Richmond v. Commissioner
In Richmond v. Commissioner (Estate of Helen P. Richmond, Deceased, Amanda Zerbey, Executrix, Petitioner v. Commissioner of Internal Revenue, Respondent. T.C. Memo. 2014-26), several key issues were addressed including:
- A split is highlighted among different Courts of Appeals and the Tax Court regarding how the implicit tax liability for a built-in capital gain (“BICG”) should be handled in a business valuation. The tax can be deferred. According to the Tax Court, a prospective BICG tax liability is not the same as a debt that really does immediately reduce the value of a company dollar for dollar.
- The Tax Court rejected the income approach to valuation for this asset-holding entity. It clearly stated that the Net Asset Value approach is consistent with the precedent of using net asset valuations for companies with asset holdings whose underlying values are readily ascertainable.
- The Tax Court assessed substantial penalties. The reported value on the estate tax return was less than 65% of the proper value, thereby triggering the benchmark for a “substantial” understatement under the tax law.
Background
At the time of her death, Helen Richmond held a 23.44% interest in a family-owned personal holding company, Pearson Holding Company (“PHC”). PHC was incorporated in Delaware in 1928 as a familyowned investment holding company, a Chapter C corporation. At the valuation date, PHC held a portfolio with an asset value of $52,159,430 and liabilities of only $45,389. Accordingly, PHC had a net asset value of $52,114,041. PHC’s portfolio of assets consisted of government bonds and notes, preferred and common stocks, cash, receivables and a modest security deposit. Common stocks represented over 97% of the total portfolio. Due to a low turnover in the underlying securities, PHC had an unrealized gain approximating $45,576,677, or 87.5% of the net asset value.
The co-executors of the estate engaged a law firm to prepare the estate tax return and retained a CPA at an accounting firm to value the PHC stock for purposes of the estate tax return. The estate tax Form 706 was filed timely. The Court noted that the CPA had a Master of Science in taxation, experience in public accounting involving audits, management advisory, litigation support and tax planning, was a member of the AICPA and other accounting groups, and had appraisal experience having written 10-20 valuation reports and testifying in court, but he did not have any appraiser certifications. The CPA prepared a draft report that valued the decedent’s interest at $3,149,767, using a capitalization of dividends method. Without further consultation with the CPA, the estate filed Form 706 based on this report. The IRS issued a statutory notice of deficiency. The IRS determined a value of the estate’s interest at $9,223,658. The tax liability was thereby increased, and a gross valuation misstatement penalty of $1,141,892 was determined.