T.C. Memo. 1999-342
UNITED STATES TAX COURT
ESTATE OF SAM HOMER MARMADUKE, DECEASED, JOHN H. MARMADUKE,
INDEPENDENT EXECUTOR, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 17047-97. Filed October 14, 1999.
William R. Cousins III, Robert Don Collier, and Robert M.
Bolton, for petitioners.
Audrey M. Morris, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined a deficiency of
$1,809,921 in the Federal estate tax of the Estate of Decedent
Sam Homer Marmaduke.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect as of September 7, 1993 (the
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date of decedent's death or the valuation date), and all Rule
references are to the Tax Court Rules of Practice and Procedure.
After settlement of some issues, the sole remaining issue
for decision is the fair market value, as of the date of
decedent's death, of 366,385 shares of common stock of a closely
held 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
Amarillo, Texas. At the time the petition was filed, John H.
Marmaduke, the executor of decedent's estate, resided in
Amarillo, Texas.
Upon his death in 1993, decedent owned 366,385 shares or
approximately 22 percent of the total outstanding common stock in
Hastings Books, Music & Video, Inc. (Hastings). Other members of
the Marmaduke family owned another 957,685 shares or 57 percent
of the total outstanding common stock in Hastings. Together, the
Marmaduke family (including decedent's wife, children, and
grandchildren) owned 79 percent of the total common stock in
Hastings.
Shareholders unrelated to the Marmaduke family, comprising
Hastings employees and a qualified employee benefit plan covering
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Hastings employees (the ESOP), owned the remaining 21 percent of
the total outstanding shares of common stock in Hastings.
The stock in Hastings is not listed on any stock exchange
and is not traded over the counter.
As of the valuation date, Hastings was engaged throughout
the Southern and Southwestern United States in the business of
operating 103 retail stores that sold prerecorded music, books,
and video cassettes.
Hastings was originally created in the 1960's as a retail
subsidiary of Western Merchandisers, Inc. (Western). Western, in
turn, was a wholesaler and distributor of similar merchandise to
stores such as Wal-Mart Stores, Inc. (Wal-Mart). In 1991,
Hastings was split off from Western in a tax-free reorganization.
Following the reorganization, Western was sold to Wal-Mart, and
Western's former shareholders held stock in both Hastings and
Wal-Mart. Pursuant to a 5-year branch service agreement,
however, Hastings' management remained dependent upon Western's
headquarters and distribution facilities, information systems,
and accounting functions.
From the date of the 1991 reorganization until the valuation
date of September 7, 1993, Hastings was in excellent financial
condition with both sales and profits increasing significantly.
In January of 1993, A.G. Edwards & Sons, Inc. (A.G.
Edwards), a valuation company, prepared a valuation report of the
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fair market value of common stock in Hastings. The purpose of
the A.G. Edwards' report was to establish the fair market value
of an approximate 3-percent interest in Hastings common stock
held by the ESOP plan. When ESOP plan participants purchased a
new home, needed money for a child's education, or terminated
employment, they had the right to direct the plan to sell shares
of Hastings stock back to Hastings at the then current fair
market value. This "put" option provided liquidity for small
blocks of stock in Hastings held by the ESOP.
Before any discount for lack of marketability, the A.G.
Edwards' report calculated the total value of Hastings as of
January of 1993 to be $100 million. The A.G. Edwards' report
then applied a 40-percent discount for lack of marketability that
would have reflected a value for Hastings stock of $35.45 per
share. However, due to the above-described liquidity of ESOP
plan shares provided by the put option, the A.G. Edwards' report
reduced the 40-percent lack-of-marketability discount in half to
20 percent and opined that the fair market value of Hastings
stock held by the ESOP was $47 per share.
In 1993, 18 separate transactions involving small blocks of
Hastings stock occurred between employees, officers, and other
individuals with an ongoing relationship with Hastings or
Western, cumulatively representing approximately 1 percent of the
total issued and outstanding shares of stock in Hastings. All
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but two of these transactions occurred at a price per share of
$47.
In June of 1993, decedent sold 7,000 shares of his common
stock in Hastings at $47 per share. Decedent sold 2,000 of these
shares to an officer and treasurer of Western who possessed full
knowledge of the financial affairs of Hastings. In November of
1993, petitioner, who is decedent's son and president and CEO of
both Western and Hastings, sold 2,000 shares of his stock in
Hastings at $47 per share.
On June 7, 1994, petitioner timely filed decedent's Federal
estate tax return. Based on a valuation report of Gibbs, Smith &
Schwartzman, a valuation company, the fair market value of
decedent's 366,385 shares of stock in Hastings was reported on
decedent's estate tax return at $13,384,044, or $36.53 per share.
On audit, based largely on the transactions in Hastings
stock that occurred in 1993, respondent determined that the total
fair market value of decedent's shares of stock in Hastings was
$17,220,095, or $47 per share. Based thereon, respondent
determined an increase in the value of decedent's gross estate of
$3,836,050.
OPINION
For Federal estate tax purposes, property is generally
included in a gross estate at its fair market value on the date
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of death. See sec. 2031(a); sec. 20.2031-1(b), Estate Tax Regs.
Fair market value is defined 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 sell and both having
reasonable knowledge of relevant facts. See United States v.
Cartwright, 411 U.S. 546, 551 (1973); Estate of Brookshire v.
Commissioner, T.C. Memo. 1998-365; sec. 20.2031-1(b), Estate Tax
Regs.
Fair market value involves a question of fact, and facts
reasonably known on the valuation date are particularly relevant.
See Estate of Newhouse v. Commissioner, 94 T.C. 193, 217-218
(1990); Estate of Brookshire v. Commissioner, supra. Arm's-
length sales of stock within a reasonable time before and after
the appropriate valuation date are strong indicators of fair
market value. See Estate of Andrews v. Commissioner, 79 T.C.
938, 940 (1982); Estate of Brookshire v. Commissioner, supra.
Additional factors that are relevant in valuing shares of
stock in closely held corporations are: The financial condition
of the corporation, the value of listed stock of corporations
engaged in similar lines of business, the corporation's net
worth, the size of the block of stock to be valued, and the
earning and dividend paying capacity of the corporation. See
Estate of Newhouse v. Commissioner, supra at 217-218; Estate of
Hall v. Commissioner, 92 T.C. 312, 336 (1989); Estate of Wright
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v. Commissioner, T.C. Memo. 1997-53; sec. 20.2031-2(f)(2), Estate
Tax Regs.; Rev. Rul. 59-60, 1959-1 C.B. 237, 238-239. Also, in
valuing closely held corporations, discounts may be warranted to
reflect the stock's lack of marketability and limitations on
transferability. See Estate of Newhouse v. Commissioner, supra
at 249; Estate of Andrews v. Commissioner, supra at 953; Estate
of Brookshire, supra.
We weigh expert witness testimony offered by the parties in
light of particular facts and circumstances of each case. See
Helvering v. National Grocery Co., 304 U.S. 282, 294-295 (1938);
Seagate Tech., Inc. & Consol. Subs. v. Commissioner, 102 T.C.
149, 186 (1994); United Parcel Serv. of Am., Inc. v.
Commissioner, T.C. Memo. 1999-268.
Petitioner's first expert, using a 60-percent discount for
lack of marketability, values the shares of decedent's stock in
Hastings at $9,210,000, or $25.15 per share. Petitioner's first
expert reached this opinion by: (1) Using the guideline company
method of valuation and comparing Hastings to several publicly
traded corporations engaged in similar lines of business;
(2) using the guideline merged-and-acquired company method and
comparing similar corporations that were bought or sold within a
reasonable time of the valuation date; and (3) using the
discounted cash-flow method. Due to alleged lack of independent
bargaining and negotiations relating to the $47 price reflected
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in the 1993 transactions involving Hastings stock, petitioner's
first expert entirely rejects the transaction method.
Petitioner's second expert, using a 40-percent lack-of-
marketability discount, values the shares of decedent's stock in
Hastings at $12,658,602, or $34.55 per share. Petitioner's
second expert relies solely on the guideline company and
discounted cash-flow methods while rejecting the transaction and
other valuation methods as inappropriate indicators of value.
Respondent's expert, using a 15-percent lack-of-
marketability discount, values decedent's shares of stock at
$17,220,095, or $47 per share. Respondent's expert utilizes the
guideline company, the discounted cash-flow, and the transaction
methods of valuation.
In the schedule below, we summarize the total equity value
of the Hastings corporation, the discount for lack of
marketability, and the per-share value of the Hastings stock as
reflected in the 1993 A.G. Edwards' report and in the reports of
the parties' expert witnesses. With regard to the A.G. Edwards'
report, in the schedule we reflect separately the indicated value
for the Hastings shares of stock owned in general and for those
stocks held by the ESOP.1
1 At trial and on brief, neither party relies on the $36.53
per-share value of decedent's Hastings stock reflected on
decedent's Federal estate tax return. Accordingly, we do not
(continued...)
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A.G. Edwards A.G. Edwards Petitioner's Petitioner's Respondent's
General ESOP First Expert Second Expert Expert
Equity Value $100,000,000* $100,000,000* $106,000,000* $97,740,000* $115,175,500*
Discount 40% 20% 60% 40% 15%
Value Per Share $35.45 $47 $25.15 $34.55 $47
* Represents the approximate average
equity value for Hastings from all
methods utilized by each expert.
We conclude that the total equity value of Hastings was $100
million on the valuation date. This falls within the range for
the estimated equity value of Hastings reflected in the reports
of each of the experts and in particular is supported by the 1993
A.G. Edwards' report.
As indicated, in determining the fair market value of
decedent's 366,385 shares of stock in Hastings, the parties'
experts all agree that some discount reflecting lack of
marketability is appropriate. They disagree, however, as to the
percentage -– suggesting 15 to 60 percent.
With regard to the appropriate marketability discount for
small blocks of stock in Hastings, the testimony of the officer
and treasurer of Western is significant. He testified that $47
per share (reflecting a 20-percent discount) was a fair and
accurate price for the 2,000 shares of stock he purchased from
(...continued)
reflect that valuation in the schedule, nor do we refer to it
again in the opinion.
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decedent shortly before the valuation date. He stated that at no
time was he under compulsion to buy or sell the shares of stock.
The value, however, of decedent's large, minority block of
366,385 shares of stock in Hastings is not controlled by the
value of 2,000 shares nor by the other 1993 transactions
involving small blocks of Hastings stock. Respondent's expert
relies heavily on transactions cumulatively representing less
than 1 percent of Hastings common stock. Decedent's stock, on
the other hand, represents some 14 times the total number of
shares of stock exchanged during 1993.
We note that the A.G. Edwards' report reduced the 40-percent
discount for lack of marketability that it would use for Hastings
stock in general to a 20-percent discount only because of the
liquidity available to the Hastings stock held by the ESOP.
We regard a 15- or 20-percent lack-of-marketability discount
as inadequate in valuing decedent's shares. It is clear that
decedent's large, minority block of Hastings stock was not
readily marketable and that a significant lack-of-marketability
discount is appropriate. Several studies in evidence confirm
that discounts for lack of marketability of stock in closely held
corporations often exceed 30 percent.
In reaching our conclusion as to the appropriate lack-of-
marketability discount to apply to decedent's stock in Hastings,
we regard the following factors as supporting a significant
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discount: The lack of a ready market for the Hastings shares,
the comparatively small size of prior transactions relative to
the size of decedent's block of stock, the continued dependence
of Hastings on the branch service agreement with Western, and the
general credibility of the A.G. Edwards' report.
Other factors, however, also indicate to us a marketability
discount considerably less than the 40- and 60-percent discounts
suggested by petitioner's experts. The several transactions of
Hastings stock that did occur in 1993 at $47 per share were not
in any way factored into the calculations of petitioner's
experts, and Hastings was in excellent financial condition as of
the valuation date.
Based on the evidence, we conclude that the appropriate
discount for lack of marketability of decedent's 366,385 shares
of common stock in Hastings is 30 percent.
Applying the 30-percent lack-of-marketability discount to
the $100 million total equity value of Hastings yields a fair
market value of $41.51 per share. We conclude that, as of
September 7, 1993, the value of decedent's 366,385 shares of
common stock in Hastings was $15,208,641 ($41.51 times 366,385
equals $15,208,641).
To reflect the foregoing,
Decision will be entered
under Rule 155.