In Guistina v.Comr., T.C. Memo 2011-141, a federal estate tax case, the Tax Court, through Judge Morrison, determined the value of a 41.128% interest in Oregon limited partnership, which owned, as its principal asset, approximately 48,000 acres of timber land. The result was a substantial victory for the IRS. The case is appealable to the U.S. 9th Circuit Court of Appeals.
At the time of his death, the decedent, through his revocable trust, owned 41.128% limited partnership interest in an Oregon limited partnership that owned approximately 48,000 acres of timber land.
The valuation positions of the parties and how the Tax Court came out are as follows:
|* Discount for delays in marketing and selling the timber land|
|Estate Tax Return Value||$12,678,117|
|Estate Litigation Value||$12,995,000|
|IRS Notice of Deficiency Value||$35,710,000|
|IRS Litigation Value||$33,515,000|
|Tax Court Conclusion of Value||$27,454,115|
|Value per Cash Flow Method||$33,800,000||$65,760,000||$51,702,857|
|Tax-Free Risk Rate||4.5%||4.52%||4.5%|
|Equity Risk Premium||3.6% (0.5 Beta)||11.7%|
|Small Stock Premium||6.4%||6.4%|
|Partnership Specific Risk||3.5%||1.75%|
|Assumed Growth Rate||4%||4%|
|Discount for Lack of Marketability||35%||25%||25%|
|Discount for Lack of Control||0%||12%||0%|
|Cash Flow Method Weighting||30%||20%||75%|
|Asset Approach Weighting||0%||60%||25%|
|Market Approach Weighting||30%||20%||0%|
|Capitalization of Distributions||30%||0%||0%|
|Asset Accumulation Method||10%||0%||0%|
|Value of Land (40% Discount*)||$142,974,438||$142,974,438||$142,974,438|
The Tax Court noted that both parties moderated their valuation positions between the time of filing the return/deficiency notice and trial. The Tax Court also sidestepped IRC Sec. 7491 burden of proof shift to the IRS be deciding the case on the preponderance of evidence.
Cash Flow Method
With respect to the cash flow method, the Tax Court found problems with the work of both appraisers. The Tax Court called down the IRS appraiser for using only one year’s worth of cash flow; the estate’s appraiser used five consecutive years of cash flows. Additionally, the IRS appraiser assumed 3% growth and flat expenses, which the Tax Court said was wrong. In the end, the Tax Court wholly disregarded the cash flow approach work of the IRS appraiser. However, the Tax Court also found fault with the work of the estate’s appraiser, disregarding the 25% discount for income taxes that the estate’s appraiser took, reasoning that the appraiser used a pre-tax, not a post-tax, capitalization rate, citing Gross v. Comr.
Discount for Lack of Marketability (“DLOM”)
In determining DLOM, both experts relied upon a benchmark analysis based upon the restricted stock studies and the pre-IPO studies. However, the IRS appraiser gave more reliance to the restricted stock studies, specifically, the SEC Institutional Investors Study, while the estate’s appraiser relied more upon the pre-IPO studies. The IRS appraiser testified that the pre-IPO studies overstated the DLOM, and, according to the Tax Court, the estate’s appraiser failed to rebut that point. Thus, the Tax Court upheld the DLOM conclusion that the IRS appraiser reached.
The Tax Court disregarded three methods that the estate’s appraiser employed, totaling 70% of that appraiser’s conclusions: the asset accumulation method, the capitalization of distributions method and the market approach (that the IRS appraiser also employed). The Tax Court disregarded the capitalization of distribution method because it found that the cash flow method was more accurate and that the two methods were duplicative because both assume continued operations. The Tax Court disregarded the asset accumulation approach, again because the Tax Court believed that the method was duplicative of the asset approach. The Tax Court disregarded the market approach that both appraisers employed because the court believed that the selected guideline companies were substantially different from the subject company and because the court noted that neither appraiser “appropriately” considered those differences.
Tax Court’s Holding on Value
Based upon its employment of a 75% weighting of the cash flow method and 25% weighting of the asset approach, the Tax Court arrived at a final value of $27,454,115, which was substantially closer to the IRS trial position than that of the estate.
This is a very interesting valuation case because the Tax Court primarily relied upon a valuation method (cash flow method) substantially more than the experts for both sides did. Query whether this gives the estate any grounds for appeal?
It is strange for either appraiser to have relied upon a benchmark approach like the pre-IPO studies and the restricted stock studies. Stranger still is the Tax Court’s claim that the estate’s appraiser failed to rebut the notion that the pre-IPO studies overstate the DLOM. Arrows of inaccuracy could have just as easily been aimed at the restricted stock studies. In my opinion, neither of these approaches is very accurate and should only be used as a sanity check.
The Tax Court employed a unique proportionality method in that the court assumed a 75% chance that the subject company would continue its timber operations as is and a 25% chance that the limited partners would force the liquidation of the subject company. The Tax Court seemed to come up with those percentages out of thin air. I can’t recall another case or situation where such a method was used. Query whether this assumption will be attacked on appeal?
Some of the mistakes that the appraisers made seem to have emanated from the valuation positions that the respective parties espoused, which often is a problem. Using a pre-tax discount rate with a tax adjustment seems to be wrong at first glance. Query how that got out of the appraiser’s office other than because it made the numbers come out close to the return position?
Given that there is a lot of money involved here, I suspect that we haven’t heard the last of this matter. I expect the estate to appeal.
Guistina v.Comr., T.C. Memo 2011-141; Gross v. Comr., T.C. Memo 1999-54, aff’d., 272 F. 3d 333 (6th Cir. 2001).