Valuing a Decedent's Closely Held Stock

A contentious issue in estate taxation is the valuation of stock in a closely held corporation. The fair value of such stock at the valuation date may be difficult to determine since no market quotations are available. Treasury regulations section 20.2031-2(f) and revenue ruling 59-60 (1959-1 CB 237) lists factors CPAs can consider in determining the value for estate tax purposes. Generally, the value would be what a willing buyer would pay to receive the economic benefits attached to that amount of stock. J.R. Simplot Co. is a family-owned corporation that processes and sells frozen food, fertilizer and cattle. The company also owns stock in Micron Technology, Inc. Simplot has two classes of common stock, A and B, which are held by family members, family trusts and an employee-stock-ownership plan. Although only class A stock has voting rights, both classes have the dividend rights (none has ever been declared), and class B stock has a slight liquidation advantage. Class A stock has a transfer restriction of 180 days during which the company may buy the stock and another 180 days in which other class A stockholders may purchase the stock before a shareholder can sell it to an outsider. At the time of his death in 1993, Richard R. Simplot owned 23.55% of the 76.445 shares of class A stock and 2.79% of the 141,288.584 shares of class B stock. His estate hired Morgan Stanley & Co. to ascertain the stock's value for estate tax purposes. Morgan Stanley determined a value of $2,650 per share. Because the decedent held only a minority interest in class A stock, it was assigned the same per-share value as the class B stock. The IRS determined a value of $801,994 per share of class A stock and $3,585 per share of class B stock and assessed a tax deficiency of $17,662,886 and penalties of $7,057,554. The estate petitioned the Tax Court for review. After hearing from valuation experts for both the IRS commissioner and the estate, the Tax Court reached its own value determination, adding a premium to the class A stock equal to 3% of the equity value ($830 million) of the company. The court based its decision on the presumption that class A stock, as voting stock, had the potential to influence and control the company. The court then allocated the total premium equally to all class A shares, resulting in a per-share value of $331,595.70, subject to a 35% discount for lack of marketability. The court created several specific scenarios to support the idea that a willing buyer might pay such a premium to obtain the decedent's 18 shares of class A stock. …