 The IRS and Tax Court's Current Views Since the Berg case, the IRS and the Tax Courts have become increasingly sophisticated in the matters of valuation approaches and theory. The Court no longer accepts simply using "bald assertions" in valuation reports and testimony. The IRS, as a result of the discounts being taken in valuations for estate and gift tax purposes, has been giving valuation reports increasing scrutiny. Karen Lewallen Sumler, IRS director of estate and gift-tax administration, in a 1998 interview with The Wall Street Journal stated... "Growing use of estate-planning techniques that can slash the valuation of gifts is prompting the IRS to boost resources in the gift-tax area". She goes on to say... "Valuation is the real frontier in estate taxes. A major IRS concern is the family limited partnership, which allows taxpayers to discount (steeply) gifts of partnership shares to family members. Some have claimed discounts of 50% or more". "...Last year's tax law put a time limit on the IRS's ability to challenge the value of gifts, requiring the IRS to act within three years of filing a proper gift tax return." (See Adequate Disclosure of Gifts, Discounts and Positions by Steve Kaplan in the May issue of CPA/LSC regarding the latest proposal regarding Gift & Estate Tax Returns). In Bernard Mandelbaum v. Commissioner (T.C. Memo1995-255, June 12, 1995) Tax Court Judge Davis Laro created significant discussion within the valuation community by raising key issues regarding marketability discounts and setting forth ten factors to be considered in determining an appropriate discount for lack of marketability. These are:
The Court considered each of the above ten factors and determined subjectively that a 30% marketability discount was appropriate. The Estate of William J. Desmond v. Commissioner (T.C. Memo 1999-76) (See Brief Case, April 1999) provides a thorough discussion of valuation methods, application of premiums and discounts and appraisal reports by the Court including criticism of the expert reports and subsequent analysis and conclusion. Briefly, the court stated that each of the expert's reports were subject to criticism. Because of the limitations imposed by the IRS on their expert the Court rejected their report. The Court further stated that the fair market value reached by the taxpayers expert better represented the fair market value of the decedent's stock in a paint manufacturer, but only adopted in part the expert's report. The Court rejected the expert's asset approach as vague and generally unhelpful implying the expert may have improperly applied the method without further elaboration. The Court also modified the computation and application of the control premium and discount for lack of marketability resulting in an increase of 10.7% over the value reported in the estate tax return. In The Estate of Jameson v. Commissioner (T.C. Memo 1999-43), the Court takes a position on several valuation issues which differ from the direct testimony of the valuation experts. The Tax Court concludes the estate tax value to be $ 5.8 million v. $4.2 million determined by the estate and $6.2 million by the IRS (See Brief Case, May 1999, for a discussion of the Court's approach to built-in gains). This case will be discussed in more detail in future issues. The Court unfortunately is not always on point. (Are any of us?) In Simplot v. Commissioner (112 T.C. No. 13 1999), March 22, 1999, the tax court demonstrated a lack of common sense. After agreeing with the Estate's expert on three of four issues, it applied a premium for control to a minority interest. In any valuation the last step is to ask, "would I buy this stock? Clearly the Court did not apply the "sanity check" in this case. Christopher Mercer reviews this case in detail at http://www.bizval.com. As demonstrated by the cases discussed above, the Court is taking the application of valuation theory to another level. Although all of the above case references refer to Tax Court cases, these principles apply to all valuation matters subject to litigation. An excellent article for your library is "Preparing Valuation Reports to Withstand Judicial Challenge" written by Robert T. Willis, Jr. CPA, CFA in the December 1998 issue of Estate Planning (RIA GROUP, Boston, MA). In that article, Mr. Willis discusses significant court cases published from 1975-1997 relating to the Court's views on valuation and commentary regarding deficiencies in valuations and the expert's testimony. Any professional involved in litigation support where valuation is at issue is urged to
keep current on the evolution of valuation developments in the Courts. This article is being reprinted from the CPA Litigation Service Counselor with permission from Harcourt Professional Publishing Division, 525 B Street, Suite 1900, San Diego, CA 92101.
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