Finding that 76 shares of voting stock of a closely held corporation were each worth $215,539, rather than $2,650 as had been reported, the Tax Court upheld most of a $17,643,886 deficiency asserted against the Estate of Richard R. Simplot, but finding reasonable reliance on tax professionals, abated all penalties. CCH Dec. 53,296
[J.R. Simplot Co. had been founded by the decedent’s father, who transferred all of the company’s stock to his children. His philosophy had been to reinvest the company’s cash-flows into long-term assets, operate privately, and pass ownership to his decedents. As of the valuation date, the company (which had never paid a dividend), was comprised of five operating groups, the largest of which, the food products group, accounted for 60% of McDonald’s domestic potato product purchases. J.R. Simplot Co. also owned 13.36% of the shares of Micron Technology. The capital structure of J.R. Simplot Co. consisted of two classes of authorized stock: 76 shares of Class A voting common, and 141,289 shares of Class B nonvoting common. Richard Simplot had owned 18 shares of Class A stock, or 23.55%; his three siblings owned the remainder. The decedent had also owned 2.79% of all Class B stock.]
The estate argued that the FMV of class A voting and class B nonvoting shares were identical since the decedent’s class A shares did not represent voting control and there was no reasonable expectation that disproportionate benefits would accrue to the class A shareholders in the immediate future. The taxpayer also argued that an existing 360-day restriction on transferability which applied solely to class A shares, in combination with a liquidation preference accorded to class B nonvoting stock, actually made the class B stock more valuable. However, the IRS argued, and the Tax Court agreed, that a voting privilege premium should be accorded to the class A stock and, more ominously for the estate, that by reason of the disparate ratio between the number of voting and nonvoting shares, the premium should be expressed as a percentage of the equity value of the corporation rather than merely as a percentage premium applied to the 76 shares of class A voting common.
In determining the equity value of J.R. Simplot, both sides’ experts used (a) income (i.e., discounted projected future operating cash-flows) and (b) market (i.e., historical and projected earnings applying market-related pricing ratios of comparable publicly traded companies) approaches and averaged the two values. Rejecting the taxpayer’s contention that equity value should be reduced for short-term debt, the Court accepted the value calculated by the government’s experts, which was (after the adjustment for short-term debt) only 1% higher than the taxpayer’s figure. (A discrepancy which the Court attributed to the taxpayer having taken two minority discounts for Micron Technology stock.)
Both sides’ experts testified that a lack of marketability discount of 35% should attach to the class A voting stock. Ironically, the government’s expert testified, and the Court agreed, that a 40% discount should attach to the class B shares due to their lack of voting rights. The Court observed that “common sense” dictated that since only four persons held all class A voting stock, those shares were, on a per-share basis, “far more valuable than the Class B shares” because of the potential for influence and control of the company (even though they did not represent a controlling block). The Court accepted the government’s lower range figure of 3% of the company’s equity value as “the fair premium” for the voting privileges of the class A stock.
Having found that the taxpayer acted reasonably and in good faith in relying on the advice of tax professionals and appraisers in valuing the voting stock for estate tax purposes, the Court abated $7,057,554 in penalties. Bearing in mind that the Court ultimately allowed a lack of marketability discount for the class B nonvoting stock of 40% (which was even higher than the taxpayer’s valuation experts had calculated), one wonders whether a more aggressive stance with respect to discounts for closely held businesses may be more than justified. The Court’s reluctance to impose penalties reflected its observation that “[d]etermining the fair market value of unlisted stock (such as J.R. Simplot Co. stock) is, to say the least, difficult.”