Corporate Valuation and Estate Planning
A “Grievous” Valuation Error
Tax Court Protects Boundaries of Fair Market Value in Grieve Decision
All fair market determinations involve assumptions regarding how buyers and sellers would behave in a transaction involving the subject asset. In a recent Tax Court case, the IRS appraiser applied a novel valuation rationale predicated on transactions that would occur involving assets other than the subject interests being valued. In its ruling, the Court concluded that this approach transgressed the boundaries of what may be assumed in a valuation.
Background
At issue in Grieve was the fair market value of non-voting Class B interests in two family LLCs.
- The first, Rabbit, owned a portfolio of marketable securities having a net asset value of approximately $9 million.
- The second, Angus, owned a portfolio of cash, private equity investments, and promissory notes having a net asset value of approximately $32 million.
Both Rabbit and Angus were capitalized with Class A voting and Class B non-voting interests. The Class A voting interests comprised 0.2% of the total economic interest in each entity. The Class A voting interests were owned by the taxpayer’s daughter, who exercised control over the investments and operations of the entities.
Valuation Conclusion – Taxpayer
The taxpayer measured the fair market value of the Class B non-voting interests using commonly accepted methods for family LLCs.
- The net asset value of each LLC was deemed to represent the value on a controlling interest basis.
- Since the subject Class B non-voting interests did not possess control over either entity, the net asset value was reduced by a minority interest discount. The taxpayer estimated the magnitude of the minority interest discount with reference to studies of minority shares in closed end funds.
- Unlike the minority shares in closed end funds, there was no active market for the Class B non-voting interests in Rabbit and Angus. As a result, the taxpayer applied a marketability discount to the marketable minority indication of value. The taxpayer estimated the marketability discount with reference to restricted stock studies.
The combined valuation discount applied to the Class B nonvoting interests was on the order of 35% for both Rabbit and Angus, as shown in Exhibit 1 on the following page.
Valuation Conclusion – IRS
The IRS adopted a novel approach for determining the fair market value of the Class B non-voting interests.
Noting the disparity in economic interests between the Class A voting (0.2%) and Class B non-voting interests (99.8%), the IRS concluded that a hypothetical willing seller of the Class B non-voting interest would sell the subject interest only after having first acquired the Class A voting interest. Having done so, the owner of the class B non-voting interest could then sell both the Class A voting and Class B nonvoting interests in a single transaction, presumably for net asset value.
