T.C. Memo. 2003-348
UNITED STATES TAX COURT
ESTATE OF MILDRED GREEN, DECEASED, THOMAS R. GREEN,
EXECUTOR, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3839-02. Filed December 29, 2003.
Jacqueline A. Dimmitt, Jay L. Levitch, and Lewis E.
Striebeck, Jr., for petitioner.
Steven W. LaBounty, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
THORNTON, Judge: Respondent determined a $1,205,541 Federal
estate tax deficiency with respect to the Estate of Mildred Green
(the estate). The issues for decision are: (1) The proper
allocation of Federal and Missouri estate taxes to the property
bequests in the will of Mildred Green (decedent); (2) the proper
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allocation of Federal generation-skipping transfer (GST) tax to
the property bequests in decedent’s will; and (3) the fair market
value of decedent’s shares of stock of Royal Bancshares, Inc.1
FINDINGS OF FACT
The parties stipulated some facts, which we incorporate,
along with the associated exhibits, into our findings of fact.
Decedent died on September 26, 1997. Her domicile at death was
in St. Louis, Missouri. When the petition was filed, the
executor’s legal residence was in St. Louis, Missouri.
Decedent’s Will
On November 10, 1997, decedent’s will, dated July 10, 1990,
was admitted to probate. Section B of Article FIRST of
decedent’s will, which deals with the payment of transfer,
estate, inheritance, succession, and other death taxes, provides:
B. I direct my Personal Representative to pay,
out of my estate, all transfer, estate, inheritance,
succession and other death taxes (exclusive of any
generation-skipping transfer tax) payable, including
interest and penalties thereon, if any, assessed by the
United States or assessed by any state thereof or by
any foreign government against my estate or against any
gift, bequest or devise, or assessed by reason of the
inclusion in my estate for tax purposes of any life
insurance proceeds, annuity, joint property, property
held as a tenant by the entirety or any other property
or interest in property (other than property of any
trust created by me under an instrument which provides
otherwise with respect to the property of such trust);
1
Respondent represents that, after our resolution of the
above-stated issues, the parties will resolve whether the estate
is entitled to deductions of $49,433 for executor’s commissions
and $8,500 for accountant’s fees.
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such taxes shall not be charged against nor deducted
from any such gift, bequest, devise, life insurance
proceeds, annuity, joint property, tenancy by the
entirety property or other property or interest in
property, upon or by reason of which such taxes are
assessed and paid. Notwithstanding the foregoing, I
direct my Personal Representative to pay, out of my
estate, any tax imposed under Chapter 13 of the
Internal Federal Revenue Code on property transferred
in a “direct skip,” as defined in Section 2612(c) of
the Code; such tax shall not be deducted from or reduce
the gift, bequest or devise which constitutes a “direct
skip.”
Article SECOND of decedent’s will provides for the disposition of
all her tangible personal property. Article THIRD gives one-half
of the “rest, residue and remainder” of decedent’s property to
the Lubin-Green Foundation, which is a charity for purposes of
section 2055.2 Article FOURTH gives the other one-half of the
“rest, residue and remainder” of decedent’s property in trust for
her grandchildren.
At death, decedent was survived by three grandchildren, each
of whom was an eligible beneficiary under Article FOURTH of
decedent’s will.
Decedent’s Shares of Common Stock of Royal Bancshares, Inc.
At death, decedent owned 3,276 of the 64,372 shares of
issued and outstanding common stock of Royal Bancshares, Inc.
(RBI). Decedent’s shares represented 5.09 percent of the
outstanding shares of RBI; hers was the fifth largest holding of
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code as amended, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
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RBI shares by any one shareholder. RBI had 62 shareholders at
decedent’s death. No one person had a controlling interest in
RBI; the largest percentage interest in RBI stock held by any one
shareholder was 14.38 percent. RBI shares have never been listed
on any securities exchange.
As of September 30, 1997, RBI had total assets of
$172,613,000. From 1993 to 1997, RBI’s total assets and earning
assets (interest and dividend-producing assets) increased. From
1993 to 1997, shareholder equity in RBI increased, and as of
September 30, 1997, totaled $17,369,000. Compared to other
banking companies in its peer group,3 RBI has an above-average
capital structure and smaller loan losses.
Between 1993 and 1997, RBI declared the following cash
dividends per share:
Year Cash Dividend Per Share
1993 $1.69
1994 2.01
1995 1.68
1996 2.19
1997 4.06
RBI wholly owned a subsidiary, Royal Banks of Missouri
(Royal Banks), a Missouri banking corporation. On the date of
decedent’s death, Royal Banks operated five branches in the St.
3
Royal Bancshares, Inc. (RBI), is a member of “Peer Group
#7” as defined by the Federal Financial Institutions Examination
Counsel, along with 972 other commercial banks having total
assets of $100 to $300 million and with three or more branch
offices in a metropolitan area.
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Louis metropolitan area. For the 12-month period October 1,
1996, through September 30, 1997, Royal Banks had earnings of
$1,721,000.
On April 24, 1996, Royal Banks lent $1.6 million to Robert
and Bonnie Havrilla (the Havrillas). Jefferson/Keeler Printing
Co. (Jefferson/Keeler) guaranteed this loan.4 By a deed of trust
dated April 24, 1996, Jefferson/Keeler granted a security
interest in certain real property that it owned.5 The Havrillas’
note was current through a payment made in July 1997; however, no
payment was made on the Havrillas’ note for August or September
1997, and at decedent’s death the Havrillas were in default on
their note.
On August 1, 1997, creditors of Jefferson/Keeler filed an
involuntary petition in Federal District Court seeking relief
under chapter 7 of the United States Bankruptcy Code. Royal
Banks was not a petitioning creditor in this case. The District
Court granted Jefferson/Keeler’s motion to convert the
involuntary bankruptcy case to a voluntary case under chapter 11
4
The guaranty was unconditional, absolute, and irrevocable.
The guaranty did not require Royal Banks of Missouri (Royal
Banks), as a condition to performance by Jefferson/Keeler
Printing Co. (Jefferson/Keeler), to seek collection from Robert
and Bonnie Havrillas (the Havrillas) or to enforce any security
interests or liens granted to Royal Banks by the Havrillas.
5
As of March 1996, the property was appraised at $2.1
million. Before the security interest was granted, there were no
other security interests or liens with respect to the property.
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of the United States Bankruptcy Code. On September 12, 1997,
counsel for Royal Banks filed a notice of appearance in the
voluntary bankruptcy case.
Decedent’s Estate Tax Return
On November 9, 1998, the estate filed a Form 706, United
States Estate (and Generation-Skipping Transfer) Tax Return,
reporting a gross estate of $3,331,853. The estate included
decedent’s 3,276 shares of RBI stock in the gross estate at an
estate tax value of $163,800, or $50 per share. The estate
claimed a charitable contribution deduction of $1,565,678 for the
bequest to the Lubin-Green Foundation. On Schedule R,
Generation-Skipping Transfer Tax, the estate reported the
property transferred in trust to decedent’s grandchildren as a
direct skip with an estate tax value of $1,565,678. In reporting
these amounts, the estate allocated and charged all estate
(Federal and Missouri) and GST tax to the portion of the estate
that passed in trust to decedent’s grandchildren.
Notice of Deficiency
On August 30, 1999, respondent commenced an examination of
the estate and GST tax return. By notice of deficiency,
respondent determined a $1,205,541 deficiency in the estate and
GST tax. Respondent determined that at the date of decedent’s
death the fair market value of the 3,276 shares of RBI stock was
$1,048,320, rather than $163,800, as shown on the estate’s tax
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return. Respondent also determined that the allowable charitable
contribution deduction for the bequest to the Lubin-Green
Foundation was $801,723, rather than $1,565,678, as shown on
decedent’s estate tax return, on the basis of a determination
that 50 percent of the estate taxes (Federal and Missouri),
including interest and penalties, and all the GST tax should be
allocated against the amount passing to the Lubin-Green
Foundation.
OPINION
A. Allocation of Federal and Missouri Estate Taxes (Apart From
GST Tax)
Generally, the manner in which estate taxes are apportioned
to the assets included in a decedent’s gross estate is determined
under State law. Riggs v. Del Drago, 317 U.S. 95, 98 (1942). In
this case, the parties agree that Missouri law governs the
apportionment of the estate’s taxes. Missouri has no
apportionment statute. See Estate of Boder v. Albrecht Art
Museum, 850 S.W.2d 76, 78 (Mo. 1993). The apportionment of taxes
is instead determined according to the decedent’s intent, looking
first to the decedent’s testamentary instrument. Id. If the
decedent’s intent is clear, it is to be given effect. Id. at 79.
If the decedent’s intent is unclear, judicial construction of the
instrument(s) is appropriate. Id. If the decedent’s intent
cannot be determined, the doctrine of equitable apportionment
applies. Id.; St. Louis Union Trust Co. v. Krueger, 377 S.W.2d
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303 (Mo. 1964); Hammond v. Wheeler, 347 S.W.2d 884 (Mo. 1961);
Carpenter v. Carpenter, 267 S.W.2d 632 (Mo. 1954). “The doctrine
of equitable apportionment places the burden of the federal
estate tax on the property that generates the tax and exonerates
from the burden the property which does not.” Estate of Boder v.
Albrecht Art Museum, supra at 78-79 (citing Jones v. Jones, 376
S.W.2d 210, 212 (Mo. 1964)).
In the notice of deficiency, respondent determined that
decedent intended 50 percent of her Federal and Missouri estate
taxes (exclusive of GST tax) to be paid out of the charitable
bequest and the other 50 percent to be paid out of the bequest in
trust for her grandchildren. For the first time on brief,
respondent has abandoned this position in favor of a new theory:
respondent now argues that decedent intended the estate taxes to
be paid entirely out of the charitable bequest to the Lubin-Green
Foundation. The estate argues that decedent’s will contains no
clear expression of intent regarding the allocation of estate
taxes, and, therefore, the doctrine of equitable apportionment
requires an allocation of all estate taxes to the property
passing in trust to decedent’s grandchildren.
Decedent’s will states, in relevant part, that decedent
directs her personal representative “to pay, out of my estate,
all transfer, estate * * * and other death taxes (exclusive of
any generation-skipping transfer tax)”. The will goes on to
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state that the estate tax “shall not be charged against nor
deducted from any such gift, bequest, devise, * * * or other
property or interest in property, upon or by reason of which such
taxes are assessed and paid”.
In the first instance, we might agree that this language
represents an attempt on the part of decedent to apportion the
estate taxes arising at her death. Arguably, this language might
be read to reflect an intent on the part of decedent that the
principles of equitable apportionment shall not apply.
Nevertheless, the language in decedent’s will is not altogether
clear as to who ultimately should bear the estate tax burden.
Respondent argues that the “plain, unambiguous” meaning of
the language in decedent’s will is that estate taxes are to be
allocated entirely against the charitable bequest to the Lubin-
Green Foundation. If this language has a “plain and unambiguous”
meaning, it eludes us, as it evidently eluded respondent inasmuch
as he previously interpreted the will language to provide for a
50-50 allocation against the residuary bequests. The language in
decedent's will does not purport to express who ultimately should
bear the estate tax burden; rather, it provides that certain
transfers or property shall not be charged with the estate taxes.
This language does not expressly or implicitly charge the estate
taxes to the property passing to the Lubin-Green Foundation.
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Respondent focuses on the language “upon or by reason of
which such taxes are assessed and paid” and contends that this
language exonerates from payment of estate taxes all gifts,
bequests, and devises other than the residuary bequest to the
Lubin-Green Foundation, reasoning that this is the only gift,
bequest, or devise that does not constitute property upon or by
reason of which such taxes are assessed and paid. Respondent’s
construction may be tenable but is by no means compelled when the
specific language that respondent relies upon is read in context
with other language in decedent’s will, including the provisions
dealing with the residuary bequest to the Lubin-Green Foundation
and the residuary bequest in trust to decedent’s grandchildren.
For example, if, as respondent contends, the language in
question requires the property passing to the Lubin-Green
Foundation to bear all the estate taxes, then that is the
property “upon which” all the taxes are ultimately assessed and
paid, and consequently that property would also be exonerated
from the payment of estate taxes. Taken to its logical
conclusion, then, this language might be read to exonerate all
gifts, bequests, and devises from being charged with the estate
taxes (other than GST tax).
Also, in the absence of some clearer expression of
decedent’s intent, we would be hard pressed to infer an intent on
her part to allocate all the estate taxes against the charitable
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bequest. See sec. 2055(c) (limiting charitable contribution
deduction to amount of charitable bequest reduced by amount of
taxes payable out of that bequest). This is especially true when
we consider the equivalency that the will otherwise gives to the
charitable bequest and the bequest in trust to decedent’s
grandchildren. These bequests are designated in decedent’s will
to each constitute one half of the “rest, residue, and remainder”
of decedent’s property.6
We agree with the estate that decedent’s will lacks a clear
expression of intent as to who is ultimately to bear the burden
of the estate taxes. The will as a whole is ambiguous on this
score. Although decedent’s will provision is susceptible to a
number of plausible ways of apportioning the estate taxes, none
of these interpretations provides a sustainable basis for
apportioning the estate taxes between the bequest in trust to
decedent’s grandchildren and the charitable bequest to the Lubin-
Green Foundation. Under these circumstances, Missouri judicial
precedents dictate that we apply the doctrine of equitable
6
This designation might support respondent’s original
interpretation, which he has now abandoned, that the will
requires a 50-50 allocation of the estate taxes between the
charitable bequest and the bequest in trust for the
grandchildren. Although this interpretation is plausible, it has
no express support in the specific provision of decedent’s will
dealing with the apportionment of taxes. Also, the fact that
both of the interpretations that respondent has forwarded, as
well as other possible interpretations, are similarly plausible
supports our ultimate conclusion that the will is ambiguous as to
the proper apportionment of the estate taxes.
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apportionment. We hold, therefore, that no portion of the estate
taxes (other than GST tax) is allocable to the bequest to the
Lubin-Green Foundation. Cf. Estate of McCutchan v. Commissioner,
T.C. Memo. 1979-393.
B. Allocation of GST Tax
“Unless otherwise directed pursuant to the governing
instrument by specific reference to the [GST] tax * * *, the tax
imposed * * * on a generation-skipping transfer shall be charged
to the property constituting such transfer.” Sec. 2603(b). The
estate argues that decedent’s GST tax should be allocated to the
property that is to pass in trust for the benefit of decedent’s
grandchildren because decedent did not direct otherwise in her
will. Respondent argues that all GST tax imposed on the transfer
in trust for the benefit of decedent’s grandchildren is to be
allocated against the charitable bequest to the Lubin-Green
Foundation.
Decedent specifically provided for the payment of GST tax on
property transferred in a “direct skip”. Decedent’s will directs
that those taxes “shall not be deducted from or reduce the gift,
bequest or devise which constitutes a ‘direct skip.’” The
parties agree that the transfer in trust for decedent’s
grandchildren constitutes a “direct skip” as defined in section
2612(c). It follows from the express language in decedent’s will
that the GST tax is not to be deducted from or reduce the
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transfer in trust for the grandchildren.
The estate argues that decedent’s will fails to instruct the
executor not to “charge” the GST tax to the trusts for the
grandchildren, as the estate contends the language of section
2603(b) contemplates it must. Contrary to the estate’s argument,
section 2603(b) does not require any specific language to elect
out of the general apportionment scheme of that section, except
for a specific reference to the GST tax. It is sufficient that
decedent’s will made manifest her intent to elect out of the
general, statutory apportionment scheme and made a specific
reference to the GST tax. Cf. Estate of Monroe v. Commissioner,
104 T.C. 352, 363-365 (1995), revd. and remanded on another
ground 124 F.3d 699 (5th Cir. 1997).
The estate contends that the will provision relating to GST
tax is “unclear and contradictory”. The estate claims that if
the GST tax is paid out of the estate and charged to the
charitable bequest, “the charitable deduction would go down, the
estate taxes would consequently go up and the bequest to the
grandchildren would go down by their share of the additional
estate tax, which would ‘reduce’ the bequest to the grandchildren
in contravention of the express language of the GST Tax
Provision.” We are unpersuaded by the estate’s argument, which
seems to us more “unclear and contradictory” than the will
provisions in question. The estate’s argument, focusing on the
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supposed collateral estate-tax effects of allocating the GST tax
to the charitable bequest, ignores the more direct and proximate
effect that would result from allocating the GST tax against the
grandchildren’s bequests. Even if, as the estate suggests,
allocating the GST tax against the noncharitable bequests would
lower the estate’s overall estate-tax burden, we are unpersuaded
that such an allocation would not reduce the amounts ultimately
received by the grandchildren, since the GST tax would then be
borne entirely by their shares, in contravention of the will
provision that the GST tax “not * * * reduce the gift, bequest,
or devise which constitutes a ‘direct skip’”.
We hold that the GST tax is not chargeable to the transfer
in trust for decedent’s grandchildren but rather is to be charged
to the charitable bequest to the Lubin-Green Foundation.
C. Valuation of Decedent’s 3,276 Shares of RBI Stock
Generally, the value of a decedent’s gross estate is
determined by including the value of all property, real or
personal, tangible or intangible, wherever situated. Sec.
2031(a). The value of every item of property includable in a
decedent’s gross estate is its fair market value at the time of
the decedent’s death (or the alternate valuation date). Sec.
20.2031-1(b), Estate Tax Regs. The fair market value of property
is the price at which the property would change hands between a
willing buyer and a willing seller, neither being under a
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compulsion to buy or to sell and both having reasonable knowledge
of relevant facts. Id.; see United States v. Cartwright, 411
U.S. 546, 551 (1973).
For unlisted stocks, the best indicators of fair market
value are actual arm’s-length sales in the normal course of
business within a reasonable time before or after the date of
death. Estate of Andrews v. Commissioner, 79 T.C. 938, 940
(1982). Where actual sale prices are unavailable, the stock
value is determined by weighing the corporation’s net worth,
prospective earning power, dividend-paying capacity, and other
relevant factors. Id.; sec. 20.2031-2(f), Estate Tax Regs.
Valuation of stock is a purely factual determination; there is no
one universally applicable formula. Hamm v. Commissioner, 325
F.2d 934, 938 (8th Cir. 1963), affg. T.C. Memo. 1961-347.
The parties dispute the fair market value of decedent’s
3,276 shares of RBI stock. Respondent, who determined in the
notice of deficiency that the fair market value of the shares was
$1,048,320 ($320 per share), now contends that the fair market
value was $860,000 ($262.52 per share). The estate, which
reported on the estate tax return that the fair market value of
the shares was $163,800 ($50 per share), now contends that the
fair market value was $655,200 ($200 per share).7
7
Generally, the estate bears the burden of proof. See Rule
142(a). Effective for court proceedings arising in connection
(continued...)
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Each party relies on an expert opinion. We evaluate expert
opinions in light of all the evidence in the record and may
accept or reject expert testimony, in whole or in part, according
to our own judgment. Helvering v. Natl. Grocery Co., 304 U.S.
282, 295 (1938); Shepherd v. Commissioner, 115 T.C. 376 (2000),
affd. 283 F.3d 1258 (11th Cir. 2002). We may be selective in our
use of any part of an expert’s opinion. Estate of Davis v.
Commissioner, 110 T.C. 530, 538 (1998).
1. The Estate’s Expert
The estate’s expert, Gary L. Schroeder, is accredited by the
American Society of Appraisers as a senior appraiser in the
valuation of businesses and intangible assets. He has been
actively engaged in the appraisal and consulting profession since
1981. Mr. Schroeder determined that, as of September 26, 1997,
the fair market value of 100 percent of the shares of RBI stock,
on a controlling-interest basis, was $25,900,000. He determined
a $12,900,000 aggregate value for RBI stock after allowing a 17-
7
(...continued)
with examinations commencing after July 22, 1998, if certain
requirements are met under sec. 7491(a), the burden of proof
shall be on the Commissioner as to any factual issue relevant to
ascertaining the tax liability of the taxpayer. See Internal
Revenue Service Restructuring and Reform Act of 1998, Pub. L.
105-206, sec. 3001(c), 112 Stat. 727. The examination in the
instant case commenced after July 22, 1998. Nevertheless,
neither party addresses whether the requirements of sec. 7491(a)
have been met, and, in any event, we do not decide any factual
issue on the basis of which party bears the burden of proof.
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percent minority interest discount and a 40-percent lack of
marketability discount.
2. Respondent’s Expert
Respondent’s expert, William C. Herber, is an associate
member (candidate) of the American Society of Appraisers and a
member of the Institute of Business Appraisers, Inc. Mr. Herber
prepares valuations and market analyses of real estate, business
enterprises, and intangible property rights. He has worked in
the valuation field since approximately 1985. Mr. Herber
determined that, as of September 26, 1997, the fair market value
of 100 percent of the shares of RBI stock before consideration of
any discounts was $26,500,000. Mr. Herber determined an $860,000
($262.52 per share) value for decedent’s shares of RBI stock. In
determining this value, Mr. Herber allowed a 15-percent minority
interest discount and a 25-percent discount for lack of
marketability.
The experts agree to a considerable extent on the valuation
of RBI stock. Indeed, the aggregate values the experts
determined are relatively close. The greatest difference in the
experts’ respective positions relates to the lack of
marketability discount.
D. Pre-Discount Aggregate Value of RBI Stock
1. Income Approach
Both experts used an income approach to value RBI stock and
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arrived at nearly identical values: Mr. Schroeder determined a
value of $23,370,000, and Mr. Herber determined a value of
$23,300,000. Respondent’s brief states: “The experts offered by
the parties are in agreement as to the value of the Royal
Bancshares derived from the discounted net income method.”
Considering this concession and out of fairness to the estate, we
accept Mr. Herber’s $23,300,000 estimate of the value of RBI
stock under the income approach.
2. Market Approaches
a. Guideline Analysis
Using a market approach, both experts used a guideline
analysis of publicly held banks and a transaction analysis of
acquisitions of privately held banks. Using the guideline
analysis, the experts arrived at similar values for RBI stock:
Mr. Schroeder determined a value of $28,330,000, and Mr. Herber
determined a value of $28 million. Respondent’s brief states:
“The experts offered by the parties are in agreement on the value
of Royal Bancshares suggested by publicly-traded guideline
banks.” Considering this concession and out of fairness to the
estate, we accept Mr. Herber’s $28 million estimate of the value
of RBI stock using the guideline analysis.
b. Transaction Analysis
Under the transaction analysis, both experts identified a
number of transactions involving the acquisition of privately
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held banks which the experts determined were similar to RBI’s
banking company.
i. The Estate’s Expert
Mr. Schroeder obtained information relating to five banks
located in either Illinois or Missouri that were acquired within
the 9-month period before September 26, 1997. Mr. Schroeder
determined a range of multiples from the price-to-earnings,
price-to-equity, and price-to-assets ratios of the acquired
banks. Because Royal Banks appeared to be located in a more
urban area than the acquired banks and because of “the potential
of a significant pending loan impairment on a loan granted to
Jefferson Printing”, Mr. Schroeder selected multiples between the
median and the low end of the range derived from the acquired
banks. Mr. Schroeder determined a controlling interest value of
$25,920,000 for RBI stock using the transaction analysis.
ii. Respondent’s Expert
Mr. Herber obtained information concerning private banks
that were similar to RBI, focusing on privately held commercial
banks whose sales were announced and completed between January
1996 and September 26, 1997, and that had assets between $20 and
$200 million. He selected nine acquired banks that he determined
to be comparable to RBI. He determined average and median price-
to-earnings, price-to-equity, and price-to-assets ratios of the
acquired banks. He compared these ratios to RBI’s ratios and
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selected appropriate multiples for RBI stock. Mr. Herber
determined a value of $28,500,000 for RBI stock using the
transaction analysis. In reaching his conclusions, Mr. Herber,
unlike Mr. Schroeder, did not consider the effects of any
potential loan impairment.
iii. Effect of Potential Loan Impairment
In their disagreement over the experts’ transaction
analyses, the parties focus on whether the multiples that the
experts selected should reflect the impairment risk of the loan
to the Havrillas and the pending bankruptcy of Jefferson/Keeler.8
Although Mr. Schroeder considered the potential of a loan
impairment in his report, it is unclear whether or to what extent
it depressed his appraisal.9 Accordingly, we are unpersuaded
that Mr. Herber’s failure to consider the potential loan
impairment materially undermines his valuation recommendations.
8
The difference in the values that the estate’s expert,
Gary L. Schroeder, and respondent’s expert, William C. Herber,
determined is not solely attributable to differing treatments of
the potential loan impairment. The experts also relied upon
different guideline transactions, which resulted in the use of
different price/earnings, price/equity, and price/assets ratios.
Respondent, however, raises no issues as to the remaining aspects
of Mr. Schroeder’s transaction analysis, including his selection
of guideline transactions. Similarly, the estate does not appear
to dispute the remaining aspects of Mr. Herber’s transaction
analysis.
9
Furthermore, the record reflects that Mr. Schroeder’s
knowledge and understanding of the circumstances of the loan
impairment were, in key respects, faulty.
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iv. Conclusion
On the basis of all the evidence and using our best
judgment, we find that the transaction analysis indicates a value
of $27,500,000.
3. Correlation of Values
We have found that the following values were indicated under
the income and market approaches that the parties’ experts used:
Approach (Analysis) Value Derived
Income approach $23,300,000
Market approach
Guideline analysis 28,000,000
Transaction analysis 27,500,000
Like the experts in their respective reports, we find that each
of these derived values is entitled to equal weight.
Accordingly, we hold that the aggregate value of RBI stock is
appropriately estimated at $26,266,667, before taking into
account any discounts.
E. Discounts
The parties and their experts agree that minority interest
and lack of marketability discounts are appropriate in valuing
decedent’s stock interest in RBI. They disagree about the
amounts of those discounts.
1. Minority Interest Discount
Mr. Schroeder determined a minority interest discount of 17
percent. Mr. Herber determined a minority interest discount of
15 percent. Both experts determined the minority interest
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discount by calculating the inverse of what they considered to be
the appropriate control premium for RBI. Mr. Herber also
considered other factors in determining his recommended minority
interest discount.
a. The Estate’s Expert
Mr. Schroeder recommended a minority interest discount of 17
percent on the basis of information contained in Mergerstat
Review 1998 regarding offers to acquire a majority interest or
total ownership of public companies. From this information, with
little explanation, he calculated a control premium of 20 percent
and an implied minority interest discount of 17 percent. As a
basis for this conclusion, Mr. Schroeder states simply that “For
Royal Banks of Missouri we have selected a control premium of 20%
as being reasonable considering its size, financial performance
and geographic location.”
b. Respondent’s Expert
Mr. Herber relied on a study of minority interest discounts
by Christopher Mercer in Quantifying Marketability Discounts.
The Mercer study indicated a median and average minority interest
discount of 19 percent. Mr. Herber conducted his own study of
control premiums in transactions involving banking companies. He
concluded that these transactions indicated median and average
minority interest discounts ranging from 18.4 to 19.6 percent,
which was “equivalent” to the Mercer study results.
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Mr. Herber then considered certain additional factors which
led him to reduce the minority interest discount to 15 percent.
First, Mr. Herber claims that decedent’s 5.09-percent stock
interest in RBI is “a substantially larger interest than typical
minority interests in publicly traded shares in banks and this
would result in a minority interest discount which would tend to
be somewhat lower than” the indicated range of 18.4 to 19.6
percent for banking interests. Mr. Herber offers no independent
evidence or empirical data to verify these conclusions, and we
are unpersuaded that he appropriately relied on this factor in
his discount analysis.
Second, alluding to the lack of concentration of ownership
in RBI stock, Mr. Herber claims that because decedent held a
relatively large minority interest, 5.09 percent, and because no
single individual controlled the company (with an interest
greater than 50 percent), “the divided interest of the larger
shareholders would tend to keep the applicable minority interest
discount also at the lower range of the market studies for
minority interest discount.” We are not convinced that
decedent’s interest in RBI stock represents a relatively large
minority interest or that the holder of that size interest faces
less of a challenge in controlling the company. Mr. Herber’s
suggestion appears purely speculative. In any event, Mr. Herber
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determined that this factor indicates a discount at the lower end
of the indicated range, not a discount below that range.
Mr. Herber also notes that the banking industry is highly
regulated and banking companies are “transparent”; i.e.,
shareholders have access to a great deal of information regarding
banking companies’ performance. He claims that these factors
support a lower minority interest discount. Mr. Herber, however,
determined the indicated range of 18.4 to 19.6 percent from his
own study of transactions involving banking companies. Because
the indicated range presumably takes into account issues relating
to the regulation of banking companies, we are unpersuaded that
these factors support a discount for decedent’s shares lower than
the indicated range.
Mr. Herber also claims that RBI is well capitalized, has
high returns on equity and assets, maintains a very high rating
in comparison to other banking companies and has offered a
“favorable dividend” over the past 5 years. He claims that these
factors reduce risk and enhance the attractiveness of a minority
position in RBI relative to other banking companies and support a
lower discount than the indicated range of 18.4 to 19.6 percent.
Mr. Herber does not attempt to quantify the effect of these
additional factors, and he provides no independent evidence or
verification regarding the comparison of RBI and other banking
- 25 -
companies. Mr. Herber has not persuaded us that these factors
support a lower minority interest discount.
c. Our Analysis
We are unsatisfied that either expert has adequately
supported his recommended minority interest discount. The
estate does not argue for a minority interest discount greater
than 17 percent. Mr. Herber, who started with a minority
interest discount range of 18.4 to 19.6 percent before making
various adjustments that we do not find well supported, has not
persuaded us that the minority interest discount should be less
than 17 percent. Accordingly, we hold that a 17-percent minority
interest discount is appropriate in valuing decedent’s shares of
RBI stock.
2. Lack of Marketability Discount
Mr. Schroeder determined a lack of marketability discount of
40 percent, and Mr. Herber determined a lack of marketability
discount of 25 percent. Both experts used information from
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restricted stock studies.10 Mr. Schroeder also used information
from initial public offering (IPO) studies.11
a. The Estate’s Expert
In determining an appropriate lack of marketability
discount, Mr. Schroeder relied on restricted stock studies that
indicated discounts ranging from 31.2 to 45 percent and an
overall average discount of 34.9 percent. He also relied on IPO
studies that indicated an average lack of marketability discount
ranging from 43 to 45.7 percent and an overall average discount
of 44.4 percent. After considering certain factors influencing
the marketability of RBI shares, Mr. Schroeder concluded that the
factors supporting a higher discount would slightly outweigh the
factors supporting a lower discount, and he selected a discount
of 40 percent.
Mr. Schroeder considered the potential impairment of the
loan to the Havrillas and the pending bankruptcy of
10
Restricted stock studies compare private-market prices of
unregistered (restricted) shares in public companies with the
public-market prices of unrestricted but otherwise identical
shares in the same corporations. See McCord v. Commissioner, 120
T.C. 358, 387-388 (2003). Historically, restricted shares
generally could not be resold in the public market for 2 years.
See 17 C.F.R. sec. 230.144(d)(1) (1996). In 1997, the required
holding period was shortened to 1 year. See 62 Fed. Reg. 9242
(Feb. 28, 1997).
11
Initial public offering (IPO) studies compare the
private-market price of shares sold before a company goes public
with the public-market price obtained in the IPO of the shares or
shortly thereafter. See McCord v. Commissioner, supra at 387.
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Jefferson/Keeler as factors indicating a higher discount. For
the reasons discussed above (including Mr. Schroeder’s
demonstrated incomplete knowledge of the potential loan
impairment and the pending bankruptcy), we find Mr. Schroeder’s
reliance on these factors unpersuasive.12
Mr. Schroeder also considered seven prior transactions
involving shares of RBI stock as supporting a higher lack of
marketability discount. Six of those transactions, however,
occurred between 1990 and 1994--more than 3 years before
decedent’s death; the remaining transaction occurred in January
1998. Mr. Schroeder provided no specifics about the prior
transactions, and we have no basis for concluding they were at
arm’s length. See Rev. Rul. 59-60, sec. 4.02(g), 1959-1 C.B.
237, 241-242. Furthermore, Mr. Schroeder does not indicate
whether or to what extent the information from the prior
transactions affected his overall conclusion of an appropriate
lack of marketability discount. Instead, he states equivocally
that the existence of prior transactions is “usually a factor
that would decrease the lack of marketability discount[;]
however, the prior transactions have been at prices which are
12
Moreover, Mr. Schroeder has failed to adequately explain
why he considered this factor both in reaching an aggregate value
for RBI stock and in calculating a lack of marketability
discount. We are unpersuaded that Mr. Schroeder’s double
counting of this factor would not lead to understating the value
of decedent’s shares.
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significantly below our appraisal value which is a factor that
would increase the lack of marketability discount.”
In sum, we believe that Mr. Schroeder’s consideration of the
potential loan impairment, the pending bankruptcy, and the prior
transactions cause his recommended lack of marketability discount
to be overstated. The remaining factors that he identified in
his report support a lower lack of marketability discount.
b. Respondent’s Expert
In determining an appropriate lack of marketability
discount, Mr. Herber relied on restricted stock studies
indicating median discounts ranging from 24 to 45 percent, with
median results from most of the studies trending in a narrow
range from 30 to 35 percent. Mr. Herber placed considerable
reliance on a Management Planning, Inc. study, which “indicates
that a discount ranged overall from 26.2% to 32.7% with a central
tendency of 30.5% overall”. Mr. Herber suggested that RBI’s
relatively smaller gross income and earnings supported a greater
discount, but that “the overriding relative stability of the
companies earnings would contribute to a lower applicable lack of
marketability discount”. He also indicated that the companies in
the studies tended not to pay dividends. Thus, in Mr. Herber’s
view, the fact that RBI paid dividends would support a lower
discount. Mr. Herber concluded that these factors together
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suggested a lower discount than “the 30% overall average found
for all observations in the Management Planning Study.”
Mr. Herber also considered certain factors identified in
Mandelbaum v. Commissioner, T.C. Memo. 1995-255, affd. 91 F.3d
124 (3d Cir. 1996), for determining whether an appropriate
discount for lack of marketability should be higher than, the
same as, or lower than the indicated range of discounts.13 In
considering these factors, Mr. Herber observed that a lack of
marketability discount applicable to decedent’s stock interest
“would have a strong central tendency relative to the overall
studies.” Taking into account RBI’s stability of earnings and
its lower overall company risk as a bank, however, he recommended
a 25-percent discount for lack of marketability, which he
characterizes as being at the “slightly lower end” of the
indicated range of median discounts.
13
The factors identified in Mandelbaum v. Commissioner,
T.C. Memo. 1995-255, affd. 91 F.3d 124 (3d Cir. 1996), include:
(1) The value of the subject corporation’s privately traded
securities vis-a-vis its publicly traded securities; (2) the
corporation’s financial statements; (3) the corporation’s
dividend-paying capacity, its history of paying dividends, and
the amount of its prior dividends; (4) the nature of the
corporation, its history, its position in the industry, and its
economic outlook; (5) the corporation’s management; (6) the
degree of control transferred with the block of stock to be
valued; (7) any restriction on the transferability of the
corporation’s stock; (8) the length of time an investor must hold
the subject stock to realize a sufficient profit; (9) the
corporation’s redemption policy; and (10) the cost of effecting a
public offering of the stock to be valued, e.g., legal,
accounting, and underwriting fees.
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We are unpersuaded by Mr. Herber’s conclusions. In the
first instance, his recommended 25-percent marketability discount
is very nearly at the rock bottom (rather than at the “slightly
lower end”) of the 24- to 45-percent range he says is indicated
by the restricted stock studies he analyzed. Furthermore, we
question his 24-percent lower range limit.14 He himself states
that most of the restricted stock studies showed median
marketability discounts in a range from 30 to 35 percent.
In his analysis of the Management Planning, Inc. study, Mr.
Herber compared RBI with the grouping of companies with gross
incomes of $10 to $30 million. The transactions involving those
14
Mr. Herber cites only two studies that he says indicate
median discounts of 24 percent or lower. One of those studies is
the Securities and Exchange Commn. Institutional Investor Study
(SEC study). See Securities and Exchange Commn., Institutional
Investor Study Report, H.R. Doc. 92-64 (Vol. 5), 92d Cong., 1st
Sess. (1971). On cross-examination, however, Mr. Herber was
unable to respond satisfactorily to the estate’s contention that
the SEC study describes various categories of sales transactions,
and that the category for nonreporting over-the-counter
companies, which are most comparable to smaller businesses like
RBI, shows a median price discount of 32.6 percent.
Mr. Herber also relied on the “Hall/Polacek study” which, in
his opinion, indicated a mean discount of 23 percent. See Hall &
Polacek, “Strategies for Obtaining the Largest Valuation
Discounts,” Estate Planning (Jan./Feb. 1994). The Hall/Polacek
study also indicates, however, that “Lack of marketability
discounts appear to increase as the capitalization of the
corporation decreases below $50 million (30%-40%) compared to
corporations with capitalizations in excess of $100 million (10%-
20%).” Id. at 43-44. Because RBI’s capitalization was below
$50 million, the Hall/Polacek Study would appear to indicate a
higher discount (30 to 40 percent) than the mean discount of 23
percent upon which Mr. Herber relied.
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companies had an overall average lack of marketability discount
of 30.8 percent. Mr. Schroeder points out, however, that this
particular group contained only two transactions involving
companies with revenues comparable to RBI’s relatively small
revenues ($12,653,000 for the 12 months preceding decedent’s
death).15 According to Mr. Schroeder, those two transactions had
an overall average lack of marketability discount of 43 percent.
The Management Planning, Inc. study indicates a clear correlation
between the size of a company’s gross income and the size of the
lack of marketability discount. See Pratt, et al., Valuing a
Business: The Analysis and Appraisal of Closely Held Companies
401 (4th ed. 2000) (“There was clear size effect in the
Management Planning Study, with smaller companies tending to have
larger discounts”). Mr. Herber admits as much on page 75 of his
report: “In other words, restricted shares of companies with
higher gross income tended to sell for lower discounts than the
restricted shares of companies with lower gross income.” Because
RBI had gross income at the lower end of the range indicated in
the Management Planning Study, we might expect the appropriate
discount for RBI to be higher than the overall average lack of
marketability discount of 30.8 percent indicated for the relevant
grouping of companies.
15
Mr. Herber was unfamiliar with the two transactions that
Mr. Schroeder identified. He could only testify that “I can look
that up. I would like to see that.”
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In sum, we are unpersuaded that Mr. Herber has adequately
supported his recommended 25-percent discount for lack of
marketability.
c. Conclusion
On the basis of all the evidence, and using our best
judgment, we hold that a lack of marketability discount of 35
percent is appropriate for decedent’s shares of RBI stock. This
discount is at the higher end of the narrow range that Mr. Herber
identified in his report and is consistent with the average
discount that Mr. Schroeder derived from the restricted stock
studies.16
5. Conclusion
We conclude that for September 26, 1997, the fair market
value of decedent’s shares of RBI stock is $721,297 ($220.18 per
share), computed as follows:
Total aggregate value of RBI stock $26,266,667.00
5.09 percent of value of stock 1,336,973.00
Less: 17-percent minority interest
discount (227,285.00)
1,109,688.00
Less: 35-percent discount for
lack of marketability (388,391.00)
FMV of decedent’s shares 721,297.00
FMV per share (3,276 shares) 220.18
16
Although we believe that the IPO studies Mr. Schroeder
used are entitled to some consideration, we do not find that
those studies justify a discount greater than 35 percent.
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We have considered all contentions the parties have raised.
To the extent not addressed herein, those contentions are without
merit or unnecessary to reach.
To reflect the foregoing,
Decision will be
entered under Rule 155.