T.C. Memo. 1998-365
UNITED STATES TAX COURT
ESTATE OF ANN H. BROOKSHIRE, DECEASED, HARVEY B. KING,
INDEPENDENT EXECUTOR, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9804-96. Filed October 8, 1998.
William R. Cousins III, Robert Don Collier, and Robert M.
Bolton, for petitioner.
Donna Mayfield Palmer, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined a deficiency of
$3,509,857 in the Federal estate tax of the Estate of decedent
Ann H. Brookshire.
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Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect as of November 20, 1993, the
date of decedent's death, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
After settlement, the issue remaining for decision is the
value, as of the date of decedent's death, of 106,826 shares of
common stock of a closely held family corporation.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time of decedent's death, decedent resided in Tyler,
Texas, and at the time the petition was filed, the executor,
Harvey B. King, resided in Tyler, Texas.
Upon her death, decedent owned directly 60,743 shares or
2.71 percent, and indirectly through a family trust 158,967
shares or 7.08 percent, of the common stock of Brookshire Grocery
Co. (Brookshire). Decedent’s stock interest in Brookshire
represented a total of 219,710 shares or 9.79 percent of the
total 2,243,727 shares outstanding.
Brookshire was founded by Wood T. Brookshire in the 1920's
and was incorporated in Texas in 1953. Brookshire owned and
operated a chain of 96 retail grocery stores located primarily in
rural communities in Texas, Louisiana, and Arkansas.
Brookshire common stock is closely held by relatives of Wood
T. Brookshire, by current and former employees of Brookshire and
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their relatives, and by an employee profit-sharing plan. The
stock is not listed on any stock exchange and is not traded over
the counter.
More specifically with regard to the ownership of Brookshire
common stock, on the date of decedent’s death, Brookshire common
stock was owned by two groups of shareholders: 66 percent was
owned by relatives of Wood T. Brookshire; and 34 percent was
owned by 200 current and former employees of Brookshire and their
relatives and by an employee profit-sharing plan.
Under longstanding buy-sell agreements to which all
shareholders in Brookshire were subject, Brookshire had a right
of first refusal or a right to purchase any Brookshire common
stock that any shareholder proposed to sell or transfer. The
price at which Brookshire could purchase shares of Brookshire
common stock under the buy-sell agreements (hereinafter referred
to as the formula price) was set at the lesser of book value or
the proposed per-share purchase price reflected by the proposed
sale or transfer.
However, on October 4, 1988, decedent and Brookshire entered
into a stock-purchase agreement under which it was provided that,
after decedent's death and at the option of decedent's estate,
Brookshire was obligated to purchase from decedent's estate the
Brookshire common stock owned by the estate. As indicated,
Brookshire's obligation under the stock-purchase agreement to
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purchase decedent’s common stock in Brookshire was triggered only
if decedent’s estate exercised the option to sell the stock, and
Brookshire’s purchase obligation was limited to the number of
shares that (under the same book-value-based formula as set forth
in the buy-sell agreements) would reflect a total purchase price
of no more than $7,844,233. This amount corresponded with the
total amount of life insurance that Brookshire carried on the
life of decedent.
The purpose of the stock-purchase agreement was to ensure
that decedent’s estate would have funds available to pay Federal
estate and State inheritance taxes relating to the Brookshire
common stock owned by decedent’s estate.
Under similar stock-purchase agreements entered into with a
number of other members of the Brookshire family, Brookshire also
was obligated, upon their death, to purchase from their estates
the number of shares of Brookshire common stock that corresponded
to the amount of life insurance Brookshire carried on their
respective lives.
On the date of decedent’s death, in addition to a chain of
grocery stores, Brookshire owned the following: (1) Two food and
merchandise distribution centers that supplied approximately 80
percent of the products sold in Brookshire stores; (2) two bakery
plants; (3) a milk processing plant; and (4) a photo processing
center.
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By the fall of 1993, Brookshire stores were experiencing
increased competition from Wal-Mart SuperCenters that were being
opened within the same geographic markets in which Brookshire
stores were located. In 1992, a Wal-Mart SuperCenter opened in
Mount Pleasant, Texas, in direct competition with two Brookshire
stores, apparently the cause in a drop of current sales of those
two Brookshire stores by 20 to 30 percent.
In 1993, prior to decedent’s death, four additional Wal-Mart
SuperCenters opened in direct competition with Brookshire stores,
apparently the cause in a drop of current sales of those
Brookshire stores by 20 to 40 percent.
In early fall of 1993, Wal-Mart announced the opening in
1994 of four or five additional SuperCenters, and Wal-Mart had
plans to open approximately 15 additional Wal-Mart SuperCenters
in the near future in the same markets as those in which
Brookshire stores were located.
To be competitive with the Wal-Mart SuperCenters that were
being opened in its markets, Brookshire would be required to make
large capital expenditures to refurbish old grocery stores and to
construct new stores.
For its fiscal year ending September 28, 1993, Brookshire's
net sales from its grocery stores and other business activities
was approximately $1.12 billion.
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For at least each of the 10 years prior to decedent’s death,
Brookshire paid cash dividends to its shareholders.
On November 20, 1993, the date of decedent’s death -- based
on an approximate total book value for Brookshire of $164,764,000
-- the per-share formula price under the buy-sell and stock-
purchase agreements for the shares of Brookshire common stock
owned by decedent’s estate was $73.43 per share.
Prior to decedent's death, no blocks of Brookshire common
stock anywhere near as large as decedent's block of 219,710
shares had been sold. In fact, in the 3 years prior to
decedent’s death, the largest block of Brookshire common stock
that had been sold consisted of 6,111 shares. Prior to
decedent’s date of death, it appears that each sale of Brookshire
stock constituted a non-arm’s-length sale.
On August 22, 1994, decedent’s estate sold 29,410 shares of
Brookshire common stock back to Brookshire for $79.50 per share
in order to provide cash to the estate for payment of decedent’s
reported estate tax liability.
On August 23, 1994, petitioner timely filed decedent's
Federal estate tax return. Based on an appraisal, the total
value of the 219,710 shares of Brookshire common stock owned
directly and indirectly by decedent’s estate was reported on the
estate tax return at $12,907,962 or $58.75 per share.
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On audit, based solely on the book-value-based formula set
forth in the stock-purchase agreement, respondent determined
that, on the date of decedent’s death, the total value of 106,826
shares of Brookshire common stock (consisting of the 60,743
shares owned directly by decedent’s estate and 46,083 of the
158,967 shares owned indirectly by decedent’s estate) was
$7,844,233 or $73.43 per share. Respondent accepted the $58.75
per-share value of the remaining 112,884 shares of Brookshire
common stock owned indirectly by decedent’s estate as reported on
decedent’s Federal estate tax return (for a value of $6,631,935).
Respondent determined the total value of all of the shares of
Brookshire common stock owned by decedent’s estate to be
$14,476,168.
In a report exchanged a few weeks before the trial herein,
respondent's expert opined that the value of the shares of
Brookshire common stock owned by decedent’s estate was $89.14 per
share or a total value for all shares of $19,584,950,
representing an increase of $5,108,782 over the value determined
by respondent in the notice of deficiency.
At the conclusion of the trial and based on the increase to
$89.14 per share that was reflected in respondent’s expert’s
report, respondent orally moved to amend the answer herein to
increase the deficiency in an unspecified amount reflecting the
total revised value of the Brookshire common stock owned by
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decedent's estate on the date of death, or alternatively, just
the revised value of 106,826 shares of Brookshire common stock
subject to the stock-purchase agreement.
On the grounds of timeliness and prejudice, petitioner
objects to any increase in respondent’s proposed deficiency. We
regard as patently prejudicial respondent’s attempt, at trial, to
increase the value of the Brookshire common stock owned by
decedent's estate by $5,108,782 or by $1,678,237, and we shall
deny respondent’s motion.
OPINION
For Federal estate tax purposes, property is generally
included in a decedent’s gross estate at its fair market value on
the date of decedent's death. Sec. 2031(a); sec. 20.2031-1(b),
Estate Tax Regs. Fair market value is defined generally as the
price at which property would change hands between a willing
buyer and a willing seller, neither being under any compulsion to
buy or to sell and both having reasonable knowledge of relevant
facts. United States v. Cartwright, 411 U.S. 546, 551 (1973);
Rushton v. Commissioner, 498 F.2d 88, 89-90 (5th Cir. 1974),
affg. 60 T.C. 272 (1973); Estate of Gilford v. Commissioner, 88
T.C. 38, 48 (1987); sec. 20.2031-1(b), Estate Tax Regs.
Fair market value involves a question of fact. Estate of
Newhouse v. Commissioner, 94 T.C. 193, 217 (1990); Estate of
Andrews v. Commissioner, 79 T.C. 938, 940 (1982).
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Arm's-length sales of stock in the normal course of business
within a reasonable time before or after the relevant valuation
date represent the best criteria of fair market value. Estate of
Andrews v. Commissioner, supra at 940. In the absence, however,
of arm's-length sales, the value of unlisted and closely held
stock often is based on the value of listed stock of corporations
engaged in similar lines of business. Sec. 2031(b); Estate of
Hall v. Commissioner, 92 T.C. 312, 336 (1989).
Additional factors that are relevant in valuing shares of
stock in closely held corporations are the following:
(1) The general economic outlook and the condition and
outlook of the specific industry involved in the
valuation;
(2) The book value of the stock and the financial
condition of the corporation;
(3) The earning and dividend-paying capacity of the
corporation;
(4) Whether or not the corporation has goodwill or
other intangible value;
(5) The corporation’s net worth; and
(6) Non-arm’s-length sales of the stock and the size
of the block of stock to be valued.
See Estate of Newhouse v. Commissioner, supra at 217-218; sec.
20.2031-2(f)(2), Estate Tax Regs.; Rev. Rul. 59-60, 1959-1 C.B.
237, 238-239.
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Generally, only facts reasonably known on the valuation date
provide a basis for the valuation. Estate of Newhouse v.
Commissioner, supra at 218.
In valuing closely held stock, discounts are often warranted
to reflect the stock's lack of marketability and limitations on
transferability. Estate of Newhouse v. Commissioner, supra at
249; Estate of Andrews v. Commissioner, supra at 953.
The fair market value of closely held stock may be
controlled for estate tax purposes by an enforceable agreement
that fixes the price at which the stock can be sold during a
taxpayer's lifetime and upon the decedent's death. Estate of
Bischoff v. Commissioner, 69 T.C. 32, 39 (1977); Estate of
Reynolds v. Commissioner, 55 T.C. 172, 188-189 (1970); Estate of
Obering v. Commissioner, T.C. Memo. 1984-407; sec. 20.2031-2(h),
Estate Tax Regs.
Under the buy-sell and stock-purchase agreements involved in
this case, if Brookshire failed to exercise its rights under the
buy-sell agreements, neither decedent nor her estate was
prohibited from selling the stock at a price lower or higher than
the formula price. We conclude, and the parties do not dispute,
that for Federal estate valuation purposes, the formula price set
forth in the buy-sell and stock-purchase agreements does not
control the value of the stock.
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In determining the fair market value of decedent’s 219,710
shares of Brookshire common stock (representing 9.79 percent of
all outstanding shares of Brookshire common stock), petitioner's
two experts and respondent's expert agree that a discount is
appropriate to reflect the lack of marketability of the stock.
They disagree, however, as to the amount thereof.
Because petitioner and respondent’s notice of deficiency
utilize the same $58.75 per-share value for the 112,884 shares of
Brookshire common stock that are not subject to the stock-
purchase agreement, we need only address the valuation of the
106,826 shares of Brookshire common stock that are subject to the
stock-purchase agreement.
Petitioner's first expert values the 106,826 shares of
Brookshire common stock subject to the stock-purchase agreement
at $6,302,734 or $59.00 per share. Petitioner's first expert
utilized: (1) The guideline company method, comparing
Brookshire's revenue, net income, earnings, cash-flow, and book
value with those of similarly sized, publicly traded corporations
operating grocery stores; (2) the discounted cash-flow method,
calculating the net present value and future earnings of
Brookshire and the return on investment using a 9-percent rate of
return; and (3) the capitalization of dividends method, using a
2-percent yield rate. Petitioner’s first expert also applied a
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discount of 45 percent to reflect the lack of marketability of
the stock.
Petitioner's second expert values the 106,826 shares of
Brookshire common stock subject to the stock-purchase agreement
at $5,237,679 or $49.03 per share. Petitioner's second expert
utilized: (1) The guideline company method, comparing
Brookshire's net income, earnings, and cash-flow with those of
similarly sized, publicly traded corporations operating grocery
stores; (2) the discounted cash-flow method, calculating the net
present value and future earnings of Brookshire and the return on
investment using an 11-percent rate of return; and (3) the
transaction method, comparing actual sales of stock within a
reasonable time before or after the valuation date and applying a
20-percent blockage discount because there were no other blocks
of stock similar in size to decedent's block of stock sold within
several years of the valuation date. Petitioner’s second expert
also applied a discount of 40 percent to reflect the lack of
marketability of the stock.
Respondent's expert values the 106,826 shares of Brookshire
common stock subject to the stock-purchase agreement at
$9,522,470 or $89.14 per share. Respondent's expert utilized:
(1) The guideline company method, comparing Brookshire's revenue,
earnings, cash-flow, and book value with those of similarly
sized, publicly traded corporations operating grocery stores; (2)
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the discounted cash-flow method, calculating the net present
value and future earnings of Brookshire and the return on
investment using a 9-percent rate of return; (3) the
capitalization of dividends method, using a 1.8-percent yield
rate; and (4) the capitalization of earnings method, using a 7-
percent current-year capitalization rate. Respondent’s expert
also applied a discount of 34 percent to reflect the lack of
marketability of the stock.
Respondent's expert overstates the value of the Brookshire
common stock because of his use of three companies as comparable
companies that have significant sales in markets other than
retail grocery and that are not comparable to Brookshire. The
use of these companies distorts each of the valuation methods
used by respondent's expert.
Respondent's expert also overstates the value of Brookshire
common stock because he does not take into account Brookshire's
loss of profits apparently caused by increased competition from
Wal-Mart SuperCenters.
Petitioner's second expert relies on the sale of small
blocks of Brookshire common stock that occurred in years prior to
decedent’s date of death and that constituted non-arm’s-length
sales.
In analyzing the economic outlook as of the date of
decedent’s death, petitioner's experts properly considered not
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only the national economy, but also the specific economies of the
geographic region in which Brookshire operated its stores.
In selecting earnings multiples, petitioner's first expert
properly considered the increased competition from Wal-Mart and
the decrease in Brookshire’s net income for Brookshire’s fiscal
year ending September 28, 1993.
For the reasons stated, we agree with petitioner's first
expert witness that, before applying any discount, the date-of-
death value of decedent's 106,826 shares of Brookshire stock
equals $11,493,409 or $107.59 per share.
With regard to the discount for lack of marketability, the
parties' three expert witnesses rely on various market studies
which indicate that discounts for lack of marketability often
fall in a range of 23 to 45 percent with an average of
approximately 35 percent for the restricted stock of a publicly
traded company.
It is clear that decedent's block of 106,826 shares was not
readily marketable and that any hypothetical purchaser would
demand a significant discount to account for that fact.
Certainly, the consistent history of Brookshire's strong
current financial position and liquidity as well as the quality
management would make Brookshire an attractive investment. There
still existed, however, no public market in which to sell the
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stock, and transfer of the stock would be subject to the
restrictive buy-sell and stock-purchase agreements.
We conclude that the appropriate discount to use to reflect
the lack of marketability of decedent's 106,826 shares of
Brookshire common stock equals 40 percent. This discount is
supported by the lack of a ready market on which to sell the
stock, the restrictive buy-sell agreements, the lack of
transactions involving large blocks of stock similar in size to
decedent's shares of Brookshire stock, and the fact that
decedent's stock reflects a minority interest.
Applying the 40-percent discount to the $11,493,409 pre-
discounted value of the stock, we conclude that the value of
decedent's 106,826 shares of Brookshire common stock on
November 20, 1993, is $64.55 per share or a total fair market
value of $6,895,618.
To reflect the foregoing,
An appropriate order will be
issued, and decision will be
entered under Rule 155.