Not Whether, But How: How Estate of Jones Went Around Gross Without Overruling It

The Business: Timber, Not a Tax Structure

Aaron Jones founded Seneca Sawmill Company (SSC) in Eugene, Oregon in 1954. SSC was a lumber manufacturer operating technologically advanced dimension and sawmills. In 1986, SSC elected S corporation status. By the mid-2000s, it employed thousands of workers. In 1992, Jones formed Seneca Jones Timber Company (SJTC) as an Oregon limited partnership to hold timberlands that would supply SSC’s mills. SJTC held approximately 1.45 billion board feet of timber across 166,000 acres of western Oregon timberland, independently appraised at $424 million. SSC owned a 10% interest in SJTC as the sole general partner.

The two entities were legally separate but operationally inseparable. They shared the same management team, the same headquarters, and the same strategic purpose: SJTC grew and harvested the trees; SSC turned them into lumber. SJTC practiced “sustained yield harvesting,” never cutting trees until they were 50 to 55 years old and limiting harvest to the annual growth of its tree farms. That philosophy kept the timber producing indefinitely but meant SJTC’s value depended on decades of future cash flows rather than the liquidation value of its land.

In May 2009 — part of a succession plan Jones had initiated in 1996, not a deathbed transfer — Jones gifted interests in both SSC and SJTC to his three daughters and to trusts for their benefit. He reported the total value of the gifts at approximately $21 million. The IRS asserted a value of roughly $120 million and a gift tax deficiency of nearly $45 million. Jones survived the gifts by about five years.

A $100 Million Gap Between the Experts

The gap between the parties wasn’t a rounding difference. The estate’s expert, Robert Reilly, valued SJTC at $21 million and SSC at $20 million, both on a non-controlling, non-marketable basis, using a DCF under the income approach. The IRS’s expert valued SJTC alone at $140 million using a net asset value method, treating SJTC as a natural resources holding company whose primary value was its timberlands.

The threshold question was whether SJTC was an operating company (value it on earnings) or a holding company (value it on assets). The answer drove a sixfold difference in value. If SJTC was a holding company, its 166,000 acres of timberland appraised at $424 million meant even a heavily discounted minority interest would be worth far more than $21 million. If it was an operating company, the DCF reflected the cash flows the timber actually generated under the sustained-yield model — which were modest relative to the asset base.

Judge Pugh found that SJTC had characteristics of both, but the income approach was more appropriate. The reasoning was practical: the likelihood that SJTC would sell its timberlands was effectively zero. The partnership agreement didn’t allow the limited partners to force a sale. SSC, as general partner, would never direct one — its sawmill operation depended on SJTC’s continued ownership of the timber. If the asset is never going to be sold, valuing it as though it will be is an exercise in theory, not economic reality.

For T&E practitioners, this is a broadly applicable holding: when the entity’s governing documents and operating reality make liquidation implausible, the income approach should carry the weight. The IRS’s NAV approach was given zero consideration — the same treatment the IRS’s asset-based approach later received in Cecil.

The Reframing: Not Whether, But How

Here’s the holding that changed the trajectory of the tax-affecting debate. The IRS argued the standard Gross position: tax-affecting is inappropriate because pass-through entities don’t pay entity-level taxes, so deducting hypothetical taxes from projected earnings understates the cash flows.

Judge Pugh declined to engage on those terms. She noted that the prior cases rejecting tax-affecting — Gross, Gallagher — were “specific cases with specific circumstances.” They didn’t establish a blanket prohibition. Then she reframed the question: the issue is not whether to take tax consequences into account when valuing a pass-through entity, but how. Reilly’s methodology — tax-affecting SSC’s and SJTC’s earnings using the SEAM (S Corporation Economic Adjustment Model) developed by Daniel Van Fleet — “may not be exact, but is more complete and convincing than respondent’s zero tax rate.”

That last sentence is the key. The court didn’t say tax-affecting is correct as a matter of principle. It said tax-affecting is more accurate than ignoring taxes entirely. A zero tax rate in the DCF implies that pass-through status has no tax consequences at all — which is economically absurd, because the owners bear the tax burden personally. Any methodology that accounts for that burden, even imperfectly, is more complete than one that pretends it doesn’t exist.

The elegance of the reframing is that it didn’t require overruling Gross. Gross rejected a specific expert’s specific methodology in a specific case. Jones accepted a different expert’s different methodology in a different case. Both outcomes are consistent if the question is how to account for tax consequences rather than whether to account for them at all. Gross said the taxpayer’s method was wrong. Jones said Reilly’s method was better than zero. No contradiction.

This is the conceptual space that Cecil later walked through. When the Tax Court in 2023 accepted tax-affecting with SEAM, it could do so without addressing Gross head-on — because Jones had already established that the question was how, not whether.

The “Fight Between Laywers”

Judge Pugh made an observation that practitioners should internalize. She noted that the IRS’s challenge to tax-affecting appeared to be more of a “fight between lawyers” than a dispute between experts. The criticism of Reilly’s methodology showed up more prominently in the IRS’s trial briefs than in its expert’s report. The IRS’s own expert, rather than arguing that tax-affecting was categorically wrong, attacked Reilly’s methodology on the grounds that SJTC was a natural resources holding company whose returns should track property rates of return — a narrower objection than the blanket Gross position.

This matters for two reasons. First, it signals that even within the IRS, the categorical opposition to tax-affecting was eroding. The agency’s litigation position said one thing; its retained experts were saying something more nuanced. That same dynamic — IRS experts conceding tax-affecting while IRS lawyers argued against it — appeared in Kress and would appear again in Cecil. Second, it underscores that the Tax Court pays attention to where the argument originates. An expert who credibly applies tax-affecting in their report is more persuasive than an expert whose methodology is defended by the lawyers in the brief.

When You Don’t Need to Relitigate the Question

If your client’s appraiser has applied tax-affecting with a documented, defensible methodology — SEAM, the Van Fleet model, or a comparable framework grounded in valuation literature — and the IRS’s examiner or expert doesn’t challenge tax-affecting as a concept, the fight is over on that front. Focus your energy on the inputs: the tax rate, the S corp premium (if any), the projection assumptions, and the discount levels. Those are the technical disputes that will determine value, and they’re the disputes where documentation quality matters most.

Where you still face risk is when the IRS assigns an examiner who takes the traditional Gross position. Jones helps — it’s the first Tax Court decision to accept tax-affecting in twenty years, and the “not whether but how” framing directly rebuts the categorical prohibition. But Jones is a memorandum opinion, not a regular opinion. Jackson (2021) rejected tax-affecting two years later. The line isn’t fully settled. Your strongest position combines the legal argument (Jones/Kress/Cecil trend) with the economic argument (no rational buyer pays the same price for an S corp as a C corp) and the practical argument (the IRS’s own experts have adopted the methodology repeatedly).

One more practical note: make sure the valuation is prepared in the ordinary course and filed with the return. Jones’s gifts were part of a succession plan he initiated in 1996. The valuations were contemporaneous. He survived the gifts by five years. This is the clean fact pattern — the opposite of the deathbed transactions in Powell and the post-hoc litigation valuations that courts scrutinize more heavily. Timing and substance matter.

The Practical Takeaway

Jones didn’t kill Gross. It went around it. By reframing the question from whether to account for tax consequences to how, Judge Pugh gave the Tax Court a path to accept tax-affecting without overruling twenty years of precedent. That path led to Cecil four years later. The $45 million deficiency asserted by the IRS was reduced to less than $2 million in gift tax — a result driven almost entirely by the court’s acceptance of the estate’s income approach and Reilly’s tax-affected DCF.

For T&E counsel: cite Jones for the principle, Kress for the IRS concession, and Cecil for the most recent Tax Court application. Together, they establish that tax-affecting pass-through entity earnings is the prevailing direction, even if Gross hasn’t been formally overruled. And make sure your appraiser documents the methodology thoroughly enough that the court can say what Judge Pugh said in Jones: it may not be exact, but it’s more complete and convincing than zero.