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Court Agrees with IRS on Valuing Estate's Closely Held Stock Using NAV Method.
(Parker Tax Publishing March 6, 2014)

The valuation of closely held stock in a company whose main asset was publicly held stock was better determined using the net asset value method rather than the capitalization-of-dividends method, and a discount was appropriate for the capital gains built-in tax liability. Est. of Richmond v. Comm'r, T.C. Memo. 2014-26 (2/11/14).

At the time of her death, Helen Richmond owned a 23.44 percent interest in a family-owned personal holding company (PHC), whose assets consisted primarily of publicly traded stock. On Helen's estate tax return, the executor reported the fair market value of her interest in PHC as $3.1 million using a capitalization-of-dividends method to value the interest. The estate also reduced the valuation of the interest by the amount of built-in capital gains tax that would result from selling the stock.

The IRS assessed a deficiency, based on its alternate valuation of the stock using the net asset value (NAV) method and its rejection of any discount for the built-in capital gains tax liability. According to the IRS, no discount was appropriate because it was uncertain when, if ever, such liability would be recognized.

The Tax Court held that the fair market value of Helen's interest in PHC was better determined by using the NAV method. The court further held that a discount was appropriate for the built-in gains tax liability but not the dollar-for-dollar discount used by the estate. According to the court, the most reasonable discount was based on the present value of the cost of paying off that liability in the future.

While noting that PHC's historic rate for turning over its securities was 70 years, the court found that this 70-year assumption did not take into account PHC's unique, subjective investment goals. The court observed that PHC had received advice to diversify its portfolio (i.e., to sell stock more quickly than its 70-year trend would call for) and a rational buyer would expect a turnover period shorter than 70 years. The decision by PHC not to follow that advice was not irrational, the court said, but it was particular to PHC's subjective goals. Even assuming that the PHC management would indefinitely follow its traditional philosophy and would sell stock only at the 70-year pace, and assuming that PHC shareholders would refuse to sell at prices that presumed a shorter turnover, that refusal would not affect the fair market value of PHC, the court concluded. It would instead indicate that PHC's particular managers and owners were willing to forfeit or forgo some of PHC's fair market value in order to pursue other aims. The court concluded that a more realistic turnover period was 20 to 30 years and, applying various discounts, came up with a discount of $7.8 million.

For a discussion of the valuation of closely held stock for estate tax purposes, see Parker Tax ΒΆ225,400. (Staff Contributor Parker Tax Publishing)

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Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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