Estate of Noble v. Comm'r

T.C. Memo. 2005-2

UNITED STATES TAX COURT

ESTATE OF HELEN M. NOBLE, DECEASED, LESLIE H. NOBLE, JR., AND
JOHN R. NOBLE, CO-PERSONAL REPRESENTATIVES, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 12606-01. Filed January 6, 2005.

Daniel J. Duffy, for petitioners.

J. Anthony Hoefer, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

LARO, Judge: Petitioners petitioned the Court to

redetermine respondent’s determination of a $223,207 deficiency

in the Federal estate tax of the Estate of Helen M. Noble (the

estate) and a $50,221.57 addition to tax under section

6651(a)(1). Following concessions, we must decide the
 -2-

September 2, 1996, fair market value of the 11.6-percent interest

in Glenwood State Bank (Glenwood Bank) that Helen N. Noble

(decedent) owned. The estate’s Form 706, United States Estate

(and Generation-Skipping Transfer) Tax Return (estate tax

return), reported the fair market value as $903,988. Respondent

determined in the notice of deficiency that the fair market value

was $1.1 million. Petitioners currently argue that the fair

market value was $841,000 or less. Respondent argues that the

fair market value was $1.1 million, as determined.

We hold that the fair market value of the interest was

$1,067,000. Unless otherwise noted, section references are to

the applicable versions of the Internal Revenue Code, and Rule

references are to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

The parties filed with the Court a stipulation of 14 facts

and 2 accompanying exhibits; namely, the estate tax return and

the notice of deficiency. We have found the stipulated facts

accordingly and have found other facts from the two exhibits.

Decedent died on September 2, 1996, while residing in Gage

County, Nebraska. John R. Noble and Leslie H. Noble, Jr., the

co-personal representatives of the estate, resided in Lincoln,

Nebraska, when the petition was filed in this Court.

The estate filed the estate tax return on July 23, 1998.

Estate tax return reported that decedent’s gross estate included
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116 shares of stock in Glenwood Bank. Those shares were part of

1,000 nonpublicly traded shares of the only class of stock that

Glenwood Bank had outstanding at the time of decedent’s death and

represented an 11.6-percent interest in Glenwood Bank. The

estate tax return reported that the fair market value of each of

the 116 shares equaled its 1996 book value ($14,169) less a 45-

percent minority interest discount, resulting in a reported total

fair market value of $903,988.

When decedent died, Glenwood Bancorporation (Bancorporation)

owned the remaining 88.4-percent interest in Glenwood Bank. The

shareholders of Bancorporation were John Dean (Dean), Dean’s son,

and Dean’s son-in-law. Dean owned 69 percent of Bancorporation’s

stock, and he was unrelated familially to decedent.

Bancorporation purchased two blocks of Glenwood Bank stock

during the 15-month period ending on the date of decedent’s

death. First, in June 1995, Bancorporation purchased 10 shares

of Glenwood Bank stock at $1,000 per share. Second, in July

1996, Bancorporation purchased 7 shares of Glenwood Bank stock at

$1,500 per share.

After decedent died, Dean sought to buy the 116 Glenwood

Bank shares held by the estate. On May 15, 1997, Dean obtained

from the accounting firm of Seim, Johnson, Sestak & Quist, LLP

(Seim Johnson), a written appraisal (appraisal) of the fair

market value of those shares as of December 31, 1996. Seim
 -4-

Johnson issued the appraisal to Dean solely to assist the

management of Glenwood Bank in making a cash purchase of the

shares. The appraisal was prepared on behalf of Seim Johnson by

Dennis R. Hein (Hein) and concluded that the fair market value of

the 116 Glenwood Bank shares held by the estate was $878,004

($7,569 per share) as of December 31, 1996. The appraisal stated

that this fair market value included a 29-percent discount for

minority interest and a 35-percent discount for lack of

marketability. The estate declined to sell its Glenwood Bank

shares to Dean at this appraised price. The estate sold those

shares to Bancorporation on October 24, 1997, for $1.1 million

($9,483 per share).

On July 18, 2001, respondent issued to the estate a notice

of deficiency in which he determined, among other things, that

the fair market value of decedent’s 116 Glenwood Bank shares was

$1.1 million. The notice states that “The value of the

decedent’s stock was adjusted to the fair market value as

determined by Shenehon Company.”

At trial, respondent called William C. Herber (Herber) as an

expert witness, and the Court over the objection of petitioners

recognized him as an expert on the valuation of financial

institutions. The Court also over the objection of petitioners

accepted into evidence Herber’s expert report under Rule 143(f)

(Shenehon report), written on behalf of his employer, Shenehon
 -5-

Co., stating that the applicable fair market value of an

11.6-percent ownership interest in Glenwood Bank was $1.1

million. The Shenehon report was a second expert report prepared

by Herber on behalf of Shenehon Co. as to the fair market value

of the 11.6-percent interest. Shenehon Co.’s first report

indicated on its face that it had been prepared by three

individuals, but only one of those individuals was available to

testify at trial. We excluded the first report from evidence on

the basis of our Opinion in Bank One Corp. v. Commissioner,

120 T.C. 174 (2003). There, we excluded from evidence the

rebuttal report of the taxpayer’s expert that was alleged by the

Commissioner to be tainted in its preparation by the significant

participation of the taxpayer’s counsel. Id. at 278. We held

that the rebuttal report was inadmissible because the expert had

not established that the words, analysis, and opinions in that

rebuttal report were his own work. Id. (citing Daubert v.

Merrell Dow Pharm. Inc., 509 U.S. 579, 592 n.10 (1993)). As is

equally true here, we were not persuaded by a preponderance of

proof that the words, analysis, and opinions in the excluded

report were the work of Herber.

The Shenehon report ascertained the fair market value of the

subject shares by considering four valuation methods (book value

method, discounted cashflow method, public guideline market

method, and private guideline market method) and applying a
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15-percent minority interest discount and a 30-percent lack of

marketability discount to the values derived under those methods.

The book value method reflected Glenwood Bank’s reported equity

as of June 30, 1996, the most current data available as of

decedent’s date of death. The discounted cashflow method applied

a 14.5-percent discount rate to Glenwood Bank’s projected annual

income for each of the years during a 10-year period ending in

December 2005 and an 11.5-percent rate to the bank’s residual

value. The public guideline market method reflected prices paid

for companies which were engaged in a business similar to

Glenwood Bank’s and whose stock was actively traded in a public

market. The private guideline market method reflected

transactions involving acquisitions of privately held banks

comparable to Glenwood Bank. The resulting values derived under

these four methods were as follows:
Discounted Public Private
Book Cash Guideline Guideline
Value Flow Market Market

Value before discounts $14,135,000 $11,100,000 $14,000,000 $18,200,000
15-percent minority interest discount 2,120,250 n/a n/a 2,730,000
Marketable minority interest value 12,014,750 11,100,000 14,000,000 15,470,000
30-percent lack of marketability discount 3,604,425 3,330,000 4,200,000 4,641,000
Nonmarketable minority interest value 8,410,325 7,770,000 9,800,000 10,829,000
Subject percentage interest 11.6 11.6 11.6 11.6
Resulting value of subject interest 975,598 901,320 1,136,800 1,256,164

The average of the resulting values is $1,067,470.50

((975,598 + 901,320 + 1,136,800 + 1,256,164)/4).

At trial, petitioners called three experts to testify in

support of petitioners’ challenge to respondent’s determination

of the fair market value of decedent’s shares. Each of these
 -7-

experts, namely, Hein, Janet M. Labenz (Labenz), and Z.

Christopher Mercer (Mercer), also prepared an expert report under

Rule 143(f). Hein’s expert report (Seim Johnson report) was

merely the appraisal with a February 8, 2003, cover letter

stating in relevant part that “Our opinion is the same opinion as

it was as of December 31, 1996". The cover letter also stated

that Seim Johnson had been

engaged with the management of the [Glenwood] Bank to
value the [estate’s 116 Glenwood Bank] shares as of
December 31, 1996. * * * We have inquired as to
significant items for the last quarter of 1996 that
would have a material effect on the valuation of the
stock from the time of Mrs. Noble’s death and the date
of our original valuation. We were informed that there
are no such items which would have materially affected
the valuation from the time of death to the valuation
date.

Labenz’s expert report (Labenz report) was accepted into evidence

as a rebuttal to the opinion of respondent’s expert. The Labenz

report addressed the differences between the Shenehon report and

the Seim Johnson report.

The Court with no objection from respondent recognized

Mercer as an expert on the valuation of financial institutions

and with no objection from respondent accepted Mercer’s expert

report (Mercer report) into evidence. The Mercer report

concluded that the fair market value of the estate’s 11.6-percent

interest in Glenwood Bank was $841,000. The Mercer report

generally arrived at this fair market value through a two-step

process. First, the Mercer report ascertained the marketable
 -8-

minority value for Glenwood Bank by considering five methods (a

transaction value method, a net asset value method, a discounted

future earnings method using a 10-percent earnings growth and a

20-percent earnings growth, and two guideline company methods,

one using a regional peer group, the other a high-equity assets

group, and both using capitalized earnings and capitalized book

value). The transaction method recognized the two sales of

Glenwood Bank stock happening before the valuation date and

reflected the $1,500-per-share price paid in the more recent

second sale. The net asset value method reflected Glenwood

Bank’s reported equity as of June 30, 1996, as adjusted to take

into account an unrealized $128,000 gain in bond portfolio and a

38-percent related tax adjustment ($48,640). The discounted

future earnings method reflected earnings growth rates of 10

percent and 20 percent and a present value rate of 14.1 percent.

The guideline company methods reflected a regional group of 11

financial institutions similar to Glenwood Bank and a nationwide

group of 19 banks that reported total assets of less than $1

billion and an asset/equity ratio of greater than 12 percent.

The resulting values derived under these five methods were as

follows:
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Method Resulting Value

Transaction value $1,500,000
Net asset value 14,124,000
Discounted future earnings:
10-percent earnings growth 11,364,000
20-percent earnings growth 14,224,000
Guideline company regional peer group:
Capitalized earnings 8,306,000
Capitalized book value 17,174,000
Guideline company high/equity assets group:
Capitalized earnings 8,543,000
Capitalized book value 16,860,000

The Mercer report gave no weight to the transaction value

method, the net asset value method, or the discounted future

earnings method, and ascertained the value of the marketable

minority interest to be $12,721,000 by averaging the other four

amounts (8,306,000 + 17,174,000 + 8,543,000 + 16,860,000)/4 =

12,720,750) and rounding the resulting average to the nearest

thousand. The Mercer report as a second step in the valuation

process then ascertained the applicable fair market value of

decedent’s 11.6-percent interest by applying a 43-percent lack of

marketability discount to the marketable minority interest value

of $12,721,000 (12,721,000 x 43% = 5,470,030) and multiplying the

resulting rounded number of $7,251,000 (12,721,000 - 5,470,030 =

7,250,970) by 11.6 percent. The Mercer report derived the

43-percent lack of marketability discount by applying a

quantitative marketability discount model (QMDM) adopted and

advocated by Mercer. The Mercer report noted that the estate had
 -10-

sold its 116 Glenwood Bank shares after decedent died and that

relative to certain assumptions in the QMDM analysis as of

September 2, 1996, the selling price for those 116 shares should

have been approximately $1.9 million, rather than the $1.1

million actually received. The Mercer report “ignored” this

postdeath sale because hypothetical investors would not have

known about it when decedent died.

OPINION

I. Preliminary Statement

Neither party called a fact witness to testify at trial.

(Each expert who testified at trial testified solely as an expert

and not as both a fact witness and an expert witness.) Nor did

either party introduce at trial any exhibit other than the expert

reports, the two stipulated exhibits, and a statement listing one

of the expert’s qualifications. Most of the facts which we find

in this case come from the stipulation of facts and the two

accompanying exhibits. While the parties invite the Court to

find additional facts solely from data relied upon by the experts

in forming their expert opinions, we decline to do so. As the

Court has stated previously in a similar setting:

Much of the purported data that * * * [the expert]
relied upon in reaching his conclusion also never made
its way into evidence. Although an expert need not
rely upon admissible evidence in forming his or her
opinion, Fed. R. Evid. 703, we must rely upon admitted
evidence in forming our opinion and, in so doing, may
not necessarily agree with an expert whose opinion is
not supported by a sufficient factual record. The mere
 -11-

fact that the Court admits an expert’s opinion into
evidence does not mean that the underlying facts upon
which the expert relied are also admitted into
evidence. Anchor Co. v. Commissioner, 42 F.2d 99
(4th Cir. 1930); Rogers v. Commissioner, 31 B.T.A. 994,
1006 (1935); see United States v. Scheffer, 523 U.S.
303, 317 n.13 (1998) (whereas expert opinion is
considered evidence, the facts upon which such an
expert relies in forming that opinion are not
considered evidence until introduced at trial by a fact
witness); see also United States v. 0.59 Acres of Land,
109 F.3d 1493, 1496 (9th Cir. 1997). In a case such as
this, where an expert witness relies upon facts which
are critical to the Court’s analysis of an issue, we
expect that the party calling the witness will enter
into evidence those critical facts. * * * [Haffner’s
Serv. Stations, Inc. v. Commissioner, T.C. Memo.
2002-38, affd. 326 F.3d 1 (1st Cir. 2003).]

II. Rules on Valuation

The value of property for Federal estate tax purposes is a

factual inquiry in which the trier of fact must weigh all

relevant evidence and draw appropriate inferences to arrive at

the property’s fair market value. Commissioner v. Scottish Am.

Inv. Co., 323 U.S. 119, 123-125 (1944); Helvering v. Natl.

Grocery Co., 304 U.S. 282, 294 (1938); sec. 20.2031-1(b), Estate

Tax Regs. For this purpose, fair market value is 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 under a compulsion to buy or to sell.

Sec. 20.2031-1(b), Estate Tax Regs.; see also United States v.

Cartwright, 411 U.S. 546, 551-552 (1973); Estate of Fitts v.

Commissioner, 237 F.2d 729, 731 (8th Cir. 1956), affg. T.C. Memo.

1955-269; Estate of Scanlan v. Commissioner, T.C. Memo. 1996-331,
 -12-

affd. without published opinion 116 F.3d 1476 (5th Cir. 1997).

The particular characteristics of these hypothetical persons are

not necessarily the same as those of any specific individual or

entity and are not necessarily the same as those of the actual

buyer or the actual seller. Estate of Curry v. United States,

706 F.2d 1424, 1428-1429, 1431 (7th Cir. 1983); Estate of Bright

v. United States, 658 F.2d 999, 1005-1006 (5th Cir. 1981); Bank

One Corp. v. Commissioner, 120 T.C. at 305. Nor are these

hypothetical persons considered to be compelled to buy or to sell

the property in question. These hypothetical persons are

considered to know all relevant facts involving the property.

Bank One Corp. v. Commissioner, supra at 304-306. Each of these

hypothetical persons also is presumed to be aiming to achieve the

maximum economic advantage (i.e., maximum profit) from the

hypothetical sale of the property. Estate of Watts v.

Commissioner, 823 F.2d 483, 486 (11th Cir. 1987), affg. T.C.

Memo. 1985-595; Estate of Curry v. United States, supra at 1428;

Estate of Davis v. Commissioner, 110 T.C. 530, 535 (1998); Estate

of Newhouse v. Commissioner, 94 T.C. 193, 218 (1990); Okerlund v.

United States, 53 Fed. Cl. 341, 345 (2002), affd. 365 F.3d 1044

(Fed. Cir. 2004).

Special rules apply when valuing the stock of a closely held

corporation. See Estate of Scanlan v. Commissioner, supra.

While listed market prices of publicly traded stock are usually
 -13-

representative of the fair market value of that stock for Federal

tax purposes, the fair market value of nonpublicly traded stock

is “best ascertained” through arm’s-length sales near the

valuation date of reasonable amounts of that stock, as long as

both the buyer and the seller were willing and informed and the

sales did not include a compulsion to buy or to sell. Polack v.

Commissioner, 366 F.3d 608, 611 (8th Cir. 2004), affg. T.C. Memo.

2002-145; accord Estate of Fitts v. Commissioner, supra at 731

(such arm’s-length sales are the “best criterion of market

value”); Estate of Hall v. Commissioner, 92 T.C. 312, 336 (1989)

(same); Estate of Andrews v. Commissioner, 79 T.C. 938, 940

(1982) (same); Duncan Indus., Inc. v. Commissioner, 73 T.C. 266,

276 (1979) (same); Palmer v. Commissioner, 62 T.C. 684, 696-698

(1974) (“Ordinarily, the price at which the same or similar

property has changed hands is persuasive evidence of fair market

value. * * * Where the parties to the sale have dealt with each

other at arm’s length and the sale is within a reasonably close

period of time to the valuation date, the price agreed upon is

considered to have accurately reflected conditions in the

market.”), affd. 523 F.2d 1308 (8th Cir. 1975). When nonpublicly

traded stock cannot be valued from such arm’s-length sales, its

value is then best determined by analyzing the value of publicly

traded stock in comparable corporations engaged in the same or a

similar line of business, as well as by taking into account all
 -14-

other relevant factors bearing on value that would be considered

by an informed buyer and an informed seller. Polack v.

Commissioner, supra at 611; Estate of Fitts v. Commissioner,

supra at 731-732; Estate of Hall v. Commissioner, supra at 336.

In this regard, section 20.2031-2(f), Estate Tax Regs., states

that

If * * * actual sale prices and bona fide bid and asked
prices are lacking, then the fair market value is to be
determined by taking the following factors into
consideration:

* * * * * * *

(2) In the case of shares of stock, the company’s
net worth, prospective earning power and dividend-
paying capacity, and other relevant factors.

Some of the “other relevant factors” * * * are: the
goodwill of the business; the economic outlook in the
particular industry; the company’s position in the
industry and its management; the degree of control of
the business represented by the block of stock to be
valued; and the values of securities of corporations
engaged in the same or similar lines of business which
are listed on a stock exchange. However, the weight to
be accorded such comparisons or any other evidentiary
factors considered in the determination of a value
depends upon the facts of each case. In addition to
the relevant factors described above, consideration
shall also be given to nonoperating assets, including
proceeds of life insurance policies payable to or for
the benefit of the company, to the extent such
nonoperating assets have not been taken into account in
the determination of net worth, prospective earning
power and dividend-earning capacity. Complete
financial and other data upon which the valuation is
based should be submitted with the return, including
copies of reports of any examinations of the company
made by accountants, engineers, or any technical
experts as of or near the applicable valuation date.
 -15-

The Commissioner has also set forth in a longstanding

ruling, Rev. Rul. 59-60, 1959-1 C.B. 237, certain criteria to

consider in determining fair market value. That ruling, which is

widely accepted in the valuation community and which is regularly

referenced by the judiciary and the Commissioner alike, Polack v.

Commissioner, supra at 611, states that the

Valuation of securities is, in essence, a prophesy as
to the future and must be based on facts available at
the required date of appraisal. As a generalization,
the prices of stocks which are traded in volume in a
free and active market by informed persons best reflect
the consensus of the investing public as to what the
future holds for the corporations and industries
represented. When a stock is closely held, is traded
infrequently, or is traded in an erratic market, some
other measure of value must be used. In many
instances, the next best measure may be found in the
prices at which the stocks of companies engaged in the
same or a similar line of business are selling in a
free and open market. [Rev. Proc. 59-60, sec. 3.03,
1959-1 C.B. at 238.]

The ruling then states that in the absence of relevant market

quotations, all available financial data and all relevant factors

affecting fair market value must be considered in valuing the

stock of a closely held corporation. Id. sec. 4.01. The ruling

lists as relevant eight specific factors. These factors, which

are virtually identical to the factors referenced in section

20.2031-2(f), Estate Tax Regs., are:

(a) The nature of the business and the history of
the enterprise from its inception.

(b) The economic outlook in general and the
condition and outlook of the specific industry in
particular.
 -16-

(c) The book value of the stock and the financial
condition of the business.

(d) The earning capacity of the company.

(e) The dividend-paying capacity.

(f) Whether or not the enterprise has goodwill or
other intangible value.

(g) Sales of the stock and the size of the block
of the stock to be valued.

(h) The market price of stocks of corporations
engaged in the same or a similar line of business
having their stocks actively traded in a free and open
market, either on an exchange or over-the-counter.
[Rev. Proc. 59-60, sec. 4.01.]

III. Approaches to Valuation

In the case of nonpublicly traded stock the value of which

cannot be determined by relevant arm’s-length sales, fair market

value is generally determined by using three approaches. The

first approach is the market approach. The second approach is

the income approach. The third approach is the asset-based

approach. Each of these three approaches includes various

valuation methods. The approach to apply in a given case is a

question of law. Powers v. Commissioner, 312 U.S. 259, 260

(1941); Bank One Corp. v. Commissioner, 120 T.C. at 306.

Litigants in this Court are usually assisted by experts in

applying these approaches.
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1. Market Approach

The market approach values a company’s nonpublicly traded

stock by using one or more methods to compare that stock to the

same or comparable stock that has sold in arm’s-length

transactions in the same timeframe. The nonpublicly traded stock

subject to valuation is valued by adjusting the sales price of

the same or comparable stock to reflect any differences between

that stock and the nonpublicly traded stock.

2. Income Approach

The income approach values a company’s nonpublicly traded

stock by using one or more methods that convert anticipated

economic benefits into a single present amount. Valuation

methods under this approach may directly capitalize earnings

estimates or may forecast future benefits (earnings or cashflow)

and discount those future benefits to the present.

3. Asset-Based Approach

The asset-based (or cost) approach values a company’s

nonpublicly traded stock by using one or more methods which look

to the company’s assets net of its liabilities.

IV. Value of the Subject Shares

The stock of Glenwood Bank was not publicly traded. Thus,

we look first to see whether there were any arm’s-length sales of

that stock near the applicable valuation date. Because neither

coexecutor elected to value the estate’s property under section
 -18-

2032(a), that applicable valuation date is the date of decedent’s

death; i.e., September 2, 1996. See sec. 20.2031-1(b), Estate

Tax Regs.

The record reflects three sales of Glenwood Bank stock near

the applicable valuation date. The first two sales involved the

10 shares and 7 shares, respectively, which were sold before the

valuation date. The third sale involved the 116 shares sold by

the estate after the valuation date. In each of these sales, the

buyer was Bancorporation.

Petitioners conceded at trial that they bear the burden of

proof in this case. They acknowledge that an arm’s-length sale

of property near the valuation date is the best indicium of its

fair market value on the valuation date, but, they assert, only

certain sales near a valuation date are “competent, substantial

and persuasive evidence” of that fair market value. According to

petitioners, sales may be probative of fair market value only if

they occur within a reasonable time before the valuation date.

Petitioners primarily support this position with a citation of

Douglas Hotel Co. v. Commissioner, 190 F.2d 766, 772 (8th Cir.

1951), affg. 14 T.C. 1136 (1950). They also assert that a prior

sale of property conclusively sets the fair market value of that

property on a later valuation date even if the seller was not

knowledgeable of all relevant facts as to that property and even

if the property that was the subject of the sale was not of
 -19-

comparable size to the property subject to valuation. They

recognize that a determination of fair market value on the basis

of actual sales has often been said to include requirements that

a seller be knowledgeable and that the seller’s property be

comparable to the property subject to valuation. They assert,

however, that the Court of Appeals for the Ninth Circuit in

Morrissey v. Commissioner, 243 F.3d 1145, 1149 (9th Cir. 2001),

revg. Estate of Kaufman v. Commissioner, T.C. Memo. 1999-119,

eroded these requirements to now make them irrelevant.

We disagree with petitioners’ assertion that the two prior

sales of 10 shares and 7 shares, either separately or together,

are an accurate measure of the applicable fair market value of

decedent’s 116 shares. In Morrissey, the Court of Appeals for

the Ninth Circuit held that sales of 10,000 and 6,960 shares of

stock on May 12 and June 16, 1994, respectively, at $29.70 per

share, reflected the fair market value of 46,020 shares of that

stock as of an earlier valuation date of April 14, 1994. The

Court of Appeals stated that the sellers were under no compulsion

to sell their shares and that they did so at the price that the

buyer had represented was the price listed in a recent appraisal.

The Court of Appeals stated that each seller testified at trial

that the price was fair and that the sale had not been compelled.

Contrary to petitioners’ assertion, we read nothing in

Morrissey to indicate that the Court of Appeals for the Ninth
 -20-

Circuit eroded the requirements that a seller of stock be

knowledgeable and that the seller’s shares be comparable in

number to the shares subject to valuation in order for the sale

to be probative of a valuation of the latter shares.1 In fact,

the Court of Appeals noted specifically as to the knowledge

requirement that both sellers had sold their stock at

approximately the same price as listed in the appraisal and that

both sellers were aware that dividends had been meager even in

prosperous years. Id. at 1148. The Court of Appeals also

indicated as to the comparable property requirement that the

prior sales of stock were not unrepresentative of the stock

subject to valuation. Id.

As to the two prior sales of stock in this case, we also are

unpersuaded that either of those sales was made by a

knowledgeable seller who was not compelled to sell or was made at

arm’s length. See Estate of Fitts v. Commissioner, 237 F.2d at

731 (taxpayer bears the burden of establishing that sales are

made at arm’s length and in the normal course of business). In

addition, contrary to the factual setting of Morrissey v.

Commissioner, supra, the two prior sellers in this case did not

sell their stock for the amount set forth in an appraisal. They

1
We use the term “comparable in number” to mean that in
this respect, as in others, the characteristics of the property
offered as a comparable must not diverge so far from those of the
property being valued that they cannot be taken into account by
adjustments.
 -21-

sold their stock for much less than the per-share value set forth

in the later appraisal; the estate, in turn, sold its shares

after the appraisal for more than the fair market value set forth

therein. Moreover, the two respective prior sales represented

1 percent and .7 percent of Glenwood Bank’s outstanding stock.

Decedent’s 116 shares, by contrast, represented 11.6 percent of

that outstanding stock and were the only shares of Glenwood Bank

stock not owned by the other shareholder. Mercer testified

credibly that it was reasonably foreseeable as of the applicable

valuation date that the other shareholder, Bancorporation, would

eventually want to buy that 11.6-percent interest at some unknown

time and that this added a special value to the interest. Our

hypothetical seller would have known the same at the time of the

hypothetical sale and as part of that hypothetical sale would

have demanded compensation for this special value so as otherwise

to not equate the selling price for the 10 shares and 7 shares

with the hypothetical selling price of decedent’s 116 shares.2

As to the third sale, which occurred on October 24, 1997,

approximately 14 months after the applicable valuation date, we

disagree with petitioners that only sales of stock that predate a

valuation date may be used to determine fair market value as of

2
In fact, petitioners are the only ones who have suggested
that one or both of the two prior sales is an accurate measure of
the fair market value of decedent’s 116 shares as of the
applicable valuation date.
 -22-

that valuation date. The Court of Appeals for the Eighth

Circuit, the court to which an appeal of this case most likely

lies, has held specifically that “In determining the value of

unlisted stocks, actual sales made in reasonable amounts at arm’s

length, in the normal course of business, within a reasonable

time before or after the basic date, are the best criterion of

market value.” Estate of Fitts v. Commissioner, supra at 731;

accord Rubber Research, Inc. v. Commissioner, 422 F.2d 1402,

1405-1406 (8th Cir. 1970), affg. T.C. Memo. 1969-24; see also

Estate of Jung v. Commissioner, 101 T.C. 412, 430-432 (1993);

Estate of Scanlan v. Commissioner, T.C. Memo. 1996-331. Although

petitioners observe correctly that the Court of Appeals for the

Eighth Circuit stated in Douglas Hotel Co. v. Commissioner,

190 F.2d at 772, that “Evidence of what property sold for within

a reasonable time before the material date upon which its fair

value is to be determined is universally considered competent,

substantial, and persuasive evidence of its fair value on the

material date”, this statement was made solely with respect to

the evidentiary value of a sale that predated the date of

valuation there. The Court of Appeals did not state as

petitioners ask us to hold that only sales which occur before a

valuation date are probative as to fair market value on the

valuation date. In fact, the Court of Appeals went on to state

specifically as to prior sales that “It is, of course, not the
 -23-

only evidence which may be considered on the subject” of

valuation. Id.; accord Polack v. Commissioner, 366 F.3d at 612

(“subsequent events that shed light on what a willing buyer would

have paid on the date in question are admissible, such as

‘evidence of actual sales prices received for property after the

date [in question], so long as the sale occurred within a

reasonable time ... and no intervening events drastically changed

the value of the property.’” (quoting First Natl. Bank v. United

States, 763 F.2d 891, 894 (7th Cir. 1985))); see also Estate of

Jung v. Commissioner, supra at 431-432; Estate of Scanlan v.

Commissioner, supra.

Generally speaking, a valuation of property for Federal tax

purposes is made as of the valuation date without regard to any

event happening after that date. See Ithaca Trust Co. v. United

States, 279 U.S. 151 (1929). An event occurring after a

valuation date, however, is not necessarily irrelevant to a

determination of fair market value as of that earlier date. An

event occurring after a valuation date may affect the fair market

value of property as of the valuation date if the event was

reasonably foreseeable as of that earlier date. First Natl. Bank

v. United States, supra at 894; Bank One Corp. v. Commissioner,

120 T.C. at 306. An event occurring after a valuation date, even

if unforeseeable as of the valuation date, also may be probative

of the earlier valuation to the extent that it is relevant to
 -24-

establishing the amount that a hypothetical willing buyer would

have paid a hypothetical willing seller for the subject property

as of the valuation date.3 Polack v. Commissioner, supra at 612;

First Natl. Bank v. United States, supra at 893-894; Estate of

Gilford v. Commissioner, 88 T.C. 38, 52-54 (1987); Estate of

Jephson v. Commissioner, 81 T.C. 999, 1002-1003 (1983); Estate of

Scanlan v. Commissioner, supra. Unforeseeable subsequent events

which fall within this latter category include evidence, such as

we have here, “‘of actual sales prices received for property

after the date [in question], so long as the sale occurred within

a reasonable time ... and no intervening events drastically

changed the value of the property.’” Polack v. Commissioner,

supra at 612 (quoting First Natl. Bank v. United States, supra at

894); First Natl. Bank v. United States, supra at 893-894; see

also Estate of Jung v. Commissioner, supra at 431-432; Estate of

Scanlan v. Commissioner, supra.

3
Subsequent events may be considered as evidence of value
if they are relevant. Federal law favors the admission of
probative evidence, and the test of relevancy under Federal law
is designed to reach that end. Sabatino v. Curtiss Natl. Bank,
415 F.2d 632, 636 (5th Cir. 1969). Fed. R. Evid. 401, a rule
that applies to this Court under Rule 143(a), states broadly that
evidence is “relevant” if it has “any tendency to make the
existence of any fact that is of consequence to the determination
of the action more probable or less probable than it would be
without the evidence.” Fed. R. Evid. 401 favors a finding of
relevance, and only minimal logical relevance is necessary if the
disputed fact’s existence is of consequence to the determination
of the action. Daubert v. Merrell Dow Pharm., Inc., 509 U.S.
579, 587 (1993).
 -25-

Petitioners try to downplay the importance of the subsequent

(third) sale of the estate’s 116 Glenwood Bank shares by

characterizing it as a sale to a strategic buyer who bought the

shares at greater than fair market value in order to become the

sole shareholder of Glenwood Bank. Respondent argues that the

third sale was negotiated at arm’s length and is most relevant to

our decision. We agree with respondent. Although petitioners

observe correctly that an actual purchase of stock by a strategic

buyer may not necessarily represent the price that a hypothetical

buyer would pay for similar shares, the third sale was not a sale

of similar shares; it was a sale of the exact shares that are now

before us for valuation. We believe it to be most relevant that

the exact shares subject to valuation were sold near the

valuation date in an arm’s-length transaction and consider it to

be of much less relevance that some other shares (e.g., the 10

shares and 7 shares discussed herein) were sold beforehand. The

property to be valued in this case is not simply any 11.6-percent

interest in Glenwood Bank; it is the actual 11.6-percent interest

in Glenwood Bank that was owned by decedent when she died. See

Bank One Corp. v. Commissioner, supra at 311-312.4 The two prior

sales of 10 shares and 7 shares, respectively, left decedent’s

11.6-percent interest as the only interest not owned by the other

4
Of course, we value that actual 11.6-percent interest in
the context of a hypothetical willing buyer and a hypothetical
willing seller.
 -26-

shareholder. The fact that decedent’s specific 11.6-percent

interest may have included a unique attribute that added value to

that interest vis-a-vis another 11.6-percent interest in Glenwood

Bank does not detract from the fair market value of decedent’s

interest. That attribute would continue to be retained by the

hypothetical buyer in our analysis following our hypothetical

sale just as it had been retained by decedent at the time of her

death.

Moreover, as to petitioners’ argument, we are unpersuaded by

the evidence at hand that Glenwood was a strategic buyer that in

the third sale paid a premium for the 116 shares. The third sale

was consummated by unrelated parties (the estate and

Bancorporation) and was prima facie at arm’s length. In

addition, the estate declined to sell its shares at the value set

forth in the appraisal and only sold those shares 5 months later

at a higher price of $1.1 million. Although the estate may have

enjoyed some leverage in obtaining that higher price, as

suggested by Mercer by virtue of the fact that the subject shares

were the only Glenwood Bank shares not owned by the buyer, this

does not mean that the sale was not freely negotiated, that the

sale was not at arm’s length, or that either the estate or

Bancorporation was compelled to buy or to sell. In fact, Mercer

through his own analysis pegged the fair market value for those

shares as of the time of the third sale at approximately $1.9
 -27-

million, or, in other words, almost twice the amount of the

price actually received. Given the additional facts that the

third sale occurred sufficiently close to the applicable

valuation date and that the record does not reveal any material

change in circumstances that occurred between that date and the

date of the third sale that would have affected the fair market

value of the subject shares, we conclude on the basis of the

limited evidentiary record before us that the third sale is the

best indicium of the fair market value of decedent’s shares at

the time of her death.5 See Estate of Fitts v. Commissioner,

237 F.3d at 731; Rubber Research, Inc. v. Commissioner, 422 F.2d

at 1406; Ward v. Commissioner, 87 T.C. 78, 101 (1986); Estate of

Andrews v. Commissioner, 79 T.C. at 940; see also Silverman v.

Commissioner, 538 F.2d 927, 931 n.7 (2d Cir. 1976) (“Arm’s length

sales of the stock to be valued are, of course, the best evidence

5
We find nothing in the record to support the conclusion
which we draw from the Mercer report that the fair market value
of the subject shares almost doubled from the applicable
valuation date to the time of the third sale and, in light of the
third sale, are unpersuaded by that report’s conclusion as to the
applicable fair market value of those shares. Mercer opined that
the third sale was an arm’s-length sale that involved a seller
who at the time of the third sale lacked knowledge that the value
of its stock exceeded the $1.1 million sale price. The fact that
a more knowledgeable seller might have extracted a higher sale
price for the subject shares does not on the record before us
detract from the probative value of the third sale. At the
least, the price in that sale serves as a floor to the fair
market value of the subject shares and, given that respondent
does not request a higher value, serves in our opinion as the
best measure of the fair market value of the subject shares as of
the applicable valuation date.
 -28-

of value.”(citing Elmhurst Cemetery Co. v. Commissioner, 300 U.S.

37, 39 (1937), and Rubber Research, Inc. v. Commissioner, supra

at 1406))), affg. T.C. Memo. 1974-285; accord Estate of Scanlan

v. Commissioner, T.C. Memo. 1996-331. To be sure, petitioners

even advocate that an actual sale is the best indicium of that

fair market value. They state in brief that expert testimony

need not be considered upon the finding of a contemporaneous,

arm’s-length sale; such a sale of property, they state, is

“indicative of its fair market value as a matter of law”.

When a subsequent event such as the third sale before us is

used to set the fair market value of property as of an earlier

date, adjustments should be made to the sale price to account for

the passage of time as well as to reflect any change in the

setting from the date of valuation to the date of the sale. See

Estate of Scanlan v. Commissioner, supra. These adjustments are

necessary to reflect happenings between the two dates which would

affect the later sale price vis-a-vis a hypothetical sale on the

earlier date of valuation. These happenings include:

(1) Inflation, (2) changes in the relevant industry and the

expectations for that industry, (3) changes in business component

results, (4) changes in technology, macroeconomics, or tax law,

and (5) the occurrence or nonoccurrence of any event which a

hypothetical reasonable buyer or a hypothetical reasonable seller

would conclude would affect the selling price of the property
 -29-

subject to valuation (e.g., the death of a key employee). See

Estate of Jung v. Commissioner, 101 T.C. at 431.

The record before us does not establish the presence of any

material change in circumstances between the date of the third

sale and the applicable valuation date. On the basis of the

record before us, we believe that the sole adjustment that must

be made to the $1.1 million sale price in order to arrive at the

fair market value of the subject shares as of the applicable

valuation date is for inflation. While the record does not

accurately pinpoint the appropriate rate to apply for that

purpose, the Bureau of Labor Statistics has stated that the rate

of inflation during each of the years 1996 and 1997 was slightly

less than 3 percent. See generally Handbook of U.S. Labor

Statistics, Employment, Earnings, Prices, Productivity, and Other

Labor Data 342 (7th ed. 2004). On the basis of a 3-percent rate,

we conclude that the applicable fair market value of decedent’s

116 shares was $1,067,000 ($1,100,000 x (1 - .03)).6 We so hold.

6
Although we do not determine this fair market value on the
basis of the methodology applied by Herber, we note that this
fair market value approximates the average of the resulting
values derived by Herber through the application of his four
methods.
 -30-

All arguments made by the parties have been considered and,

to the extent not discussed herein, are irrelevant and/or without

merit. To reflect concessions,

Decision will be entered

under Rule 155.