The Crack in the Gross Wall: How Kress v. United States Changed the Tax-Affecting Debate

For years after Gross v. Commissioner (1999), the IRS’s position on valuing S corporations was simple: you don’t deduct hypothetical corporate taxes from a pass-through entity’s earnings, because the entity doesn’t pay them. The Tax Court enforced that position case after case. Valuation professionals objected — no rational buyer would pay the same price for an S corp’s earnings as for a C corp’s after-tax earnings, because the S corp owner bears the tax burden personally — but the objections didn’t produce results in court.

Then the IRS’s own expert conceded the point. In Kress v. United States (E.D. Wis. 2019), all three valuation experts — two for the taxpayer, one for the government — applied a C corporation tax rate to the subject company’s earnings. The government’s expert tax-affected the earnings and then added an S corp premium on top. The court accepted tax-affecting and rejected the premium. For the first time in a federal court, the economic argument the valuation profession had been making for two decades had judicial support. And because the IRS’s own expert had adopted the methodology, the agency’s ability to argue against it in future cases was fatally compromised.

Kress didn’t end the tax-affecting debate. It cracked the wall. What came after — Estate of Jones (T.C. Memo. 2019-101), Estate of Jackson (T.C. Memo. 2021-48), and then Estate of Cecil (T.C. Memo. 2023-24) — happened in the opening Kress created.

The Facts: A Real Company, Not a Tax Structure

Green Bay Packaging (GBP) was a family-owned S corporation founded in 1933 by George Kress. By the mid-2000s it was a substantial industrial business: approximately 3,400 employees across 32 manufacturing locations in 15 states, producing corrugated packaging, folding cartons, and coated labels. The company’s Fiber Resources division managed over 210,000 acres of timberland in Arkansas. GBP had a strong balance sheet, minimal debt relative to equity, and non-operating assets including a $65–77 million investment portfolio (Hanging Valley Investments) and group life insurance policies with cash surrender values of $142–158 million.

James and Julie Kress gifted minority shares in GBP to their children and grandchildren in 2006, 2007, and 2008. The gift tax returns were based on annual valuations prepared by John Emory, who had valued the company since 1999 in the ordinary course of business. Emory’s valuations tax-affected GBP’s earnings at a C corp rate with no S corp premium. The Kresses paid approximately $2.4 million in gift taxes based on those values.

Four years later, the IRS challenged the valuations. The agency initially asserted values as high as $50.85 per share — more than double Emory’s $21.60 per share for the 2008 valuation date. The Kresses paid the $2.2 million in additional taxes and interest, then filed in U.S. District Court for a refund.

Why It Mattered That This Was District Court

Here’s the structural detail that most commentary glosses over. The Kresses didn’t fight this in Tax Court. They paid the deficiency and sued for a refund in the U.S. District Court for the Eastern District of Wisconsin. That procedural choice had consequences.

The Tax Court is where the IRS litigates most gift and estate tax valuation cases. It has its own body of precedent on tax-affecting, built on Gross and its progeny. Tax Court memorandum opinions don’t bind other Tax Court judges, but they create strong gravitational pull — a judge is unlikely to depart from a line of memorandum opinions without a reason. The Gross line had created exactly that kind of gravity: case after case rejecting tax-affecting, with each new decision reinforcing the last.

District Court was different terrain. Chief Judge Griesbach wasn’t bound by Tax Court memoranda. He wasn’t writing within the Gross tradition. He was evaluating the expert testimony on its own terms, and the expert testimony was unanimous: all three experts — the taxpayer’s two (Emory and Nancy Czaplinski of Duff & Phelps) and the government’s one (Francis Burns) — agreed that GBP’s earnings should be tax-affected at a C corp rate. The court accepted that consensus without fanfare.

The practical significance: Kress demonstrated that the IRS’s position on tax-affecting could not survive contact with its own experts. The agency had spent twenty years arguing in Tax Court that pass-through entity earnings shouldn’t be tax-affected. But when the IRS hired an expert to actually value GBP — a real, operating S corporation with $70+ million in revenue and 3,400 employees — that expert did what every practitioner does: tax-affected the earnings. The gap between the IRS’s litigation position and its experts’ professional practice was now on the record.

The S Corp Premium: The Fight the IRS Lost

The government’s expert didn’t just tax-affect GBP’s earnings. He then added an upward adjustment — an S corp premium — to account for the perceived tax advantages of pass-through status. The logic: even after tax-affecting to a C corp equivalent, the S corp is still worth more than the C corp because its shareholders avoid the double taxation layer.

The court rejected the premium. Chief Judge Griesbach found it “unclear” that minority shareholders would enjoy whatever benefits flowed from S corp status, because minority shareholders couldn’t control whether the company maintained or terminated its S election. The court declared itself “neutral” on the theoretical question but found no factual basis to apply the premium to minority interests in GBP.

This holding is distinct from the tax-affecting holding and arguably more consequential for gift tax practitioners. Tax-affecting reduces the valuation by accounting for hypothetical taxes. The S corp premium adds value back. If courts accept tax-affecting but also accept the premium, the two adjustments partially offset each other, and the valuation benefit to the taxpayer is reduced. Kress accepted one and rejected the other — the best possible outcome for the taxpayer. Cecil later followed the same pattern: all experts tax-affected, the court accepted the lowest SEAM adjustment (17.6%), and the taxpayer captured most of the valuation benefit.

For practitioners: the S corp premium is where the next fight is likely to focus. Tax-affecting is increasingly accepted. Whether to add value back for the S corp election — and if so, how much — is the open question. Make sure your appraiser documents the premium analysis (or the decision not to apply one) with the same rigor as the tax-affecting itself.

GBP’s bylaws restricted share transfers to Kress family members. The taxpayer’s expert factored this restriction into his marketability discount, arguing it further limited the universe of potential buyers. The court rejected this, finding that the Kresses had not satisfied the third prong of the §2703(b) exception — specifically, they failed to present evidence that the restriction’s terms were comparable to those in arm’s-length transactions.

The impact was modest: the court reduced the DLOM by approximately 3 percentage points, settling on discounts of 25–27% depending on the valuation year. But the lesson is practical. If your client’s company has family transfer restrictions, and you want those restrictions reflected in the marketability discount, you need comparable evidence from arm’s-length transactions. Without it, §2703(a) requires the restriction to be disregarded, and the appraiser’s DLOM loses its factual support.

The Timeline That Build the Case for Tax-Affecting

The reason Kress matters beyond its own facts is what happened next. The case didn’t just win for the Kresses. It created a pattern that the Tax Court eventually couldn’t resist:

1999 — Gross v. Commissioner: Tax Court rejects tax-affecting. The IRS’s position is established. Valuation professionals object but lose repeatedly in Tax Court for the next two decades.

2019 — Kress v. United States: District Court accepts tax-affecting. Critically, the IRS’s own expert tax-affects. The agency’s litigation position and its experts’ professional practice diverge on the record.

2019 — Estate of Jones v. Commissioner: Tax Court allows tax-affecting for the first time, but with a narrow framing. The court emphasizes the question is not whether to account for tax consequences but how.

2021 — Estate of Jackson v. Commissioner: Tax Court rejects tax-affecting, holding the estate’s experts hadn’t persuaded the court that the hypothetical buyers would be C corporations. A reminder that Gross isn’t dead yet.

2023 — Estate of Cecil v. Commissioner: Tax Court accepts tax-affecting again — because, as in Kress, the IRS’s own expert adopted the methodology. The court explicitly cabins its holding to the “unique setting at hand,” but the pattern is now undeniable: when the IRS’s experts tax-affect, the IRS can’t credibly argue against it.

The through-line is the IRS’s own experts. Kress was the first case to put the concession on the record. Cecil was the case where the Tax Court finally acknowledged it. The crack became a door.

When the Tax-Affecting Fight Is Already Won

If your client’s S corp gift valuation goes to examination and the IRS retains an expert who tax-affects the earnings — as happened in Kress, Jones, and Cecil — the conceptual argument is over. Your appraiser doesn’t need to relitigate Gross. The dispute will be about the rate (what C corp tax rate to apply), the S corp premium (whether to add value back for pass-through status), and the discount levels (DLOC and DLOM). Those are narrower, more technical fights, and they’re fights where the appraiser’s documentation matters more than the legal precedent.

Where you still need to prepare for a full tax-affecting challenge is when the IRS assigns an examiner who takes the old-school Gross position. Jackson (2021) shows that the Tax Court hasn’t categorically abandoned Gross — it rejected tax-affecting as recently as three years ago. The strongest defense remains the economic argument: no rational buyer would pay the same price for the S corp’s earnings stream, because the owner bears the personal tax liability. Combine that with the Kress/Jones/Cecil trend line, and the IRS’s position becomes increasingly difficult to maintain — but it hasn’t been formally overruled.

The Practical Takeaway

Kress is not the most recent case in the tax-affecting line, and it’s not the most authoritative (Cecil holds that distinction as a Tax Court decision). But it’s the most important inflection point in the twenty-year debate, because it’s where the IRS’s own expert broke ranks. Once the government’s retained appraiser looked at a real operating S corporation — with 3,400 employees, 32 plants, and 210,000 acres of timberland — and concluded that tax-affecting was the right approach, the theoretical argument was over. The litigation lag just took a few more years to catch up.

For T&E counsel advising on S corp gift valuations: make sure your appraiser tax-affects with a documented, defensible methodology. Make sure the SEAM or S corp premium analysis is thorough enough to survive scrutiny on its own terms. Make sure family transfer restrictions are supported by arm’s-length comparable evidence if they’re going to affect the DLOM. And watch the IRS’s expert’s report carefully when it arrives — if they tax-affect, the fight is about the rate, not the concept. Kress proved that distinction matters.

If you’re preparing an S corp gift valuation and want to make sure the tax-affecting methodology, SEAM adjustment, and discount analysis are positioned correctly under the current case law, happy to talk through the approach. The documentation decisions you make before filing matter more than the litigation strategy you’d need afterward.