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Estate & Gift Valuation E-Flash The following FCG Estate & Gift Valuation E-Flash is being provided to you compliments of the following FCG member firm: ValuePoint Consulting Group, LLC Contact: W. James Lloyd, CPA/ABV, CBA jlloyd@valuepointconsulting.net ********************************************* CITATION: SUMMARY: DETAILS: Built-in Gain The Tax Court recited the history of the built-in gains tax dispute at the Tax Court and Appeals Court levels and readers are commended to the full text of the case for this thorough analysis. The Court went into some detail to compare this case to the 5th Circuit's opinion in Dunn ( Estate of Dunn v. Commissioner 301 F. 3d 339, 2002) even though the 5th Circuit would not be where an appeal to this matter would be filed. The Court differentiated this case from Dunn because here decedent held a minority interest, while Dunn dealt with a controlling interest. The Tax Court said, “ There is no need to express agreement with the automatic use of an assumption of liquidation when using an asset-based approach to value a majority interest because we are valuing a small minority interest … Even if we were considering the value of a majority interest in CCC, a hypothetical buyer would not purchase the shares and then sell the stock to realize the net asset value, less the built-in capital gain liability. All of the securities held by CCC could have been acquired on the open market without the built-in capital gains. ” The estate argued that CCC's relatively low earnings and modest dividends would cause a hypothetical buyer to prefer liquidation. The Tax Court disagreed because the company “… kept pace with the S&P 500 [and] … neither the circumstances of this case nor the theory or method used to value the minority interest in CCC requires an assumption of complete liquidation on the valuation date… A hypothetical buyer of CCC is, in most respects, analogous to an investor/buyer of a mutual fund. The buyer is investing in a securities mix and/or performance of the fund and would be unable to liquidate the underlying securities. This is especially true here when we consider a 6.44-percent investor, who, inherently is unable to cause liquidation. In addition, the record reveals that there was no intention of the trusts of the Jelke family shareholders to liquidate. ” The estate's appraiser argued that the present value of the tax on the built-in gain assuming future sales should be the same as for an immediate sale since the stock portfolio would appreciate at the same rate as the discount rate. The Tax Court noted that this approach results in the consideration of future tax not “built-in” at the valuation date. The IRS appraiser argued that the built-in gains tax valuation is analogous to the need to discount net operating loss carryforwards because they cannot be used until years after the valuation year. The Tax Court concluded that a $21 million reduction for the built-in gain tax liability should be included in the calculation of net asset value based on the IRS appraiser's analysis. Discount for Lack of Control The IRS appraiser arrived at a 5% discount for lack of control. He based this on the 8.61% average discount for closed-end funds that he obtained from an article in the Journal of Economics. He argued that an investor in CCC, like mutual fund investors, would prefer not to have control, making a discount less significant. The Tax Court was critical of the taxpayer appraiser's analysis of the closed-end funds he chose. The Court also was unable to agree with the taxpayer appraiser's assumption that the discounts reflected in the closed-end funds he chose were due solely to lack of control suggesting that part of the discount might be due to lack of marketability. The Court said, “... the amount of discount in these comparable funds that is due to lack of control, rather than from some other factor is speculative. ” The Court concluded that a 10% discount for lack of control was appropriate. Discount for Lack of Marketability The Court disagreed with the analyses of both appraisers. The Court found the restricted stock studies provided a “ limited amount of guidance ,” but was unable to give any weight to the studies used by the taxpayer appraiser because they were not sufficiently similar to CCC. The Court found the IRS expert's Mandelbaum analysis flawed, but endorsed the Mandelbaum approach. The Court performed its own Mandelbaum analysis [ Editor's note – the starting point for the Court's analysis was not disclosed in the opinion, but presumably it was the 20% used by the IRS expert .] The Court determined an overall lower than average discount was appropriate and arrived at a 15% discount for lack of marketability. ************************* We encourage you to forward this E-flash, with attribution intact, to other interested parties. This FCG Estate & Gift Valuation E-Flash has been sent to you by your local Financial Consulting Group member firm: ****************************** ValuePoint Consulting Group, LLC
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