclude that
the Tax Court did not abuse its discretion in not admitting the expert witness reports into
evidence.
Respecting Court procedures and deadlines
IRS Procedure 96-53 Section 9.05 states the taxpayer must provide a waiver
under section 6103(c) to the Service for purposes of discussing returns or return
information with the expert. The taxpayer must also ensure that the expert is familiar with
the provisions of this revenue procedure and that any opinion rendered by the expert
complies with those provisions.
In Keogh v. Commissioner (Docket No. 92-4133, 1995), petitioner claims that
the tax court abused its discretion by refusing to allow his expert witness to testify. Tax
Court Rule 143(f) requires any party who plans to call an expert witness to "cause that
witness to prepare a written report for submission to the Court and to the opposing
party." The report must include the qualifications of the witness as well as his opinion and
the facts or data on which it is based. As it applied to this case, the rule required the
expert's report to be submitted to the court and opposing counsel fifteen days before "the
call of the trial calendar." Finally, Rule 143(f) states that the "expert witness' testimony
will be excluded altogether for failure to comply with the provisions of [the rule]."
Here, trial was scheduled to begin on March 20, 1990. On March 6, at a pre-trial
conference, the tax court specifically informed petitioner's counsel that his expert's report
must be submitted to the court and opposing counsel by March 7. On March 7, petitioner
failed to submit an appropriate report, submitting instead a one-page draft that did not
comply with Rule 143(f). Then, on March 16, petitioner's counsel informed respondent
that he would not be relying on that expert but, rather, that he would present another
expert. Petitioner never informed the court of this fact and never requested a continuance
in order to comply with the mandates of Rule 143(f). Finally, three days before trial was
to begin, petitioner submitted his expert witness report to respondent.
On March 23, the trial court inquired as to why petitioner had not complied with
Rule 143(f). Counsel claimed that he was not aware of the tax court rules and that the
delay was caused by his first expert, who decided to cancel. The record indicates that
petitioner was given ample opportunity to submit his expert's report but failed to do so.
Under the circumstances, we find that the tax court did not abuse its discretion in
excluding the expert testimony.
Ensuring independence of expert witnesses
IRS Procedure 96-53 Section 9.03 states that an expert is independent if the
expert has not participated to any material extent in the development of the request and
has not in the past assisted either the Service or the taxpayer in matters substantially
related to the request.
In Hospital Corporation of America v. Commissioner (T.C. Memo. 1996-559,
1996), the judges are not convinced that an independent appraiser can serve as an agent of
the client and also faithfully carry out the responsibilities and duties of an appraiser. If an
appraiser was an agent of the client, the appraiser would not be independent because the
appraiser would owe an undivided loyalty to the client. The expert appraiser, however,
owes a fiduciary duty to the court and to the public.
An appraiser is barred from presenting facts in a biased manner calculated to be
favorable to the client's position. Id. Experts who author appraisal and valuation reports,
moreover, serve as advisers to the courts. The appraiser's duty to the court exceeds any
duty owed the client. An independent appraiser, therefore, could not subject himself or
herself to the control of the client, as an agent must do, and still fulfill his or her duty to
the court and to the public (expert witness generally would not be agent of client because
an expert normally would not agree to be subject to the client's control with respect to
consultation and testimony). Generally, the client can influence but not control an expert's
thought processes.
Moreover, the judges believe that an agent appraiser must have to act as an
advocate of the principal's position to fulfill the fiduciary duty an agent owes his or her
principal. Such advocacy, however, is contrary to the duty owed the court and the public
in general and precludes the assistance of the expert at trial. The Tax Court, in fact, has
rejected expert testimony when the methods opined by the expert constituted advocacy.
Respecting Court authority and discretion
In Republic Plaza Properties Partnership v. Commissioner (107 T.C. No. 7,
Tax Court Docket No. 23300-94, 1996), Judges evaluate the opinions of experts in light
of the qualifications of each expert and all other evidence in the record. Judges have
broad discretion to evaluate the overall cogency of each expert's analysis. Judges are not
bound by the formulae and opinions proffered by an expert, especially when they are
contrary to our own judgment. Instead, judges may reach a decision based on our own
analysis of all the evidence in the record. The persuasiveness of an expert's opinion
depends largely upon the disclosed facts on which it is based. While the judges may
accept the opinion of an expert in its entirety, they may be selective in the use of any
portion of such an opinion. Furthermore, the judges may reject the opinion of an expert
witness in its entirety.
Fees charged for the service of expert witnesses
IRC section 7430 (Awarding of costs and certain fees) states that the term
"reasonable litigation costs" includes (A) reasonable court costs, and (B) based upon
prevailing market rates for the kind or quality of services furnished-- (i) the reasonable
expenses of expert witnesses in connection with a court proceeding, except that no expert
witness shall be compensated at a rate in excess of the highest rate of compensation for
expert witnesses paid by the United States.
Other factors as instructions
The following menu lists many important factors to a successful expert witness.
General instruction:
Maintain the Sympathy of the Jury
Stay Within Your Area of Expertise
Verbal Techniques and Nonverbal Techniques
Documents Read Aloud
Practice Testifying
Prepare Thoroughly
Protection by the Judge
Qualifications and methodology:
Provide an Accurate Curriculum Vitae
Licensing /Certifications
Gaps in Your Curriculum Vitae
Knowledge, Skill, Experience, Training, and Education
Credibility:
Your Fee based on IRC Section 7430
Marketing Activities
Relationship to Retaining Party or Attorney
Affiliation with an Insurance Company
Conversations with Retaining Attorney
Indirect Monetary Interest
Prior Testimony
Professional Presentations
Professional and Personal Writings
5. Guidelines for Expert Witnesses
Our expert witnesses may consider the following items as guidelines: business
valuation; lost earning engagement; financial reconstruction; transfer pricing; completeness
of expert reports; selecting an appropriate methodology in the expert witness reports.
Business Valuations
When analyzing a company, the accountant must focus on the earnings capability
of the business as the company may not be financially stable at the time of the proceedings.
To accomplish this, the accountant must determine possible borrowings and distributable
future cash flows to assist the court in determining the proper settlement (Taub,
Accountancy). Without this informed determination, each party would be presenting a
strictly arbitrary figure.
Specifically, the objective of a business valuation is "to establish a realistic value,
often with limited information, that is both consistent with the client's goal and defendable
under cross examination in the courtroom." (Cenker, The Practicing Accountant) The
forensic accountant must first understand that the due to the controversial matter at hand,
all available financial data may not be turned over for evaluation. That data which is
received may be a misrepresentation of the true financial picture. To compensate for this
possibility, the accountant must delve deeper into the presented financial information for
areas of concern that may be hidden from the face value of the balance sheets and earnings
statements.
This process of delving deeper into the presented financial information requires the
accountant to in effect become an investigator. He must learn to question all presented
information to ask if it is a valid, correct representation of the financial picture for the
company in question. Once these areas are reviewed and opinions formed, the forensic
accountant assists the litigating attorney in defending the information in the courtroom in
the role of expert witness.
Lost Earnings Engagements
Another key focus of the forensic accountant in the area of litigation support is lost
earning engagements. Lost earnings are defined as "the money the plaintiff would have
made but for the actions of the defendant," especially in the areas of personal injury,
wrongful death, and damage/loss estimates (Bjorklund, The Practical Accountant). To
determine lost earnings, the forensic accountant must gather and analyze a variety of
information, then provide informed opinions based on the analysis outcomes. This entire
process requires the accountant to make a variety of judgment calls, specifically weighing
his obligations to the client with those standards established through the CFE and CIRA.
Essentially, the accountant is "not being paid to support a client's case, but to develop an
opinion and then restrict the client's thinking to those issues (the accountant) can support"
(Bjorklund, The Practical Accountant).
To accomplish this goal, the forensic accountant must follow a five-step process to
correctly estimate the value of lost earnings. These steps are as follows:
Identify an amount to be used as "base earnings";
Establish a damage period;
Identify an appropriate rate of growth;
Adjust damages for mitigating circumstances;
Choose an appropriate discounting technique.
Finding an appropriate base earning requires the accountant to identify the amount
of revenue being received prior to the incident which caused earnings to cease or decline.
Taken into consideration should be revenues from regular operations, special projects,
and, in the case of personal injury/wrongful death, the inclusion of appropriate fringe
benefits. The accountant must next identify the applicable damage period, or "the time
period during which the injured party is expected to experience lost earnings" (Bjorklund,
The Practical Accountant).
Upon establishment of the first two factors, the forensic accountant must next
determine an appropriate growth rate. This growth rate would be the "percentage rate that
earnings would be expected to increase during the damage period." The accountant
would use a variety of sources to determine this rate, including industry standards,
historical data, or the Bureau of Labor and Statistics. Once set, the accountant then
considers this rate as constant throughout the damage period and moves on to identify
mitigating items. Mitigating items offset the monetary value of the damage suffered and
can include insurance money received, the effect of income taxes, and the effect of
consumption of resources, to name a few.
Finally, the forensic accountant must determine the appropriate discount method.
Six methods of discounting are offered for the accountant's use. They include the
following methodologies: Traditional discounting; inflate discounting; partial offset
discounting; total offset discounting; Supreme Court discounting; and trial and error
discounting. Each method requires the quantification of future earnings and the
discounting of those earnings to a present value, based on a variety of different factors
(Bjorklund, The Practical Accountant).
Financial reconstruction
Financial reconstruction is a forensic accounting technique used to develop
financial statements for companies by observing their business activities and then
reconstructing costs and revenues. Once a theoretically sound model has been develop and
reliable data has been obtained, forecasts of future financial statements can be developed.
1. Define the Production Process;
2. Work closely with the client to define the specific steps in the production process, the
type of facility required, the types of materials used, and the variable and fixed cost
items;
3. Consult with industry experts or secondary sources if necessary;
4. Develop a Financial Model;
5. Identify the cost accounting, asset pricing, micro-economic, finance, probability and
statistical principles and formulas to be used in the reconstruction and forecasting of
financial statements;
6. Build a computerized financial model, to be refined later, in order to identify the
specific variables that must be gathered through lawful investigative techniques;
7. Attempt to Lawfully Obtain Confidential Financial & Operating Data;
8. Review all available secondary sources for clues;
9. Obtain and analyze all primary documents relating the company and piece together
vital bits of information from multiple, often hidden sources;
10. Surveillance, from public property, of plant operations. Surveillance includes recording
the amount of material arriving and leaving from shipments and deliveries, the names
of suppliers and customers, the number of employees and shift breakdowns, and the
activities of key personnel;
11. Interview rank and file employees, suppliers, customers and other relevant parties;
12. Reconstruct Financial Statements & Create Forecasts;
13. Input operational, cost and applicable financial data into the computerized financial
model;
14. Refine the model to account for the type of data obtained from our investigations;
15. Create a best estimate of the company's past and present financial statements;
16. Forecast future financial and operational outcomes based on scenarios developed by
the client.
Transfer Pricing
IRS Procedure 96-53 has provided updated procedures on how to obtain an
advance pricing agreement (APA) from the Office of the Associate Chief Counsel
(International) for the prospective determination and application of transfer pricing
methodologies (TPMs) for international transactions.
Section 9.04 states that the expert will critically analyze the taxpayer's proposed
TPM and render a written opinion. The opinion will address any questions and concerns
raised by the Service or the taxpayer (and, if involved, the foreign competent authority);
conclude whether the proposed TPM or a revised version fairly supports and produces an
arm's length approach; and provide the basis for this opinion. However, the expert's
opinion will not be binding on any of the parties. The taxpayer and the Service (and, if
involved, the foreign competent authority) will have access to the expert's report and
supporting documentation. The Service and the taxpayer shall both be kept fully informed
of any communications between the other party and the independent expert, and receive
copies of all information provided by such other party to the expert.
Completeness of Expert Witness Report
Revenue Regulation Sec. 20.2031-6 (d) (Valuation of household and personal
effects) states that if expert appraisers are employed, care should be taken to see that they
are reputable and of recognized competency to appraise the particular class of property
involved. In arriving at the value of antiques such as silverware, the appraisers should
take into consideration its antiquity, utility, desirability, condition, and obsolescence.
In Citrus Valley Estates v. Commissioner (99 T.C. No. 21, 1992), the court
contrasted the approach of the expert witness for the petitioners, which it characterized as
"well-reasoned," with the approach of the IRS' expert, which was "less complete and did
not account for all of the factors affecting the choice of an interest rate assumption."
In Hudspeth Pine v. Commissioner (T.C. Memo. 1985-628, 1985), the expert
witnesses of both Hudspeth Pine and the Service relied on other sales of timber to
establish the value of Hudspeth Pine's inventory. The company's expert chose comparable
sales to establish the value of the company's timber "almost exclusively on the basis of
whether or not the bid ratio for sales of pine was at least 40 percent or greater, whether or
not the sale was in fact comparable in time or location to the timber being valued in this
case," the court stated. The sales used for comparison by the government's expert witness,
the court said, were chosen for "their locations and their comparability as to species
composition, identity of the seller, market area, and quality of timber."
According to the court, the selection of comparable sales to determine the value of
the timber in issue by the company's expert "appears to have been based primarily on
whether the sale value of the timber was equal to or greater than the value which
petitioner wishes to have established as the fair market value of the subject timber on the
two valuation dates." The rejection of sales in close geographic and chronological
proximity to the subject sales, the court said, made the entire report of the company's
expert "suspect."
In Estate of Freeman v. Commissioner (T.C. Memo. 1996-372, 1996, Tax Court
Docket No. 22427-93), the court rejected the valuation by the estate's expert witness, who
failed to establish that he identified comparable companies and used data with respect to
those comparable companies in setting "appropriate market-reflective variables." Judge
Halpern also found that the estate's expert "ignored the dynamic state of the corporation,
which had experienced exceptional growth" since it was founded in 1985. Judge Halpern
further faulted the expert for failing to consider the company's plans for a public offering,
which occurred within a year of the decedent's death. The court held that no minority
discount was appropriate, reasoning that the market would recognize the minority position
of a single share of stock.
Appropriate methodology used in expert witness report
In IRS Action on Decision CC-1987-023 (1987), the issue was the fair market
value of a statue contributed by petitioner's limited partnership to the State of California in
1979. The partnership obtained an appraisal of $750,000 for the statue and took an I.R.C.
section 170(c) deduction for that amount. Petitioner deducted his proportionate share,
$36,722.00. In his notice of deficiency, the Commissioner determined that the statue was
worth $50,000 and disallowed $34,274.00 of the petitioner's claimed charitable deduction.
Trial was essentially a contest of expert witnesses. Based on post-deficiency
expert appraisal, the Commissioner contended that the statue's value was no more than
$275,000. The petitioner's expert reiterated the $750,000 to $800,000 value claimed by
the partnership.
In arriving at a $600,000 figure, the court did "not completely embrace either
expert's report" but did find the report of the petitioner's expert "more persuasive".
Petitioner's expert calculated fair market value by taking a "weighted" average of three
separate values: the 1979 replacement cost, the 1979 cost of a comparable sculpture by
comparably famous California artists, and a value extrapolated from the fair market value
of Bufano's smaller works. This last method of extrapolating value from smaller works is
known as the French Grid system.
Many critics and appraisers agree with the Service that the French Grid system is a
theoretically weak method of determining the value of art. Like any extrapolation, it loses
its rationale when it is applied to works (even by the same artist) of different styles,
materials, periods, and functions. Clearly, the French Grid system could be used to justify
abusive, inflated appraisals for art's white elephants. The Service will resist excessive or
unrealistic appraisals based on the French Grid system.
Other factors to be considered
The following menu lists some factors that can be regarded as guidelines for an
expert witness.
Dealing with Challenges to expert's opinion:
Your Opinion's Foundation
Reliance on Tests Not Personally Performed
Reliance on Other Experts' Records
Reliance on Self-Reported History
Omitted Facts
Hypothetical Questions
Erroneous Facts and New Facts
Trial tactics:
Area of Expertise
Insisting on a "Yes" or a "No" Answer
Professional Discipline
Inquiries into Your Personal Life
Initial Contact
Your Files and Documentation
Time Line
Importance of First-Hand Knowledge
Searching Other Experts' Opinions
Recognizing the Opposition
Using the Tools of the Trade
Working as a Professional Witness
Portrayal as a Cold, Calculating Scientist
Avoid Making Mistakes in Calculations
Causation
Charts and Summaries
Opinion for Litigation Only
Courtroom Demonstrations
Reports and Calculations
Textbooks and Articles Relied Upon
Attacking Your Opinion as Absurd
Prognosis
Reasonable Degree of Scientific Certainty
Notes on Records
Last Minute Changes of Opinion
6. Summary
Based on the above discussion on expert witness selection and instructions and guidelines
for them, ABC Accounting Firm will be able to properly handle the expert witness side of
litigation. A qualified, competent, and well-prepared expert witness is an essential integral
part of a litigation effort.
Appendix: List of References
Bjorklund, Paul R. "Calculating Lost Earnings for Damage Awards." The Practical
Accountant June 1991:62-70.
Cenker, William J. and Monastra, Carl J. "The Basic of Business Valuation in Divorce
Settements." The Practicing Accountant January 1991: 19-26.
Crumbley, D. Larry. "Forensic Accountants Appearing in the Literature" at ATM web
site http://www.dlc@wcba-nt.tamu.edu
de Lorenzo, Justin. "Forensic Accounting" on Australian Accountant, March 1993.
Jarnigan, David D. , Lisa M. Shafer and Ronald M. Mano. "Forensics: The Hotbed in
the Accounting Profession" on New Accountant Oct.1995: 25-30.
Taylor, John F., and Kent N. Scheider. "Uncovering Hidden Assets." National Public
Accountant May 1993: 18-21.
Singleton-Green, Brian. "Birth of an Expert Witness." Accountancy November 1992.
Taub, Michael. "Untying the Financial Knot." Accountancy February 1994:75-76.
"The Business World's Answer to Interpol". KPMG media release on May, 1995.
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