Estate of Deputy v. Comm'r

T.C. Memo. 2003-176

UNITED STATES TAX COURT

ESTATE OF HELEN A. DEPUTY, DECEASED, WILLIAM J.
DEPUTY, CO-EXECUTOR, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 9308-01, 9309-01. Filed June 13, 2003.

Albert L. Grasso, Donald J. Russ, Jr., and John P. Adams,

for petitioner.

Michael F. O’Donnell, Gregory J. Stull, and Thomas D. Yang,

for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GERBER, Judge: In these consolidated cases,1 respondent

determined a $1,295,274 deficiency in estate tax and a $162,715

deficiency in gift tax. The parties have resolved all issues

1
These cases were consolidated for purposes of trial,
briefing and opinion.
 - 2 -

except for the fair market value of an interest in a closely held

corporation that was included in decedent’s estate as part of a

family limited partnership.2

FINDINGS OF FACT

Helen A. Deputy (decedent) died on September 15, 1997, when

her legal residence was in Elkhart, Indiana. William J. Deputy

and Robert J. Deputy were appointed coexecutors of decedent’s

estate. William J. Deputy, as coexecutor of the estate, filed

timely petitions with respect to respondent’s determination of

separate estate and gift tax deficiencies. At the time the

petitions were filed, William J. Deputy resided in New Buffalo,

Michigan, and Robert J. Deputy resided in Elkhart, Indiana.

Decedent was married to Sherrill S. Deputy. They had six

sons, including William J. Deputy and Robert J. Deputy, the

coexecutors of decedent’s estate. On December 12, 1996, decedent

formed a family limited partnership (Deputy FLP), retaining a 99-

percent limited partnership interest and creating two 0.5-

percent general partnership interests, one held by decedent and

2
These cases involve the fair market value of interests in
a closely held corporation transferred by gift during 1997 and
another interest held by decedent through a family limited
partnership at the time of her death, Sept. 15, 1997. The
transferred interests were substantially smaller than the
interest held by decedent. The parties have stipulated that the
Court’s decision with respect to the fair market value on Sept.
15, 1997, will bind them with respect to the 1997 gift tax
values. Accordingly, we consider only the fair market value on
Sept. 15, 1997.
 - 3 -

one by her son William. On May 31, 1997, decedent gave each of

her six sons a 1-percent limited partnership interest in Deputy

FLP.

On July 18, 1997, decedent transferred 5 of her 192.5 shares

of Godfrey Conveyor Co., Inc. (Godfrey), to her grandson, Matthew

Deputy. The 5 shares represented 0.53 percent of the issued and

outstanding shares of Godfrey. On July 20, 1997, decedent

transferred her remaining 187.5 of the issued and outstanding

shares of Godfrey to Deputy FLP.

As of the date of decedent’s death, September 15, 1997,

there were 938 shares of Godfrey stock outstanding, which were

held as follows: 553.5 shares (59.01-percent interest) by the

Sherrill S. Deputy Trust; 187.5 shares (19.99-percent interest)

by Deputy FLP; 117 shares (12.47-percent interest) by Robert J.

Deputy; and the remaining 80 shares, 5 each (.53-percent

interest), by 16 other Deputy family members (16 x 5 = 80).

Decedent’s six sons are the beneficiaries of the Sherrill S.

Deputy Trust, and all six must consent to the sale of any Godfrey

shares by the trust.

Godfrey was founded in Indiana during 1919 and engaged in

the manufacture of coal-handling machinery and related products.

Decedent’s husband acquired a majority of Godfrey’s shares

during 1953, at a time when Godfrey’s financial condition was

poor. He converted Godfrey to a manufacturer of recreational
 - 4 -

aluminum pontoon boats sometime in the late 1950s. Godfrey

expanded, in part, by acquisitions of companies in the same

industry, during 1968 and 1974, and by expansion into the

manufacture of aluminum fishing boats.

During 1987, Godfrey entered into a joint venture with

Dynasty Boats, Inc., concerning the manufacture and sale of

fiberglass boats and other marketing arrangements with outboard

motor manufacturers. During 1993, Godfrey acquired Dynasty,

Boats, Inc., and an outboard motor company. At the time of the

acquisition, both companies were financially troubled. By 1994,

and during the valuation period under consideration, Godfrey was

the largest manufacturer of aluminum pontoon boats in the United

States. Its main plant was in Elkhart, Indiana, with other

manufacturing facilities located in Mississippi and Alabama.

During 1997, Godfrey employed approximately 750 people, and,

with the exception of its truck drivers, it was a nonunion

operation. Godfrey generally enjoyed good employee relations.

Godfrey had a well-trained and qualified workforce, and employee

reductions occurred only with respect to seasonal manufacturing

needs. During 1997, Godfrey had a good reputation and was known

for quality products, service, and moderate pricing.

Merchandising was accomplished through a network of approximately

500 loyal dealers. As of 1997, Godfrey marketed several
 - 5 -

successful product lines that were sold under legally protected

trade names.

During the period 1981 through mid-November 1995, Godfrey

experienced a consistent growth in net sales at a compounded rate

that approached 18 percent. From 1991 through September 15,

1997, Godfrey experienced consistent growth in its profitability.

On the basis of earlier planning, a 100,000-square-foot expansion

of Godfrey’s Elkhart facility was commenced during 1998. For its

year ended December 31, 1996, Godfrey earned almost $2.5 million

in net income from approximately $61 million in sales. For the

years 1993 through 1997, Godfrey did not pay dividends to its

shareholders. Although Godfrey’s sales of pontoon boats

increased by a few percentage points from 1996 to 1997,

nationwide sales of pontoon boats decreased by 5 percent.

On June 17, 1998, the estate filed a Form 706, United States

Estate (and Generation-Skipping Transfer) Tax Return, in which

the 187.5 Godfrey shares were reported as having a discounted

fair market value of $2,246,500. The value reported was based on

an appraisal prepared by Michael A. Dorman, which was attached to

the Form 706. Respondent issued a May 8, 2001, notice of estate

tax deficiency determining that the fair market value of

decedent’s interest in Deputy FLP was $4,835,300, as opposed to

the $2,589,000 reported by the estate. On June 2, 2001, the

estate filed an amended Form 706, in which the 187.5 Godfrey
 - 6 -

shares were reported as having a fair market value of $1,941,000.

The reduced value was based on a revised appraisal prepared by

Michael A. Dorman, which was attached to the amended Form 706.

On May 26, 1998, a Form 709, United States Gift (and

Generation-Skipping Transfer) Tax Return, was filed for

decedent’s tax year ended December 31, 1997. In that return,

$607,040 of taxable gifts was reported. Respondent issued a May

8, 2001, notice of gift tax deficiency, determining that the fair

market values of decedent’s gifts of interests in the Deputy FLP

should be increased as follows:

Date of Gift Value Reported Value Determined

May 31, 1997 $79,620 $127,680
July 20, 1997 481,350 843,804
July 20, 1997 62,020 74,515

Similar to the amendment of the estate tax return (Form 706), on

May 21, 2001, an amended Form 709 was filed for decedent’s tax

year ended December 31, 1997. In that return, $570,570 of

taxable gifts was reported. The reduction in the amount of gifts

reported for the 1997 year was attributable to the revised

appraisal reducing the value assigned to the interest in Godfrey.

OPINION

The controversy in these cases concerns the fair market

value of an interest in a closely held family corporation that,

in turn, is held by the same family’s limited partnership.

Because the largest asset of the partnership is an interest in a
 - 7 -

closely held corporation that corporation’s value as of

decedent’s date of death is key to our holding on valuation. The

parties also disagree as to the types and amounts of discounts to

be applied to the value found by the Court.3 The evidence

consists of a stipulation of facts, along with attached exhibits,

and a transcript containing the testimony of one fact witness.

In addition, each of the parties has offered an expert’s opinion,

ostensibly to assist the Court in its consideration of the facts

and conclusion as to the fair market value of the controverted

interest.

A. The Question of the Burden of Proof

In its posttrial brief the estate for the first time

interposed section 74914 and argued that the burden of proof

should shift to respondent with respect to the remaining

valuation question. The following statement is at the heart of

the estate’s contention:

It is respectfully submitted that the combined
testimony of Mr. Deputy and Mr. Dorman[5] plus the
Stipulation of Facts and the contents of the associated
exhibits is credible evidence within the meaning of

3
The parties have agreed to discounts with respect to the
interest in the family limited partnership.
4
All section references are to the Internal Revenue Code in
effect as of the date of decedent’s death, and all Rule
references are to the Tax Court Rules of Practice and Procedure,
unless otherwise indicated.
5
Mr. Deputy is one of the estate’s coexecutors, and Mr.
Dorman is the estate’s expert witness.
 - 8 -

Section 7491(a)(1) sufficient to shift the burden of
proof to Respondent.

Section 7491(a)(1) provides that if, in any court proceeding, the

taxpayer introduces credible evidence with respect to a factual

issue relevant to ascertaining the taxpayer's liability for a tax

(under subtitle A or B), the burden of proof with respect to such

a factual issue will be placed on the Commissioner.

For the burden to shift to the Commissioner, however, the

taxpayer must comply with the substantiation and record-keeping

requirements of the Internal Revenue Code. See sec.

7491(a)(2)(A) and (B). In addition, section 7491(a) requires

that taxpayers cooperate with reasonable requests by the

Commissioner for “witnesses, information, documents, meetings,

and interviews”. Sec. 7491(a)(2)(B). Finally, the benefits of

section 7491(a) are not available in cases of partnerships,

corporations, and trusts unless the taxpayer meets the net worth

requirements of section 7430(c)(4)(A)(ii). See sec.

7491(a)(2)(C). Taxpayers bear the burden of proving that these

requirements are met. Higbee v. Commissioner, 116 T.C. 438

(2001); H. Conf. Rept. 105-599, at 240 (1998), 1998-3 C.B. 747,

994; S. Rept. 105-174, at 45 (1998), 1998-3 C.B. 537, 581.

Respondent argues that the estate failed to introduce

evidence during the trial to show that the requirements of

section 7491(a) were satisfied. Respondent also argues that the

estate should not be allowed to initiate a burden of proof
 - 9 -

question during posttrial briefing. If the estate is allowed to

raise the burden of proof question at this juncture, respondent

contends that he will be subjected to surprise and prejudice.

See Seligman v. Commissioner, 84 T.C. 191, 198-199 (1985), affd.

796 F.2d 116 (5th Cir. 1986). Respondent also points out that he

has not been afforded the opportunity to present evidence to

counter the estate’s unproven allegations that it has met the

statutory requirements. See Ware v. Commissioner, 92 T.C. 1267,

1268 (1989), affd. 906 F.2d 62 (2d Cir. 1990).

We agree with respondent that the estate’s attempt to raise

this matter in a posttrial brief constitutes surprise and is

therefore untimely.

In addition, section 7491(a), as a prerequisite to the

shifting of the burden of proof, requires the taxpayer to provide

credible evidence. Section 7491 does not define the term

“credible evidence”. The legislative history underlying the

enactment of section 7491 contains the explanation that

Credible evidence is the quality of evidence which,
after critical analysis, the court would find
sufficient upon which to base a decision on the issue
if no contrary evidence were submitted (without regard
to the judicial presumption of IRS correctness). A
taxpayer has not produced credible evidence for these
purposes if the taxpayer merely makes implausible
factual assertions, frivolous claims, or tax protestor-
type arguments. The introduction of evidence will not
meet this standard if the court is not convinced that
it is worthy of belief. If after evidence from both
sides, the court believes that the evidence is equally
balanced, the court shall find that the Secretary has
not sustained his burden of proof.
 - 10 -

H. Conf. Rept. 105-599, supra at 240-241, 1998-3 C.B. at 994-995.

In the context of the valuation issue presented in these

cases, the question of who has the burden or proof is irrelevant.

The parties have stipulated the operative facts and documents.

Quantitatively, the parties’ stipulation is the source of the

vast majority of the facts predicated in our opinion. In

addition to the parties’ stipulation, during the trial, each

party offered four items of documentary evidence, seven of which

were received into the record of these cases. Finally, only one

fact witness, coexecutor William J. Deputy, was called to

testify. Most of the transcript consists of the cross-

examination of the parties’ tendered experts’ opinion testimony

on the question of value.

The parties were required to file simultaneous posttrial

briefs. The estate’s reply brief, filed in response to

respondent’s opening brief, contained no objections to

respondent’s extensive proposed findings of fact. Likewise,

respondent’s reply to the estate’s opening brief contained only

limited objections to the estate’s proposed findings. In great

part, the parties’ posttrial briefing focused on the experts’

opinions and their “spin” on the essentially agreed facts.

In these circumstances, the question of which party has or

had the burden of proof has become wholly academic. In the

context of these cases, there is no need to analyze or decide
 - 11 -

whether the estate met the “credible evidence” requirement

because, as a finder of facts, we consider essentially agreed

underlying facts and look to the experts’ reports for guidance in

order to resolve the valuation issue.

B. The Value of Godfrey on September 15, 1997

The parties have narrowed the focus of their controversy to

the question of the value of a 19.99-percent interest in Godfrey,

a closely held Deputy family corporation. For purposes of the

gift and estate tax provisions, the value of property transferred

on a particular date provides the base upon which the tax rate is

applied, after appropriate adjustments. See secs. 2001,

2501(a)(1). For purposes of the gift and estate tax property

value is determined by considering the price at which the

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. Sec.

20.2031-1(b) Estate Tax Regs.; sec. 25.2512-1, Gift Tax Regs.

The determination of the fair market value of property is a

factual determination, and the trier of fact must weigh all

relevant evidence of value and draw appropriate inferences.

Commissioner v. Scottish Am. Inv. Co., 323 U.S. 119, 123-125

(1944); Helvering v. Natl. Grocery Co., 304 U.S. 282, 294 (1938);

Symington v. Commissioner, 87 T.C. 892, 896 (1986).
 - 12 -

To determine the value of an unlisted stock, an actual

arm’s-length sale of a similar stock within a reasonable time

before or after a decedent’s date of death is indicative of its

fair market value. Ward v. Commissioner, 87 T.C. 78, 101 (1986).

In the absence of arm’s-length sales, fair market value

represents the price that a hypothetical willing buyer would pay

a hypothetical willing seller, both persons having reasonable

knowledge of all relevant facts and neither person compelled to

buy or sell. Estate of Hall v. Commissioner, 92 T.C. 312, 335

(1989). It is implicit that the buyer and seller would aim to

maximize profit and/or minimize cost in the setting of a

hypothetical sale. Estate of Watts v. Commissioner, 823 F.2d

483, 486 (11th Cir. 1987), affg. T.C. Memo. 1985-595; Estate of

Newhouse v. Commissioner, 94 T.C. 193, 218 (1990). Therefore, we

consider the view of both the hypothetical seller and buyer.

Kolom v. Commissioner, 644 F.2d 1282, 1288 (9th Cir. 1981), affg.

71 T.C. 235 (1978).

On the original estate tax return, the estate reported

$2,246,500 as the discounted value of the Godfrey interest.

After respondent determined that the discounted value of the

Godfrey interest was $4,835,300, the estate, in an amended estate

tax return, reported a reduced discounted value of $1,941,000.6

6
We note that values or discounts reported or claimed on an
estate tax return may be considered admissions and, to some
(continued...)
 - 13 -

For purposes of this controversy, the estate contends that the

value reported on the amended returns is correct. Respondent

relies on his expert’s discounted value of $4,608,825, which

closely approximates the $4,835,300 value determined in the

notice of estate tax deficiency.

As already discussed, for all practical purposes, the facts

in the record are not in dispute. The parties’ experts have used

diverse judgmental factors which resulted in differing values’

being advanced by the parties. Accordingly, we proceed to

examine the parties’ experts’ opinions and methodologies.

A court, in approaching expert opinion evidence, is not

constrained to follow the opinion of any expert when the opinion

is contrary to the court’s own judgment. A court may adopt or

reject expert testimony. Helvering v. Natl. Grocery Co., supra

at 295; Silverman v. Commissioner, 538 F.2d 927, 933 (2d Cir.

1976), affg. T.C. Memo. 1974-285. Valuation cases are usually

6
(...continued)
extent binding or probative, restricting an estate from
substituting a lower value without cogent proof that those
admissions are wrong. Estate of Hall v. Commissioner, 92 T.C.
312, 337-338 (1989); Estate of Pillsbury v. Commissioner, T.C.
Memo. 1992-425; Estate of McGill v. Commissioner, T.C. Memo.
1984-292. In that regard, the estate used the same expert for
purposes of the values claimed in the original and amended estate
tax returns. Ultimately, the valuation question we have
considered was framed by a factual record and the parties’
arguments in connection with their respective experts’ reports.
The value we have decided was larger than the value reported in
the original estate and gift tax returns, and so there was no
need to analyze whether the estate should have been bound by the
latter values.
 - 14 -

fact specific and are relied on by litigants and courts for

generalized guidance, but they do not establish bright-line rules

for valuation; i.e., they do not establish specific percentage

discounts to be applied under particular factual circumstances.

The estate’s expert, Mr. Dorman, mentioned three different

approaches in valuing the common stock of Godfrey, to wit:

“Market Comparison Approach”, “Adjusted Net Book Value Approach”,

and “Capitalized Earnings Approach”.7 Although his report

contains some discussion of all three methods, ultimately, he

relied solely on the net asset approach.

Mr. Dorman rejected the market approach because he could not

find what he believed to be comparable companies. Of six

comparable companies, he noted that four, unlike Godfrey,

reported losses.8 The remaining two were rejected because he

“determined that using only the remaining two public companies,

Brunswick Corp. and Fountain Powerboat Ind., Inc., would not

provide reliable comparable data to arrive at a market measure of

value.” Mr. Dorman, even though he labeled the six companies

7
For convenience, we use “market approach”, “net asset
approach”, and “income approach” instead of “Market Comparison
Approach”, “Adjusted Net Book Value Approach”, and “Capitalized
Earnings Approach”, respectively.
8
We find Mr. Dorman’s reason for abandoning the comparable
or market approach to be somewhat curious because, in spite of
the “comparable companies” losses, respondent’s expert’s
calculations with similar comparables resulted in the potential
for values that were two to three times the value reached by use
of the approach advanced by Mr. Dorman.
 - 15 -

“comparable”, did not explain with specificity why the companies

with losses or the remaining limited universe would not be

“reliable”.

Mr. Dorman concluded that Godfrey’s adjusted net book value

was $17,341,379, as of September 15, 1997. That number is close

to Godfrey’s unadjusted balance sheet total shareholders’ equity,

which was $17,160,705 on the valuation date. Mr. Dorman started

with the shareholders’ equity and deducted $126,806 to account

for the partial year. Mr. Dorman explained the deduction as

being attributable to an expectation that shareholders’ equity

would decrease by the end of the year.9 We could find no

foundation for such a deduction. He then converted the book

values to fair market values, resulting in a $2,392,916 increase

or excess of fair market value over book value. Mr. Dorman then

formulated a $1,919,869 deduction for something he labeled

“Environmental Liabilities”. Finally, he deducted $165,566 for

Federal and Indiana tax (ostensibly for the capital gains on

liquidation and/or sale of the assets).

With respect to Mr. Dorman’s net asset approach, we found

his reasoning and/or basis for his conclusions in support of the

adjustments (reductions) to be inadequate and without meaningful

explanation.

9
In the use of a net asset valuation approach, it would be
irrelevant that shareholders’ equity decreases after the
valuation date.
 - 16 -

As a third approach, Mr. Dorman explained that the income

approach is used to determine the fair market value of an ongoing

business enterprise on the basis of its earning capacity. Mr.

Dorman provided the caveat that Godfrey’s management made

representations concerning future operating outcomes, but he did

not explain or provide those representations. He then annualized

the September 30, 1997, earnings, which he found to be

$3,085,615. The 4 preceding years’ earnings were then weighted,

giving the most emphasis to 1996 and least to 1993. Mr. Dorman

ignored the 1997 results “due to the cyclical nature of the

business” and arrived at normalized annual earnings of

$1,846,793. If Mr. Dorman had included the annualized amount for

1997 and used a similar approach to weighting the income results,

normalized earnings would have been approximately $2,259,334 or

22 percent larger.

Next, a capitalization rate was selected. This rate should

constitute a reasonable rate of return. Mr. Dorman referenced

the Dun & Bradstreet’s 1996-97 median after-tax return on net

worth for the boat building and repairing industry, which was

12.9 percent. He then explained that an investor would want to

receive a rate of return at least 12.9 percent; but if another

investment alternative would produce a better return with the

same degree of risk, the investor would want a better return than

the industry average.
 - 17 -

After discussing the 12.9-percent median industry return,

Mr. Dorman switched to a customized approach to derive a

capitalization rate. He started with a 6.14-percent rate of

return on 5-year U.S. Treasury bonds as a riskless rate. He then

added to the 6.14-percent base, increases of 7.9 percent, 5.78

percent, and 3 percent for “Premium for Equity”, “Premium for

Small Stock”, and “Company/industry”, respectively. Those

increases are generally explained as excess of return of common

stock over bonds; excess of return of small capitalization

companies over stock exchange common stock; and finally an

increased risk factor based on either industry or company

conditions.

The add-ons to the 6.14-percent return for a riskless

investment increased the capitalization rate to 22.85 percent,

which Mr. Dorman reduced by 5.5 percent to account for Godfrey’s

growth, finally arriving at a 17.5-percent capitalization rate

(rounded to the nearest 0.5 percent). Using the 17.5-percent

rate and his $1,846,793 annualized earnings computation, Mr.

Dorman’s analyses result in a capitalized value for Godfrey of

$10,553,101, which is almost $7 million or 40 percent less than

Godfrey’s net assets or ostensible liquidation value.

Ultimately, Mr. Dorman discarded the income approach and

concluded that Godfrey had a fair market value of $17,341,379, on

the basis of his net asset approach. Mr. Dorman also applied a
 - 18 -

discount to that value to arrive at the per-share value of the

interest in question.10

Respondent’s expert, Francis X. Burns, also considered three

approaches to value and concluded that Godfrey’s fair market

value on September 15, 1997, was $30,740,869. Mr. Burns

explained that the income, market, and net asset approaches are

used to value a business. Messrs. Burns and Dorman generally

agree about the three methodologies normally used to value a

closely held business.

For purposes of the income approach, Mr. Burns attempted to

normalize the historical earnings to reflect the expectations for

Godfrey’s future profits. He referred to the National Marine

Manufacturers Association’s compiled statistics. They reflected

that a general recession occurred during the years 1990 through

1994 and had a profound effect on the boating industry. From

this premise, Mr. Burns concluded that Godfrey’s 1990 through

1994 earnings “would likely understate the company’s expected

future earnings as of 1997.”

Mr. Burns calculated the 1997 normalized earnings at

$3,077,161. We note that Mr. Burns’s figure is only $8,454, or

less than 1 percent, different from Mr. Dorman’s $3,085,615

figure for 1997 normalized earnings. Because he concluded that

10
The amount of the discount to be applied is discussed
later in this opinion.
 - 19 -

the 1990-94 earnings were lower than normal, Mr. Burns used a

3-year spread of 1995-97, with 1997 more heavily weighted. In

this way, Mr. Burns arrived at normalized 1995-97 earnings of

$2,551,487 per year.

In computing a capitalization rate, Mr. Burns, in a manner

similar to Mr. Dorman’s, started with a 6.56-percent riskless

rate on U.S. Treasury bonds and added a 7.50-percent premium for

equity and a 5.78-percent premium for small stock. Finally, he

made an industry-specific reduction of 5.20 percent to arrive at

a total of 14.64 percent. From the 14.64 percent, Mr. Burns

deducted 4.63 percent to reflect Godfrey’s growth, resulting in a

10.01-percent capitalization rate. We note that Mr. Dorman and

Mr. Burns started with comparable rates for U.S. Treasury bonds

and made, for the most part, similar categorical adjustments, as

follows:

Item Mr. Dorman Mr. Burns
Percent (%) Percent (%)
Treasury bond rate 6.14 6.56
Premium for equity 7.90 7.50
Premium for small stock 5.78 5.78
Company/industry 3.00 (5.20)

Total 22.82 14.64

Less: Growth (5.50) (4.63)
1
Capitalization rate 17.50 10.01
1
Rounded to the nearest 0.5.

Accordingly, the major difference between the experts’

approaches resides in the “Company/industry” adjustment. Mr.
 - 20 -

Burns derived his 5.2-percent Company/industry reduction directly

from a data base published by Ibbotson Associates, which suggests

a 5.2-percent reduction for companies in the “Ship and boat

building and repairing” category. This obviously translates into

a premium for that industry’s category.

Mr. Dorman, on the other hand, listed six general categories

and the fact that Godfrey was a small company to increase the

risk factors and arrive at his 3-percent adjustment in the

Company/industry category. That, of course, translates into a

discount for the industry category. Here again, Mr. Dorman’s

explanation for his adjustment is without specifics.

The estate argues that the 5.2-percent Company/industry

reduction that Mr. Burns obtained from the Ibbotson Associates

data base was inappropriate because the data, to some extent,

were derived from years after 1997. Mr. Burns explained that

such information was not available before 2001 and the data base

included the years 1996 through 2001. In defending his use of

that data base, Mr. Burns explained that industry risk tends to

trend and does not generally have spikes. In addition, Mr. Burns

compared some “betas” of comparable publicly traded companies and

found that they had a composite 5-percent industry

risk premium, which supports the 5.2-percent premium Mr. Burns

used.
 - 21 -

Ultimately, we accept Mr. Burns’s explanation that there is

a premium in the industry, on the basis of his analysis of

publicly held companies. We note that there is no meaningful

universe of information available for closely held companies or

Godfrey’s particular boat manufacturing niche. Although the 5.2-

percent premium was based on some data from years subsequent to

1997, we are satisfied that the 5.2 percent is within a

reasonable range. In part, we base our conclusion on Godfrey’s

tendency to generally outperform the industry and economy, so

that the 5.2-percent premium may be on the conservative side.

Moreover, we are more comfortable with Mr. Burns’s methodology,

for which he has provided explanations supporting his conclusions

and assumptions. On the question of industry risk, Mr. Dorman’s

figures are without empirical support or explanation and appear

to be purely subjective.

Mr. Burns used a 10.01-percent discount rate, which

translates into an approximately 9.9900099-percent capitalization

rate. That capitalization rate produced an income approach value

of $30,740,869 when multiplied by Mr. Burns’s $3,077,161

normalized earnings for 1997. Likewise, Mr. Dorman, by using a

17.50-percent discount rate, which translates into a 5.7142857-

percent capitalization rate, produced an income approach value of
 - 22 -

$10,553,101 when multiplied by his $1,846,793 normalized

(indexed) earnings for 1993 through 1996.11

Mr. Dorman, however, abandoned his income approach value and

market (comparative) approach and relied solely on his net asset

approach value of $17,341,379. Conversely, Mr. Burns did not use

the net asset approach because Godfrey had “been engaged in the

manufacture and marketing of boats since 1958 * * * [and] is

clearly an established and successful operating company.”

Because of that fact, Mr. Burns concluded that valuation of

Godfrey’s assets is “inappropriate because it implies that the

company’s value is limited to its tangible assets.”

Mr. Burns also performed a market approach analysis and

located 15 public equity companies in the same general industry

as Godfrey. He noted that many of the companies were also listed

in a 1995 independent appraisal seeking to establish valuation

multiples for Godfrey. Mr. Burns admits that none of the 15 are

“perfect comparables”, but he contended that they are

sufficiently similar to “indicate acceptable valuation

multiples”. Using those multiples, Mr. Burns’s market approach

resulted in a value range for Godfrey of $34,700,000 to

$51,500,000. Mr. Burns also noted that Godfrey’s profitability

11
It is conceptually incongruent that an income approach
would produce a $10,553,101 value, approximately 40 percent less
than a $17,341,379 net value approach for a manufacturing company
with a sustained successful income and profit history.
 - 23 -

and debt levels relative to the guideline companies supported use

of the median multiples he used, and that Godfrey had generally

higher profitability and less debt than the guideline companies.

Ultimately, Mr. Burns did not rely on the market approach but

relied on his income approach value of $30,740,869, which was

based only on 1997 earnings.

Generally, we agree with Mr. Burns that an asset value

approach is inappropriate in valuing a long-established,

financially successful operating company. The estate argues that

it was customary for businesses in this industry to be acquired

for net asset value. In that regard, William J. Deputy, who was

the chief operating officer of Godfrey at the time of trial,

testified that he had been involved in entity purchases in the

boating industry where the business acquisition was for an amount

approximating net asset value. Those acquisitions by Godfrey,

however, involved companies that were financially troubled.

Considering Godfrey’s sustained financial success, the use of net

asset value to acquire financially troubled companies is not

analogous or helpful in the circumstances we consider.

In an attempt to minimize Godfrey’s financial success, the

estate argued that Godfrey did not have any intangible values

attributable to patents or workforce. Admitting that Godfrey had

engineering drawings and design formulas, the estate also

contended that competitors could easily copy the design and
 - 24 -

eliminate any advantage that Godfrey had. The estate’s

arguments, however, do not explain away Godfrey’s long-

established financial successes, good worker relationships,

extensive and loyal dealer marketing relationships, and good

reputation for product and service. Although neither party

attempted to isolate or separately value those aspects, they

represent some of the reasons for Godfrey’s past success and,

likewise, reasons for the potential for future success. The

long-established ability of the entity to earn income and profit

render inappropriate the use of a net asset approach to value

Godfrey.

Accordingly, like Mr. Burns, we give no weight to the net

asset approach in considering the value of Godfrey. We also

generally agree with Mr. Dorman’s view that the comparables were

not a good fit with this company. Similarly, Mr. Burns did not

rely on or factor in the market approach in reaching his value

for Godfrey.

It would appear that the income approach is the best

approach for valuing Godfrey, a long-established, financially

successful, closely held operating company that has shown

consistent profit and growth. In that regard, we adopt Mr.

Burns’s 10-percent discount rate, which translates into a 10-

percent capitalization rate. We do not, however, adopt the

normalized value approaches adopted either by Mr. Burns or Mr.
 - 25 -

Dorman. Instead, we believe that the normalized value lies

somewhere between the two approaches.

In particular, Mr. Burns used the three most current years,

which left out the reduced income levels occurring from 1990

through 1994. Ultimately, Mr. Burns relied solely on normalized

1997 earnings to calculate value. Conversely, Mr. Dorman

emphasized the recessionary period by using a 4-year pattern and

leaving out the income increases in the 1997 year. Using Mr.

Dorman’s annualized 1997 income (which was almost the same as Mr.

Burns’s figure) and incorporating the figures for the 3 preceding

years, we decide that $2,400,000 represents the normalized

earnings for Godfrey, as follows:

Year Income Weight Weighted Income

1997 $3,085,615 4 $12,342,460
1996 2,497,222 3 7,491,666
1995 1,082,997 2 2,165,994
1994 1,958,688 1 1,958,688
Total 23,958,808

Divided by weight factor of 10
and rounded 2,400,000

Using a capitalization rate of 10 percent, we find that

Godfrey’s undiscounted fair market value was $24 million as of

September 15, 1997.

C. Discounts To Be Applied

Respondent’s expert, Mr. Burns, concluded that no minority

discount should be used to compute decedent’s interest in the

property. He reached that conclusion on the basis of his
 - 26 -

expedient logic that the exclusive use of capitalized earnings

and the income method in the valuation would result in treating

all interests in the entity equally. In other words, he

concluded that minority interests would receive the same

percentage return on their investment as a majority interest.

Mr. Burns did, however, employ a 25-percent marketability

discount. To compute the discounted value, Mr. Burns began with

his $30,740,869 income method valuation of Godfrey and calculated

that a 19.99-percent interest resulted in an undiscounted value

of $6,145,100. After applying a 25-percent marketability

discount of $1,536,275, he arrived at his discounted fair market

value of $4,608,825.

Mr. Burns relied on two different studies that surveyed

restricted stock transactions of otherwise publicly traded stock.

Based on those studies and his analysis, Mr. Burns concluded that

a 25-percent marketability discount was appropriate for the

19.99-percent interest in Godfrey. One study, which was

conducted by FAIR MARKET VALUE Opinions, Inc., surveyed

restricted stock transactions from 1979 through 1992 and resulted

in a mean discount of 23 percent. A second study, conducted by

Management Planning, Inc. (MPI), with respect to restricted stock

transactions occurring from 1980 through 1995, resulted in an

average discount of 19.4 percent for companies with revenues

ranging from $50 million to $100 million. In the MPI study, the
 - 27 -

share prices paid in private placements of restricted stock were

compared with the same company’s freely traded market price.

After considering those studies, Mr. Burns arrived at a 25-

percent discount to account for “the fact that an interest in

Godfrey * * * would likely not be able to be sold immediately.”

The estate’s expert, Mr. Dorman, reached the conclusion that

the 19.99-percent interest in Godfrey should be discounted by 44

percent to account for the minority interest and marketability

limitations. He calculated a discounted value of $1,941,000 by

dividing his $17,341,379 adjusted net asset value by 938 (the

number of Godfrey shares outstanding) to arrive at an $18,488-

per-share value. He then multiplied the per-share value by 187.5

(the number of shares being valued) to arrive at an undiscounted

value of $3,466,427. By applying the 44-percent discount

($1,525,228) for lack of marketability and the minority interest,

Mr. Dorman arrived at a discounted value of $1,941,199, which he

rounded to $1,941,000.

Mr. Dorman’s combined 44-percent minority interest and lack

of marketability discount was derived by use of a matrix table

devised by his company. The table is divided into six rating

factors, which Mr. Dorman believes “replicate an investor’s

decision process.” The table has values (amounts of percentage

discount) assigned to each of five categories (descending from

good to poor) for each of the six factors. The matrix also has
 - 28 -

built-in indexing to place more emphasis on some categories over

others. For purposes of our analysis and clarification, we

replicate the table used by Mr. Dorman with the final column

showing the percentage discount he assigned with respect to the

19.99-percent interest in Godfrey:

Percent(%) of Discount Based
on Condition
Above Below Dorman’s
Good Average Average Average Poor Rating

1. Information availability
and reliability 1 2 3 4 5 2

2. Investment size 1 2 4 6 8 6

3. Company outlook, manage-
ment & growth potential 2 4 6 8 10 4

4. Ability to control 0 5 10 15 20 10

5. Any restrictions on trans-
ferability, anticipated
holding period and com-
pany’s redemption policy 2 5 8 11 14 8

6. Dividend payout history and
outlook 2 5 8 11 14 14

Total 8 23 39 55 71 44

Mr. Dorman’s report also contained references to discount

studies as background and/or to support his own approach. In

regards to the marketability discounts, Mr. Dorman discussed

various studies, including some that were relied on by Mr. Burns.

The majority of the studies referenced by Mr. Dorman, however,

resulted in marketability discounts ranging from approximately 26

percent to 45 percent, with most in the 32- to 35-percent range.

Most of the data for the studies referenced by Mr. Dorman were
 - 29 -

not contemporaneous to the 1997 valuation year because they were

gathered in the mid to late 1960s and early 1970s.

Mr. Dorman also provided a brief discussion on minority

discounts which concluded with the statement that an analysis of

“Tax Court cases between 1950 and 1982 * * * disclosed a median

25-percent minority discount.” Following this general discussion

of marketability and minority discounts, Mr. Dorman, in an

attempt to summarize his commentary, referenced a study by

Professor Steven E. Bolten which concluded that on the basis of

other studies in existence as of 1984, average discounts for

marketability and minority were 39.86 percent and 29.37 percent,

respectively.

Neither party’s expert attempted to persuade us to rely or

not to rely on the various studies he referenced. Mr. Dorman’s

discount approach focuses more specifically on Godfrey’s unique

attributes and therefore provides a more direct approach to

evaluate the interest in Godfrey. Additionally, we do not accept

respondent’s expert’s position that no minority discount should

apply where value is estimated by means of an income approach.

Although Mr. Dorman’s approach is more subject specific, no

foundation or background is provided to support the indexing in

each category in the matrix. In that regard, the matrix was

created by Mr. Dorman’s company and is obviously subjective.

Finally, as explained below, we do not agree with parts of Mr.
 - 30 -

Dorman’s analysis and conclusions. The divergent valuation

approaches by the parties’ experts force the Court to choose one

method over the other without necessarily fully accepting that

method or approach. Accordingly, we use Mr. Dorman’s table

merely as a guide to assist in our analysis of the facts

presented in the record of these cases.

The first category of the matrix rates the subject’s

financial information availability and reliability with a range

from one discount point for the best to five discount points for

the poorest condition. Mr. Dorman selected an above-average 2-

percent rating, noting that Godfrey had available financial

statements that were audited by independent public accounts. It

is enigmatic that Mr. Dorman would assign a less than favorable

rating under these circumstances. Moreover, there is no reason

provided as to why any discount should be attributable here,

where the subject has ample and quality financial information

available. Accordingly, we do not attribute any discount to this

factor.

The scale provided to rate investment size is an arithmetic

progression by 2, starting with one and proceeding to eight

discount points. Mr. Dorman explains that this adjustment is

made to reflect the premise that the larger the necessary capital

investment, the less likely a buyer would be willing to place it

at risk. Because Mr. Dorman reached a $3,466,000 undiscounted
 - 31 -

value for the 187.5 shares in Godfrey, he considered the

investment quite large and therefore assigned six discount points

to this aspect. We view this aspect as one of the considerations

associated with the risk factor in investing in a minority

interest in a closely held family corporation. It would be

reasonable to assess six discount points for this factor.

The third category concerns Godfrey’s financial outlook,

management, and growth potential, and the scale is another

arithmetic progression by 2. However, it starts with 2 and

proceeds to 10 discount points. Here Mr. Dorman indicates that

Godfrey has had some sales fluctuation, but that operating

expenses have shown continuous and steady decline, and that the

short-term financial information indicates an improving trend.

The record here reflects a much more positive picture of

Godfrey’s financial record and prospects. Accordingly, we

consider Mr. Dorman’s evaluation to be too conservative.

From another perspective, the financial outlook category

should ostensibly be addressing the potential for return on

invested capital. In that regard, the sixth category of the

matrix more directly addresses that aspect and assigns as much as

14 discount points for that aspect. The third category appears,

in that respect, to be a duplication. Mr. Dorman has given an

“above average” rating, assigning 4 discount points to the third
 - 32 -

category. In any event, Godfrey’s financial picture is such that

we would assign no discount for that aspect.

Ability to control is the fourth category, and Mr. Dorman

assigns a median discount of 10 in an arithmetic progression by

5, ranging from 0 to 20. His reasoning is that the 187.5 shares

“represents 20 percent of the outstanding common stock, and is

therefore the second largest holding out of approximately twenty

shareholders.” He concludes that the investor would not have

control but “would enjoy swing power, and have a strong voice in

the day-to-day operations and decision making of the company.”

We agree with Mr. Dorman’s use of 10 discount points for lack of

ability to control.

In the fifth category, which concerns restrictions on

transfer and anticipated holding period, Mr. Dorman selected a

median 8 discount points in an arithmetic progression by 3,

ranging from 2 to 14. His conclusion is based on a holding

period of 5 years or more. Mr. Dorman stated that “To the best

of * * * [his] knowledge at the present time, there is no

likelihood that Godfrey * * * will be sold within the foreseeable

future.” We agree that there would be restrictions and possible

delay in a sale of an interest in a family-owned entity as

opposed to a publicly traded stock. The record before us,

however, does not reflect that the holding period would be

extended for 5 years or more, or that there are any particular
 - 33 -

difficulties in connection with the Deputy family. Accordingly,

five discount points would be more appropriate to reflect the

restriction situation in these cases.

Finally, the sixth category, which addresses dividend payout

history, seems to address the return on capital factor. In this

category, Mr. Dorman selected the poorest rating of 14 discount

points from an arithmetic progression by 3, ranging from 2 to 14.

His reason for the rating is that Godfrey has not paid any

dividends and it is unlikely that any will be paid in the future.

However, the actual payment of dividends is not the sole measure.

The potential to pay dividends must also be considered. A return

may also be expected in the form of increase in the value of the

investment or potential for capital gain. In other words,

prospective earning power is important. See sec. 20.2031-2(f),

Estate Tax Regs.; Rev. Rul. 59-60, 1959-1 C.B. 237.

Mr. Dorman’s analysis completely ignores any potential for

gain due to increase in value. Godfrey’s financial performance

and future prospects would likely result in an increase in the

investment value. The lack of dividends, when factored with the

prospect of capital appreciation, would place Godfrey’s return

potential more in the middle range. Accordingly, 8 discount

points would seem a better match than the 14 discount points

attributed by Mr. Dorman to this aspect.
 - 34 -

Using the matrix as a guide, we would have arrived at a sum

of 29 percent after considering the six factors. Factoring in

the studies cited in the reports of the experts, considering the

record in these cases, and recognizing the imprecise nature of

the process in which we are engaged, we hold that a 30-percent

discount is appropriate to reflect the lack of marketability and

minority discounts connected with the 187.5 shares of Godfrey.

Accordingly, we hold that the 187.5 shares of Godfrey had a

discounted value of $3,358,20912 on September 15, 1997, the date

of decedent’s death.

To reflect the foregoing,

Decisions will be entered

under Rule 155.

12
Fair market value of Godfrey of $24,000,000, divided by
938 outstanding shares equals $25,586.35 per share, times 187.5
shares equals $4,797,441, less 30 percent ($1,439,232) equals
$3,358,209.