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Daubert Challenge - What You Need to Know as an Expert Witness

By: George D. Abraham

CEO & Chief Appraiser

The United States Supreme Court issued a landmark ruling in 1993 in the case of Daubert v. Merrill Dow. In that decision, the Supreme Court changed 70 years of case precedent for the admission of expert testimony.  

Daubert changed the w ay in which federal courts are required to evaluate scientific and technical evidence. Prior to Daubert, federal courts admitted scientific and technical evidence only if the principle upon which it was based was sufficiently established to have general acceptance in the field to which it belonged. In Daubert, the Supreme Court invalidated the "general acceptance" standard, and instead held that, according to Rule 702 of the Federal Rules of Evidence, scientific and technical evidence is admissible only if: (1) the testimony is based upon sufficient facts or data; (2) the testimony is the product of reliable principles and methods; and (3) the witness has applied the principles and methods reliably to the facts of the case. In addition, the Supreme Court expanded the measure of reliability. The court created a new standard based upon a broader analysis of the evidence. The Daubert decision outlined a series of inquiries to be considered, including:

1) Has the theory or technique been tested, under appropriate standards and controls?

2) Has the theory or technique been subjected to peer review?

3) Does the theory or technique have a known or potential rate of error?

4) Has the theory or technique gained "general acceptance" in the field or profession?

Daubert was also significant because the Supreme Court held that federal judges are required to ensure that scientific and technical evidence is both relevant and reliable. Although the trial judge's inquiry is flexible, the Supreme Court recognized that the judge must make a "preliminary assessment of whether the reasoning or methodology underlying the testimony is scientifically valid and of whether that reasoning or methodology properly can be applied to the facts in issue."

The 2000-2007 Financial Expert Witness Daubert Challenge Study, by PriceWaterhouseCoopers, examines more than 2,354 federal and state court opinions from 2000 through 2007 in which Daubert challenges arose. The analysts identified 3,681 individual expert witness challenges, of which 635 were addressed to financial experts. Some interesting results of the study are the following:

• The number of Daubert challenges to financial experts has been rising every year since 2001. In 2007, 116 financial experts were challenged, an increase of 9% over 2006.
• The percentage of Daubert challenges of financial experts which have been successful has varied widely over the past eight years, ranging from 29% in 2002 to 59% in 2005. The rate was 41% in 2007.
• Of all the financial experts challenged during 2000-2007, 29% were completely excluded, 18% were partially excluded and 50% were admitted. In the remaining 3% of cases, no decision was made. This breakdown was similar to that for experts of all types.
• Plaintiff-side financial experts were challenged much more frequently than defendant-side financial experts. Among all challenges to financial experts during 2000-2007, 70% were targeted at the plaintiff side.
• Over the 2000-2007 period, challenged plaintiff-side and defendant-side financial experts were excluded from testifying in almost equal proportion: 47% on the plaintiff side versus 46% on the defendant side.

In summary, it has changed the way appraisers write their reports. In a recent Business Valuation Resource webinar, Robert M. Lloyd (University of Tennessee College of Law) and Jonathan Dunitz (Friedman Gaythwaite Wolf & Leavitt) offered several suggestions for writing a report that will reduce vulnerability to Daubert challenges.

"The first thing is to use the Daubert factors in your report," said Professor Lloyd. Second, show your work. "I sound like a middle school teacher in an arithmetic or an algebra class, but it's really important to let the court know exactly what you did - all the steps, show what you did, explain the reasoning step by step in detail - and write it in a language that the judge can understand. Define and explain technical terms."

"The other thing you need to remember is that ultimately, if the case is tried, you'll be speaking to jurors who will probably have even less understanding than the judge does, added Dunitz. "So it's really important to think in those terms and, from the very beginning in writing your report, to remember that you're ultimately going to have to explain this to complete novices and be able to explain it in a way that they will understand and accept as being accurate."

In examining the reasons for expert disqualification, the analysts found that "lack of reliability" was the leading cause for exclusion, being found in 74% of cases resulting in exclusion, followed:    

In summary, it has changed the way appraisers write their reports. In a recent Business Valuation Resource webinar, Robert M. Lloyd (University of Tennessee College of Law) and Jonathan Dunitz (Friedman Gaythwaite Wolf & Leavitt) offered several suggestions for writing a report that will reduce vulnerability to Daubert challenges.  

"The first thing is to use the Daubert factors in your report," said Professor Lloyd. Second, show your work. "I sound like a middle school teacher in an arithmetic or an algebra class, but it's really important to let the court know exactly what you did - all the steps, show what you did, explain the reasoning step by step in detail - and write it in a language that the judge can understand. Define and explain technical terms."     

"The other thing you need to remember is that ultimately, if the case is tried, you'll be speaking to jurors who will probably have even less understanding than the judge does, added Dunitz. "So it's really important to think in those terms and, from the very beginning in writing your report, to remember that you're ultimately going to have to explain this to complete novices and be able to explain it in a way that they will understand and accept as being accurate."

Tax Law Updates

By Dr. Jerrrold J. Stern 

Two major legislative acts passed in 2010 contain tax implications for individuals. Some provisions extend the Bush-era tax cuts until 2013 when tax rates will rise to pre-Bush era levels. Other rules introduce new taxes that take effect in 2013. Here is a review of tax changes most relevant to our readers. There may be further changes to the tax law in December 2011 or during 2012 based on August 2011 legislation. 

Tax Rates  

Vigorously debated changes concern tax rates for all individuals, especially those earning above $200,000. For 2011 and 2012, the tax bracket rates for 2010 and earlier years (10, 15, 25, 28, 33 and 35 percent) remain intact. In 2013, the rates become 15, 28, 31, 36 and 39.6 percent. Thus, the increase will affect all taxpayers. In 2013, payroll taxes will increase by 0.9 percentage points for singles earning more than $200,000 salary and married couples earning more than $250,000 salary. The same is true for self-employed individuals (which include most brokers and sales associates) earning over $200,000/$250,000. 

'Unearned Income' Taxes

Starting in 2013, a 3.8 percent surtax will apply to unearned income of highincome taxpayers earning more than the $200,000/$250,000 threshold. "Unearned income" generally includes income from investments, such as capital gains, interest, dividends, "passive activity" rents (for example, the passive rental of farm land), royalties and some annuities. The following are not considered unearned income: "active business rents" such as apartment and commercial building rents; municipal bond interest; and qualified retirement income from qualified pensions such as 401(k) plans, certain annuities and IRAs. The top capital gains and dividends tax rate in 2013 will be 20 percent, up from 15 percent. This change will affect the majority of investors. The combination of the unearned income surtax and the tax increase for capital gains and dividends will be particularly felt by high-income individuals and couples. For example, a married couple with $250,000 earned income and $100,000 capital gains will pay $23,800 tax ($100,000 × [20 percent + 3.8 percent]) on their capital gains rather than $15,000 ($100,000 × 15 percent), an increase of $8,800, or 8.8 percent from what they would owe under current tax law.

Itemized Deduction Phaseout 

Beginning in 2013, taxpayers will have to reduce most itemized deductions (mortgage interest, real estate taxes, charitable contributions and miscellaneous itemized deductions) by 3 percent of the excess of adjusted gross income (AGI) over a threshold amount. The 3 percent rate represents an upward adjustment of the current 1 percent rate. For example, $169,550 is the threshold amount in 2011. Taxpayers could lose up to 80 percent of their itemized deductions. Assume a married couple has $250,000 AGI and $30,000 itemized deductions subject to phaseout. Because their AGI exceeds the threshold amount by $80,450 ($250,000 minus $169,550 threshold), their itemized deductions would decrease by $2,414 (3 percent × $80,450), costing them an additional $869 ($2,414 × 36 percent).

Exemptions Phaseout 

Also in 2013, the total amount of personal and dependency exemptions is subject to phaseout. The total will be reduced by 2 percentage points for each $2,500 by which AGI exceeds a threshold amount. If this phaseout existed in 2011, the threshold

amount would be $169,550 for singles and $254,350 for married couples. Let's say a married couple has $350,000 AGI and four personal dependency exemptions totaling $14,800 (4 × $3,700). Their exemptions would be reduced by $11,544. The reduction is calculated as follows: ($350,000 minus $254,350 threshold) ÷ $2,500 = 39 (rounded up). Then, 39 × 2 percentage points = 78 percent and 78 percent × $14,800 = $11,544. The tax cost of this reduction would be $4,571 ($11,544 × 39.6 percent). The 2010 tax changes are complex and affect other areas of taxation as well. Consultation with a tax accountant or tax attorney is recommended.

THE TAKEAWAY 

Taxes for individuals, particularly high-income individuals and investors, are scheduled to rise in 2013. Areas affected include tax bracket rates, payroll and self-employment tax rates, capital gains, dividends, itemized deductions, and personal and dependency exemptions.

Dr. Stern (stern@indiana.edu) is a research fellow with the Real Estate Center at Texas A&M University and a professor of accounting in the Kelley School of Business at Indiana University.

A Reprint from Tierra Grande; Journal of the Real Estate Center; at Texas A&M University; OCTOBER 2011.

IRS Publishes Guidance on Tax Treatment of Mobile Phones

By Michael Cohn, Accounting Today

Washington, D.C. (September 15, 2011) 

The guidance explains a provision of last fall's Small Business Jobs Act of 2010 that removed cell phones from the definition of listed property, a category under tax law that normally requires taxpayers to perform additional recordkeeping.    

IRS Notice 2011-72, issued Wednesday, Sept. 14, provides guidance on the treatment of employer- provided cell phones as an excludible fringe benefit. According to the new guidance from the IRS, when an employer provides an employee with a cell phone primarily for noncompensatory business reasons, the business and personal use of the cell phone is generally nontaxable to the employee. The IRS will not require recordkeeping of business use in order to receive this tax-free treatment.

Employers had long complained that the categorization of mobile phones as listed property required businesses and their employees to keep detailed records listing exactly which phone calls were business related and which ones were personal. Many employees needed to carry multiple cell phones just to avoid having their personal calls going to their business phone, and risk a heavy recordkeeping burden.

Simultaneously with the Notice issued Wednesday, the IRS also announced in a memo to its examiners a similar administrative approach that applies with respect to arrangements common to small businesses that provide cash allowances and reimbursements for work-related use of personally owned cell phones.

Under this approach, employers that require employees, primarily for noncompensatory business reasons, to use their personal cell phones for business purposes may treat reimbursements of the employees' expenses for reasonable cell phone coverage as nontaxable. This treatment does not apply to reimbursements of unusual or excessive expenses or to reimbursements made as a substitute for a portion of the employee's regular wages, the IRS noted.

Under the guidance issued Wednesday, in cases where employers provide cell phones to their employees or where employers reimburse their employees for the business use of their personal cell phones, tax-free treatment is available without burdensome recordkeeping requirements. The guidance does not apply to the provision of cell phones or reimbursement for cell phone use that is not primarily business related, as such arrangements are generally taxable. Details are in the memo and in Notice 2011-72, posted on IRS.gov.