1995 Tax Ct. Memo LEXIS 178 | Tax Ct. | 1995
1995 Tax Ct. Memo LEXIS 178">*178 Decisions will be entered under Rule 155.
MEMORANDUM FINDINGS OF FACT AND OPINION
PARR,
The issues for decision are: (1) Whether 91 shares of common stock of Magton, Inc., transferred shortly before decedent Anthony's death are includable in petitioner Anthony's gross estate pursuant to
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. At the time the petitions herein were filed, executor Anthony J. Frank resided in Ocean City, New Jersey.
Decedents Anthony and Margaret were husband and wife. Anthony died on October 26, 1988; Margaret died on November 10, 1988. At the time of their deaths decedents owned shares in Magton, Inc. (Magton).
Magton is a closely held New Jersey corporation incorporated in 1964. Magton was authorized to issue 1,000 shares 1995 Tax Ct. Memo LEXIS 178">*180 of common stock, par value $ 100 per share. As of June 1, 1988, a total of 501 shares of Magton common stock was issued and outstanding. The shares were owned as follows:
Anthony J. Frank, Sr. | 252 shares |
Margaret E. Frank | 68 shares |
Anthony J. Frank (decedents' son; hereafter | |
referred to as Anthony Jr.) | 80 shares |
David E. Frank (decedents' son) | 80 shares |
Margaret F. Frank (decedents' daughter) | 21 shares |
Magton was a family-run business. Decedent Anthony was the president of Magton. He made all of the most important decisions and directed corporate policy. Decedent Margaret was the secretary of Magton. She had minimal involvement in running the business. Their daughter Margaret, prior to her death, was the executive housekeeper. Anthony Jr. handled the day-to-day operations as the general manager and vice president. David was also a vice president and corporate controller. In addition, Anthony Jr.'s and David's wives worked in the business.
At the time of decedents' deaths, among the assets of Magton were three motels: The Beach Club (formerly named the Sting Ray), the Impala, and the Tahiti. All three motels were located in Ocean City, New Jersey, a family-oriented1995 Tax Ct. Memo LEXIS 178">*181 seashore resort. The three motels were appraised by Carroll-McIlhinney, Inc. (real estate appraisers and consultants), as follows:
3/20/84 | 2/13/86 | 11/10/88 | |
Beach Club | $ 3,500,000 | $ 4,000,000 | $ 4,400,000 |
Tahiti Motel | 1,350,000 | 1,500,000 | 1,800,000 |
Impala Motel | 3,000,000 | 3,400,000 | 3,150,000 |
The Impala is located near the ocean; it consists of 109 units, a 110-seat restaurant, and two swimming pools. The Tahiti is closer to the ocean than the Impala. It consists of 54 units, a 64-seat restaurant, and a swimming pool. The Tahiti was sold by Magton to an unrelated party in an arm's-length sale on April 10, 1989, for $ 2,100,000. The Beach Club consists of 82 units, a 76-seat restaurant, and a swimming pool. Between October 1987 and May 1988, renovations costing approximately $ 1 million were made to the Beach Club. At or about the dates of death, the aggregate number of rooms of the motels owned by Magton was 15-20 percent of the total rooms in Ocean City.
In 1986, Magton sold an undeveloped parcel of land which adjoined the Impala to PDT Enterprises (PDT), a corporation owned by the children and decedent Anthony. PDT developed a 28-unit condominium development1995 Tax Ct. Memo LEXIS 178">*182 on that parcel, the Wild Dunes. All but one of the condominium owners rent their units to vacationers. Magton had leasing, housekeeping, and maintenance contracts with these owners. Pursuant to the leasing contracts, Magton acted as rental agent for the condominium owners. The contracts were for terms of 1 year. Since 1986, Magton has entered into these contracts and has generated revenue from such contracts.
The shares of common stock of Magton were valued on the Federal estate tax returns for Anthony's and Margaret's estates at $ 5,000 per share. The valuation was based upon a buy and sell agreement dated July 20, 1983, entered into by the Magton shareholders.
Decedent Anthony created a revocable trust dated June 1, 1988, appointing decedent Margaret and himself as trustees. Relevant terms of the trust agreement follow. The beneficiaries of the trust were decedent Anthony's wife (i.e., decedent Margaret), his children, and his grandchildren. Distributions from the trust could be effected in one of two ways: (1) Upon written request of decedent Anthony; or (2) at the trustees' discretion for the welfare, comfort, or support of decedent Anthony or any of his dependents. 1995 Tax Ct. Memo LEXIS 178">*183 Decedent Anthony as grantor, alone, retained the power to alter, amend, or revoke all or any part of the trust.
On July 1, 1988, decedent Anthony created a power of attorney appointing his son, Anthony J. Frank, as attorney in fact to, inter alia, "withdraw and receive the income or corpus of a trust" for decedent Anthony's benefit. Further, the power of attorney granted decedent Anthony's attorney in fact the power "to make gifts, without consideration in any amount to anyone, including my attorney, outright or in trust."
On October 24, 1988, Anthony Jr., acting on his father's behalf pursuant to the power of attorney, withdrew 91 shares of Magton stock from the revocable trust, which were placed in his father's name, as evidenced by share certificate No. 21. Those shares were then transferred to decedent Margaret, as reflected in share certificate No. 22, issued to her on the same date.
Decedent Anthony died on October 26, 1988. The executor filed Form 706, United States Estate Tax Return, including 161 shares of Magton in decedent Anthony's gross estate. The executor did not include the stock transfer from the revocable trust as part of Schedule G, which requests a listing1995 Tax Ct. Memo LEXIS 178">*184 of transfers made within 3 years of death.
Decedent Margaret died on November 10, 1988. The executor filed Form 706, including 159 shares of Magton in decedent Margaret's gross estate. The 159 shares include the 91 shares transferred from decedent Anthony through his attorney in fact.
In the statutory notices of deficiency respondent determined deficiencies in petitioners' Federal estate tax. The greater part of the deficiencies, and the only parts here in issue, result from respondent's determination that shares of corporate stock were undervalued on petitioners' Federal estate tax returns, and that the amount of such shares includable in petitioner Anthony's estate was understated. Furthermore, respondent disallowed petitioners' claim for refund of estate tax attributable to the payment of additional State death taxes. However, this item was subsequently conceded by respondent upon substantiation by petitioners.
OPINION
Respondent contends that the transfer of the 91 shares of Magton from the revocable trust to decedent Margaret constitutes a relinquishment by decedent Anthony, through his attorney in fact, of his power to alter, 1995 Tax Ct. Memo LEXIS 178">*185 amend, or revoke the trust with respect to those shares and, therefore, the shares are includable in petitioner Anthony's estate. Petitioner Anthony's estate argues that the transfer was a gift made by Anthony, through his attorney in fact, to his wife decedent Margaret and not a transfer from the trust. Petitioner Anthony's estate maintains that Anthony did not relinquish a power over the trust, but rather exercised a power to withdraw the shares from the trust and then made a gift of them to decedent Margaret. Therefore, it is contended that the shares are not includable in petitioner Anthony's estate.
The Federal estate tax imposes a tax on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States.
(1) In general. -- Except as otherwise provided in this subsection, subsection (a) shall not apply to the estate of a decedent dying after December 31, 1981. (2) Exceptions for certain transfers. -- Paragraph (1) of this subsection * * * shall not apply to a transfer of an interest1995 Tax Ct. Memo LEXIS 178">*187 in property which is included in the value of the gross estate under section 2036, 2037, 2038, or 2042 or would have been included under any of such sections if such interest had been retained by the decedent.
Thus,
Of the various sections enumerated in
(a) In General. -- The value of the gross estate shall include the value of all property -- (1) Transfers after June 22, 1936. -- To the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for adequate and full consideration in money or money's worth), by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired such power), to alter, amend, revoke, or terminate, or where any such power is relinquished during the 3-year period ending on the date of the decedent's death.
Thus, the value of the gross estate includes the value of any interest transferred by the decedent, the enjoyment of which is at the time of his death subject to change by virtue of the decedent's retention of the power to alter, amend, revoke, or terminate, or where such power is relinquished during the 3-year period ending with the decedent's death.
Respondent asserts that the Court should disregard the form of the transaction, whereby the 91 shares of Magton were withdrawn from the trust and retitled in decedent Anthony's name before being transferred to decedent Margaret, and find that such a transfer constitutes a relinquishment of decedent Anthony's powers over the transferred property pursuant to
Petitioner Anthony's estate contends that decedent Anthony, through his attorney in fact, exercised his power to withdraw assets from the trust, and the subsequent transfers were gifts made by decedent Anthony in his individual capacity to the donee. Accordingly, petitioner Anthony's estate argues that because the withdrawn assets were not subject to inclusion in the gross estate pursuant to
Both parties cite
The determination of whether transfers occurring within1995 Tax Ct. Memo LEXIS 178">*190 3 years of death are to be included in a decedent's gross estate pursuant to
With respect to the initial transfers, made in 1984, we concluded that the decedent had made withdrawals from the revocable trust followed by gifts over to the donees.
We stated in
However, as to subsequent transfers from the revocable trust, we reached the opposite conclusions.
In the instant case, at the time of the transfer decedent Anthony and his spouse, as cotrustees, had the authority to effect transfers from the revocable trust. Further, as grantor, decedent Anthony reserved power to withdraw income or principal from the trust. We find that decedent Anthony effected a withdrawal from the revocable trust, through his attorney in fact.
Respondent urges us to apply the doctrine of substance over form. Respondent argues that we should disregard the transfer from the revocable trust to decedent Anthony, as accomplished through his attorney in fact, under the premise that it was made solely1995 Tax Ct. Memo LEXIS 178">*193 to obtain a minority discount in the valuation of the Magton stock for estate tax purposes. Petitioner Anthony's estate argues that there was no tax avoidance plan. Moreover, petitioner Anthony's estate asserts that a substantial block of stock was transferred (approximately 18.2 percent of the total outstanding shares). This reduced decedent Anthony's ownership from 50.3 percent to 32.1 percent. If tax avoidance was the sole motive, a substantially smaller number of shares could have been transferred. We find it unnecessary to decide this dispute over the motive for the transfer.
As a general rule, we will respect the form of a transaction. We will not apply substance over form principles unless the circumstances so warrant.
In the instant case, decedent Anthony created a power of attorney vesting his son with authority to perform specific acts, including the authority to "withdraw and receive the income or corpus of a trust" on decedent Anthony's behalf, and to "make gifts, without consideration in any amount to anyone." 1995 Tax Ct. Memo LEXIS 178">*194 In the exercise of that power, the son withdrew the 91 shares of Magton from the trust, which were placed in decedent Anthony's name before being transferred from decedent Anthony to decedent Margaret. The transactions were respected by Magton as evidenced by its issuance of share certificates, No. 21 to decedent Anthony, followed by No. 22 to decedent Margaret. 3
Accordingly, we conclude that decedent Anthony exercised his power to withdraw assets from the trust and subsequently made a gift in his individual capacity to the donee. We therefore hold that the 91 shares transferred from the revocable trust are not to be included in petitioner Anthony's estate.
Because we 1995 Tax Ct. Memo LEXIS 178">*195 held that the 91 shares are not includable in petitioner Anthony's estate, only 161 shares (252 minus 91) are so includable. The 91 shares are includable in petitioner Margaret's estate; at her death decedent Margaret owned a total of 159 shares (91 plus 68). Therefore each of decedents died possessed of only a minority interest in Magton. Because they died within 15 days of each other, the following analysis of the fair market value of the shares applies equally to both estates.
The general rule for valuing property to be included in a decedent's gross estate is provided in
The willing buyer and seller are hypothetical persons, instead of specific individuals or entities.
In determining the value of stock that is not listed on an exchange, actual arm's-length sales of such stock in the normal course of business within a reasonable time before or after the valuation date are the best criteria of market value.
Similarly,
1995 Tax Ct. Memo LEXIS 178">*200 This Court has recognized that the valuation of stock in a closely held family corporation is often a difficult question.
Both parties relied upon experts to consider and analyze the value of the corporation's real estate in order to derive a valuation of the corporation's stock. However, due to fundamental differences in approach between the parties' experts, particularly with respect to the weight to be placed upon net-asset value as opposed to earnings capacity or a going-concern value, and with respect to the adjusted book value of the assets, the valuations determined by the experts were quite far apart.
Respondent's determination of the fair market value of the stock is presumed correct, and petitioners1995 Tax Ct. Memo LEXIS 178">*201 bear the burden of overcoming the presumption of correctness. Rule 142(a);
At trial, we received testimony from expert witnesses, and we weigh that testimony in light of the experts' qualifications as well as all the other credible evidence.
Both experts employed an approach based on the asset values of Magton, albeit petitioners refer to their expert's approach as an "adjusted book value approach" and respondent refers to her expert's approach as an "adjusted net worth approach." In addition, petitioners' expert attempted to factor in the use of leveraged funds to a hypothetical buyer. To this 1995 Tax Ct. Memo LEXIS 178">*203 end, petitioners' expert reduced value by an amount of purchase price that a buyer of the assets could finance. Petitioners' expert argues that a hypothetical investor would not pay more for the stock than he would have to put down in cash to purchase the motels as separate assets. Petitioners' expert contends that a buyer, when purchasing the motels as separate assets, could borrow 75 percent of the purchase price and deduct the interest payments and depreciation on the full cost basis (i.e., including debt).
We reject this "leverage" part of petitioners' expert's analysis. A fundamental problem with his analysis is that the borrowed funds have economic substance and must be repaid. In fact petitioners' expert recognizes this fact in pointing out the depreciation is computed on the full cost basis. See
Petitioners' expert attempted to factor into his analysis comparable publicly traded companies. However, petitioners' expert placed a relatively small amount of weight on the comparables. Respondent challenged the use of the comparables; three of the companies operate chain type motels over a large geographical1995 Tax Ct. Memo LEXIS 178">*204 area, cater to business or budget travelers, and have significant operations in businesses other than motel operation. None of the companies appears to be in the vacation/resort market, as is Magton. After reviewing the record, we find that the four companies are not engaged in sufficiently similar businesses to treat them as comparables.
Another fundamental difference between the experts' opinions is attributable to the different asset values used for the motels. Petitioners' expert accepted the values computed in the report prepared by Carroll-McIlhinney. Respondent's expert did not accept those values in toto. Respondent's expert contends that the Impala and the Tahiti motels were undervalued. Because the Tahiti was sold at arm's length in April of 1989 for $ 2,100,000, we find that price to be the best evidence of the motel's fair market value rather than the $ 1,800,000 value in the Carroll-McIlhinney report. Furthermore, respondent's expert finds fault with the 1988 valuation ($ 3,150,000) ascribed 1995 Tax Ct. Memo LEXIS 178">*205 to the Impala because in comparison to the prior appraisals (1984 -- $ 3,000,000 and 1986 -- $ 3,400,000) and relative to the Tahiti5 the Impala is undervalued. Respondent's expert would value the Impala at $ 4,300,000.
Although Mr. McIlhinney has experience in appraising real property, we will not treat his report as an expert's report. He was not called to testify, and his report was not admitted into evidence as expert testimony. Rule 143(f);
Beach Club | $ 4,400,000 |
Tahiti Motel | 2,100,000 |
Impala Motel | 3,850,000 |
Total asset value | 10,350,000 |
Furthermore a difference exists as to the valuation of Magton's management contracts with owners of condominiums in the Wild Dunes. Respondent asserts that Magton has derived, and continues to derive, substantial revenue from the Wild Dunes management contracts. Petitioners contend that such contracts are for 1 year and therefore are of merely speculative or negligible value.
Since the contracts have been executed each year that Wild Dunes has been in existence, starting with 1986, and due to the nature of the contracts, 6 we find that a value should be assigned to these contracts. Because petitioners have not offered any amount to the contrary and because we find the amount asserted by respondent to be reasonable in light of the prior revenue that has been generated, we hold that the value of the management contracts at the time of decedents' deaths was $ 225,000.
1995 Tax Ct. Memo LEXIS 178">*207 Because we believe that petitioners' expert's valuation is significantly distorted by the use of the leverage analysis and because petitioners have not met their burden of proving error in respondent's valuation, we find that the net asset value of Magton, before any discount for lack of marketability and minority interest, is equal to $ 4,946,000 ($ 5,396,000 (determined by respondent) less $ 450,000 (the fair market value of the Impala Motel, as adjusted from $ 4,300,000 to $ 3,850,000 by our holding above, see p. 21
"The lack of marketability discount * * * is designed to reflect the fact that there is no ready market for shares in a closely held corporation."
A discount in the value of the closely held stock is appropriate for lack of marketability.
The parties agree that a discount for lack of marketability is appropriate. Respondent's expert would apply a 35-percent marketability discount; petitioners' expert would apply a 25-percent marketability discount. Based on the evidence presented, including the experts' opinions and the empirical studies upon which they rely, we hold that a marketability discount of 30 percent is appropriate.
We have held that a minority discount is appropriate if the block of stock does not enjoy the variety of rights associated with control.
In the instant case, each decedent's interest in Magton was insufficient to confer control over the corporation. The parties are in agreement that a 20-percent minority interest discount is appropriate. 1995 Tax Ct. Memo LEXIS 178">*210 Because we determined that the 91 shares transferred from the trust should not be includable in petitioner Anthony's estate, the minority discount applies to both petitioners.
Applying a 30-percent lack of marketability discount to the net asset value of $ 4,946,000 and then a 20-percent minority interest discount, we hold that the value of Magton stock at the time of decedents' deaths was $ 2,769,760 or $ 5,528 per share ($ 2,769,760/501 shares).
To reflect the foregoing,
Footnotes
1. The cases were tried by Attorney Mildred M. Moon, representing respondent. The cases were subsequently transferred to Attorney Lisa Primavera-Femia for posttrial briefing.↩
2. All section references are to the Internal Revenue Code in effect as of the dates of decedents' deaths, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩
3. In
, 16 F.3d 303">305↩ n.1 (8th Cir. 1994), the Government conceded that if the stock involved had been retitled in the decedent's name before being transferred to her descendants, it would not have been includable in the decedent's gross estate.McNeely v. United States , 16 F.3d 303">16 F.3d 3034. In addition, we have recognized that the Commissioner's
Rev. Rul. 59-60, 1 C.B. 237">1959-1 C.B. 237 , which both parties' experts have relied upon, has been widely accepted as setting forth the appropriate criteria to consider in determining fair market value of stock of closely held corporations for estate tax purposes. , 94 T.C. 193">217 (1990). The revenue ruling recognizes that a determination of fair market value is a question of fact and will depend upon the circumstances of each case:Estate of Newhouse v. Commissioner , 94 T.C. 193">94 T.C. 193No formula can be devised that will be generally applicable to the multitude of different valuation issues arising in estate and gift tax cases. Often an appraiser will find wide differences of opinion as to the fair market value of a particular stock. In resolving such differences, * * * [the appraiser] should maintain a reasonable attitude in recognition of the fact that valuation is not an exact science. A sound valuation will be based upon all the relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance. [
Rev. Rul. 59-60, 1959-1 C.B. at 238 ↩.]5. The per-unit value of the Impala Motel was deemed by petitioners' expert to be 8 percent more than that of the Tahiti in 1984, and 10 percent more than that of the Tahiti in 1986, only to drop to 14 percent below that of the Tahiti as of November 1988, and 26 percent below the actual per-unit price paid for the Tahiti.↩
6. The contracts provided leasing, housekeeping, and maintenance services, including use of swimming pools located on the motel property owned by Magton, which are important amenities to the Wild Dunes vacationers.↩