Article: "Who Wants To Be A Valuation Expert? "
Cases:
· DiSanto (T.C. Memo 1999-421)
· Borgatello (T.C. Memo 2000-264)
· Adams (86 A.F.T.R. 2d 99-10497)
· Shepherd (115 T.C. No. 30)
· Church (85 AFTR2d Par.2000-428)
· Kerr (113 T.C. No.30)
· Reichardt (114 T.C.No.9)
Who Wants To Be A Valuation Expert?
Many do, but few are. Who is the best valuation expert, especially in the Tax Court arena? Management Planning, Inc., you say? Is that your final answer? Of course.
At MPI, we are proud of our record.. The Tax Court’s endorsement of our valuation work in three decisions (Smith, DiSanto and Borgatello) in less than a ten month period is a unique achievement. We won all three of these cases and the IRS experts lost. We must emphasize, though, that we have never had to go to Tax Court to defend our valuation work when we were hired at the origination of a matter, such as the filing of an estate or gift tax return. Our valuation work has always been accepted as filed or a settlement has been reached at the Agent or Appeals level. Actually, we consider going to Tax Court on behalf of a client to be a failure. We do not seek out Tax Court expert witness engagements but we execute them diligently when we have been selected. When members of our staff have testified in Tax Court, we have been hired for one or more of the following reasons:
(a) the taxpayer did not use a valuation expert to begin with; or
(b) the taxpayer was not wholly confident in the original valuation expert and wanted a supplemental expert; or
(c) the use of a second expert was deemed to be a good strategy.
In one of the cases discussed in this document, DiSanto, Judge Colvin used MPI’s values to the penny, calling the MPI appraisal "reasonable", "credible" and "cogent and persuasive evidence". Rarely does the Tax Court completely agree with one of the experts in the case, and in DiSanto there were a total of four. In the Smith case, decided last year, the judge had this to say about our work:
The MPI expert witness’ conclusion was "very persuasive and well supported by his underlying reasoning."
In other Tax Court appearances in recent years, such as Lauder and McCormick, we have also done extremely well.
By way of contrast, the following comments were made by Tax Court judges about valuation experts in the cases discussed herein:
"We give little weight to _____’s analysis."
"We reject both of these positions."
"We reject ______’s estimate."
We at MPI are continually disappointed by the weak performances of so many appraisers in Tax Court decisions, particularly in view of the expansion in the amount of appraisal education, publications, seminars and training available today. We certainly enjoy our position, our reputation and our success in Tax Court. We strive each day to earn the confidence of both our clients and the courts.
RECENT VALUATION DECISIONS
Estates of Frank M. and Grace J. DiSanto v. Commissioner, T.C. Memo 1999-421. Filed December 27, 1999.
Frank DiSanto, the owner of a controlling 53.5% block of Morganton Dyeing & Finishing Corp. ("MD&F"), died in November 1992. As a result of her disclaimer in May 1993, Mrs. DiSanto was to receive only a minority interest in MD&F stock. She died in June 1993. The disclaimer would presumably reduce the marital deduction in Mr. DiSanto’s estate but his executors tried to calculate the deduction based on the value of the controlling interest left to her under the Will. Judge Colvin disagreed and ruled that the marital deduction for stock in a closely held corporation must equal "the value of the interest that passes to the surviving spouse."
MPI was one of four valuation experts, three for the executors and one for the IRS. Trial testimony was given by MPI, who prepared the valuation analyses ultimately relied upon by Judge Colvin in determining controlling and minority interest values of MD&F. Judge Colvin used MPI’s values to the penny, calling the MPI appraisal "reasonable," "credible" and "cogent and persuasive evidence."
COMMENT: Rarely does the Tax Court fully agree with the conclusion of any valuation expert. We at MPI are proud that Judge Colvin recognized the reliability of our work product.
Estate of Charles A. Borgatello v. Commissioner, T.C. Memo 2000-264. Filed August 18, 2000.
The fair market value of the decedent’s 82.76% stock interest in a real estate holding company (a C corporation) was the issue in this case. The court’s acceptance of a substantial capital gains discount on a controlling interest is revolutionary.
MPI was the estate‘s business valuation expert. Both MPI and the government’s expert agreed on a net asset value method but differed on the size of the applicable discount. The MPI discount was 35%, while the government was at 27%. The judge agreed on a 33% reduction from net asset value, comprised of 24% for capital gains, 3% for restrictions on transfer and 6% for transaction costs.
COMMENT: Prior tax court cases dealing with the potential tax liability on built-in gains have involved minority interests (see Davis 110 T.C. No 35 and Eisenberg, No.97-4331 CA2, 8/18/98) so the Borgatello decision is significant, especially since even the government’s expert supported an overall 27% discount.
Adams v. United States, 86 A.F.T.R. 2d 99-10497. Filed July 5, 2000.
The Fifth Circuit reversed and remanded a district court decision (83 A.F.T.R. 2d 99-1887) concerning the value of a deceased partner’s 25% interest in a Texas general partnership.
The partnership of four siblings, each with 25% shares, owned a ranch, securities and oil and gas interests worth $33.081 million. The death of a partner triggered dissolution under Texas law and a deceased partner’s heirs could assert liquidation rights as assignees. The district court went along with the IRS and said fair market value was liquidation value, calculated to be 25% of the partnership’s net asset value less liquidation costs. Discounts for minority interest, lack of marketability and unattractive asset mix were not allowed.
The Fifth Circuit’s review of Texas partnership law indicated that an assignee’s liquidation rights were not a sure thing. This uncertainty, which a hypothetical willing buyer of the assignee interest would have to face in exercising liquidation rights, was enough to send the case back:
"On remand, the district court must consider evidence that the liquidation rights of an assignee are NOT clearly established but that, to the contrary, they are unsettled, and must consider the applicability of the various claimed discounts and the correct percentages of those that are found to apply."
COMMENT: We, too, thought the district court erred (see our Series XX bulletin) because the partnership’s ranch land and oil and gas would be difficult to fractionalize and sell, a willing buyer of the assignee interest would be hard to find, and the uncertain assignee rights would merit a significant discount from net asset value.
At a recent conference, the appraiser in Adams revealed that a valuation discount of 48% was negotiated in settlement discussions, a number not far from the 53.2% originally claimed by the taxpayer.
J.C. Shepherd v. Commissioner, 115 T.C. No. 30. Filed October 26, 2000.
J.C. Shepherd deeded leased land to the Shepherd Family Partnership, a general partnership, on August 1, 1991. The partnership agreement, under which he was to have a 50% interest and his two sons 25% interests each, was signed by Shepherd on August 1 and his sons on August 2. His 1991 gift tax return reported gifts of land to each son and reflected a "minority and marketability discount" of 33.5% attributable to the sons’ minority interests in the partnership.
While acknowledging that a 33.5% discount would be otherwise appropriate, the IRS disallowed the discount because it felt the gifts were of land, not partnership interests.
The court decided Shepherd made indirect gifts to his sons of 25% undivided interests in the land by virtue of a transfer of the land to the partnership completed on August 2 after the partnership came into existence. The opinion emphasizes the Kincaid case [682 F.2d 1220 (5th Cir. 1982)] where property transferred to a corporation was deemed a gift to the other shareholders to the extent its value exceeded the value of what was received in exchange.
A 15% discount comprising lack of control (3%), the possibility of disagreement between co-owners (10%) and the eventuality of partition (2%) was allowed in valuing the undivided interests. There was no discount for lack of marketability because the court felt it had already been considered in adjusting the discount rate used in an income approach to value the land as a whole.
COMMENT: A 15% discount is low in our experience and also when compared to results in recent court cases.
Elsie Church, deceased v. U.S., 85 AFTR2d Par. 2000-428. Filed January 18, 2000.
The IRS argued that the creation of a family limited partnership two days before death resulted in a gift by the decedent to her children of the difference between the value of what she contributed and the fair market value of her limited partnership interest. This so-called "gift on formation" argument failed because there were non-tax reasons for the partnership’s existence and "the value of her partnership interest was directly proportional to the contributions of other partners to the partnership".
Elsie Church died unexpectedly on October 24, 1993, two days after she and her children had contributed their undivided interests in the family ranch to Stumberg Ranch Partners, Ltd. Mrs. Church also contributed $1 million in securities. Pooling their undivided interests gave them control (57%) of the ranch and much-needed leverage in dealing with a contrary nephew who owned part of the other 43%. The court said that "the Partnership was not formed solely to reduce estate taxes" but also "to preserve the family ranching enterprise for themselves and their descendants."
COMMENT: The IRS lost in its attempt to sustain a gift on formation argument and, significantly, chose not to contest the nearly 60% discount used in valuing Mrs. Church’s limited partnership interest. The 60% discount seems justifiable in view of the market conditions onvaluation date and the underlying real estate assets.
Kerr v. Commissioner, 113 T.C. No. 30. Filed December 23, 1999.
Blaine and Mildred Kerr created family limited partnerships in 1993. The assets of Kerr Family Limited Partnership ("KFLP") included life insurance policies and limited partnership interests in Kerr Interests Limited Partnership ("KILP") which owned stocks, bonds and real estate. Among other transfers, the Kerrs assigned limited partnership interests in KFLP to their respective GRATs in 1994. Since there was no consent to admission of the GRATs as limited partners, the Kerrs treated the interests transferred to the GRATs as assignee interests, not limited partnership interests, for valuation purposes. A 25% discount for lack of marketability was used in valuing the KILP interests owned by KFLP while minority and marketability discounts of 17.5% and 35%, respectively, were applied in determining the fair market value of a limited partnership interest in KFLP.
Both partnership agreements contained liquidation provisions under which the partnerships would dissolve or liquidate in 2043 or by agreement of all of the partners. In addition, limited partners could not withdraw or have their capital contributions returned. Texas law provided for a partnership’s dissolution upon the occurrence of events specified in the partnership agreement or upon the written consent of all of the partners. Texas law also said a limited partner could withdraw on six months’ written notice.
The government said restrictions on liquidation in the partnership agreements should be ignored in the valuation process because they were "applicable restrictions" under Code Section 2704(b) and therefore no marketability discount was allowable. Briefly stated, an "applicable restriction" is any limitation on the ability to liquidate that is more restrictive than what state law provides.
Judge Jacobs had two issues to decide:
1. Did the Kerrs transfer assignee interests (in which case larger valuation discounts are often appropriate)?
2. Were liquidation provisions in the partnership agreement more restrictive than Texas law?
The Kerrs lost on the first issue as Judge Jacobs used a "substance over form" approach to conclude that limited partnership interests had been transferred. He thought the rights of limited partners and assignees in the partnership agreement were not significantly different and believed the Kerrs were motivated "to circumvent Section 2704(b)."
The applicable restriction issue went in the Kerrs’ favor. Partnership liquidation provisions were deemed similar to Texas law. More importantly, the government’s argument that a limitation on a limited partner’s withdrawal rights was an applicable restriction was rejected. Section 2704(b) pertains to the "limitation on the ability to liquidate the entity," and does not affect "the withdrawal of a limited partner from the partnership."
COMMENT: This case is bad for the IRS and its reliance on 2704(b) to discourage the use of family limited partnerships in discount planning.
Estate of Charles E. Reichardt v. Commissioner, 114 T.C. No. 9. Filed March 1, 2000.
Although it is a decision for the IRS, Reichardt brings to mind the Service’s apparent continuing policy to tolerate family limited partnerships unless the facts are bad.
Mr. Reichardt transferred most of his assets, including real estate and marketable securities, to a revocable trust of which he was a co-trustee with his two children. The trust’s assets were then contributed to an FLP in exchange for 1% general and 99% limited partnership interests. Gifts of 30.4% limited partnership interests to each child followed soon thereafter.
So far so good. The problem was that nothing else changed. Reichardt continued to manage and control the assets, commingled them with his own, remained in the house without paying rent, received all the income, etc. His children, although authorized to act in the trust agreement, did absolutely nothing. Reichardt’s relationship to the assets looked the same as always so the court implied an agreement between Reichardt and his children to keep the status quo and ignore the trust and partnership arrangement. An accountant’s attempt to make year-end adjusting entries was to no avail. The assets were brought back into Mr. Reichardt’s estate under Code Section 2036(a) because he had retained the right to enjoy them during his lifetime.
An interesting point was the court’s position on the burden of proving the implied agreement between Reichardt and his children. Because this was a transaction involving family members, the estate had to prove there was no such agreement, which it could not.
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