Estate of Amlie v. Comm'r

T.C. Memo. 2006-76

UNITED STATES TAX COURT

ESTATE OF PEARL I. AMLIE, DECEASED, RODNEY B. AMLIE, EXECUTOR,
Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 16039-02. Filed April 17, 2006.

Robert E. Dallman, Michael G. Goller, and Robert B. Teuber,

for petitioner.

James E. Schacht and Mark J. Miller, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GALE, Judge: Respondent determined a Federal estate tax

deficiency of $360,266, and an accuracy-related penalty under
 - 2 -

section1 6662(a), with respect to the Estate of Pearl I. Amlie

(the estate).2 After concessions, the issues remaining for

decision are:

(1) The fair market value of First American Bank Group, Ltd.

(FABG) stock held by Pearl I. Amlie (decedent) at her death.

Subsumed within this issue is the question of whether an

agreement restricting the sale of decedent's FABG stock fixes the

stock's value or should be disregarded in determining value for

Federal estate tax purposes;3

(2) the fair market value of five parcels of agricultural

real property (farm land) owned by decedent at her death;

(3) whether the reimbursement by decedent's conservator,

prior to decedent's death, of $30,000 of litigation expenses

1
Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1986 as in effect at the date of
decedent's death, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
2
In the notice of deficiency, respondent also determined a
fraud penalty of $193,391 under sec. 6663(a). Respondent has
since conceded the fraud penalty and proceeds on his alternate
determination of an accuracy-related penalty for negligence or
disregard of rules or regulations under sec. 6662(a), confined to
that portion of the underpayment arising from the value reported
for decedent's FABG stock, or $51,571.
3
The estate argues, in the alternative, that if the value
of the FABG stock is as determined by respondent, then the Rodney
B. Amlie Trust had a claim against the estate of $495,968,
deductible by the estate under sec. 2053(a)(3). As we decide
this case on other grounds, we find it unnecessary to consider
this argument.
 - 3 -

incurred by her son, Rodney B. Amlie (Rod), constituted a gift;

and

(4) whether the estate is liable for an accuracy-related

penalty of $51,571 under section 6662(a) for underpayment of

estate tax attributable to understatement of the value of

decedent's FABG stock.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. We

incorporate by this reference the stipulation of facts and the

accompanying exhibits.

Decedent was a U.S. citizen domiciled in Fort Dodge, Iowa,

when she died testate on October 18, 1998. Rod was appointed

executor of the estate and continues to function in that

capacity. At the time of filing the petition, Rod resided in

Humboldt, Iowa.

Introduction

Decedent executed her last will and testament in November

1978. The will included a specific bequest of decedent's farm

land to her daughter, Rosemary Ahlerich, and her son, Thomas,4 in

equal shares. The will also included a specific bequest to Rod

of a portion of certain bank stock, discussed infra, that

decedent held at the time her will was executed. The portion

4
As Thomas predeceased decedent, his interest passed to his
two children, Susan Wendel and Thomas Robert Amlie.
 - 4 -

left to Rod was such amount as would equal one-half the value of

decedent's farm land as valued for Iowa inheritance tax purposes

which, in general, is fair market value.5 After certain other

small bequests, the residue of decedent's estate was to go to her

three children, Rosemary, Rod, and Thomas, in equal shares. Rod,

his wife, and their children were also given the first right to

purchase the residual balance of the bank stock not passing to

him; i.e., the portion of the stock passing to the residual

beneficiaries other than Rod.6

In July 1986, decedent executed a codicil to her will that

struck all bequests to Rod individually and instead made these

bequests to a spendthrift trust, the Rodney B. Amlie Trust (Rod

Amlie Trust), created by the codicil for the benefit of Rod.

In 1988, decedent realized she was having difficulty

managing her financial affairs, so she filed a voluntary petition

for appointment of a conservator. Decedent's initial conservator

resigned in 1993 and was replaced by Boatmen's Bank of Iowa, N.A.

Decedent remained a ward of the conservatorship for the remainder

of her life.

5
See Iowa Code sec. 450.37 (1998 & Supp. 2005). The basis
on which to value the bank stock for purposes of this bequest was
not addressed in the will.
6
The price at which Rod and his family members were
entitled to purchase the residual balance of the back stock was
not addressed in the will.
 - 5 -

During the conservatorship, decedent's prospective heirs7

had frequent acrimonious disputes with respect to her assets.

The prospective heirs other than Rod generally distrusted Rod,

whom they considered responsible for the FDIC's forced closure of

one of the banks decedent owned and Rod had managed. The

disputes among the prospective heirs often involved small

matters, such as appropriate reimbursements each should receive

for travel to visit decedent, use of decedent's lake house, and

one prospective heir's purportedly causing the conservatorship to

pay his drycleaning bills. In the conservator's opinion, these

disputes were highly contentious in view of the amounts involved.

Decedent's Bank Stock

At the time decedent executed her will the stock to be

bequeathed consisted of both common and preferred shares of Agri-

Bank Corp. (Agri-Bank), Farmers National Bank of Webster City,

Iowa, and Commercial State Bank of Pocahontas, Iowa. At some

time prior to the appointment of her conservator, decedent's

Farmers National Bank of Webster City stock was exchanged for

additional shares of Agri-Bank stock, and Commercial State Bank

of Pocahontas ceased to exist (having been ordered closed by the

FDIC). When decedent's conservator filed the initial report and

7
All references to decedent's "prospective heirs" include
her surviving children, Rosemary Ahlerich and Rod Amlie, and her
deceased son Thomas's adult children, Susan Wendel and Thomas
Robert Amlie.
 - 6 -

inventory for the conservatorship, decedent had assets in excess

of $1.7 million, including 9,046 shares of Agri-Bank common stock

and 13,377 shares of Agri-Bank preferred stock. During

decedent's conservatorship various agreements were entered into

regarding this stock, as discussed below.

The 1991 Agreement

In 1991, decedent's 9,046 common shares constituted 13.6

percent of the common stock of Agri-Bank. David Hill was the

controlling shareholder (with 73.2 percent of the common stock)

and president of Agri-Bank. Sometime in 1991, Mr. Hill formed a

new holding company called Agri Bancorporation (Agri). Agri

offered to exchange one share of Agri common stock and one share

of Agri preferred stock for each share of common stock held by

Agri-Bank shareholders other than Mr. Hill. In addition, Agri

and Mr. Hill sought an agreement for the eventual sale of the

Agri stock that decedent would obtain in the exchange.

On August 23, 1991, decedent's conservator, with the

approval of the Humboldt County, Iowa, District Court (district

court), exchanged decedent's Agri-Bank common stock for 9,046

shares of Agri common stock and 9,046 shares of Agri preferred

stock, and entered into an agreement with Agri and Mr. Hill with
 - 7 -

respect to decedent's Agri stock and Agri-Bank preferred stock8

(1991 Agreement).

According to its preamble, the 1991 Agreement's purpose was

to restrict the transferability of decedent's shares and provide

for their purchase by Agri upon the occurrence of certain events

(including decedent's death), as well as to ensure that, in the

event a controlling interest in Agri were sold, decedent would

receive the same consideration per share for her minority

interest as Mr. Hill received for the sale of his controlling

interest.

In specific terms, the 1991 Agreement prohibited decedent

from transferring her Agri stock9 without (i) having obtained the

consent of Agri and Mr. Hill, or (ii) having offered to sell the

stock to Agri at the price contained in any bona fide third-party

offer. Under the 1991 Agreement, the conservatorship received

put options whereby the conservator could require Agri to

purchase all of decedent's Agri common stock for book value, and

all of decedent's Agri preferred stock for par plus unpaid

dividends. Agri likewise received call options, exercisable

8
Decedent's 13,377 shares of Agri-Bank preferred stock were
not exchanged, Agri-Bank having survived the exchange as a
subsidiary of Agri.
9
An exception was made for transfers to decedent's lineal
descendants and their spouses, who would be bound by the 1991
Agreement.
 - 8 -

during the 1-year period following decedent's death, to purchase

all of decedent's Agri stock at the same prices.10

Finally, the 1991 Agreement prohibited Mr. Hill from selling

his controlling interest to a third party unless decedent were

offered the opportunity to sell her Agri stock to the same third

party for the same consideration per share (Hill Rights). For

this purpose, "consideration" included the value of any

noncompete, consulting, or similar arrangements or payments

providing financial benefit to Mr. Hill. In addition, if the

prospective third-party purchaser of Mr. Hill's controlling

interest were to condition the purchase of Mr. Hill's interest

upon the right to acquire decedent's shares as well, the 1991

Agreement required decedent to sell her Agri shares (for the

prescribed consideration).

One of the conservator's principal considerations in

negotiating the 1991 Agreement was to avoid any sale of

decedent's stock before her death, after which the basis of that

stock would be stepped up to fair market value. By securing a

10
The 1991 Agreement also gave the conservatorship and
Agri reciprocal put and call options, respectively, for the sale
of all of decedent's Agri-Bank preferred stock at par plus unpaid
dividends. These options commenced 1 year after the date of the
agreement, and expired 1 year after decedent's death. At some
point after the 1-year waiting period and before the appointment
of a successor conservator (Boatmen's) in 1993, the put option
was exercised with respect to decedent's Agri-Bank preferred
shares. The conservatorship kept the proceeds received from the
sale in segregated accounts.
 - 9 -

guaranteed buyer and price (which, in the event of any change in

control, would approximate the per-share price paid for the

controlling interest), the conservator also secured a hedge

against the risk decedent bore in holding a minority interest in

a closely held bank. The conservator was also concerned about

liquidity in decedent's estate, which included a number of

valuable illiquid assets, as decedent's estate tax liability was

expected to be substantial. Concluding that the 1991 Agreement

was in decedent's best interest, the district court approved the

conservator's application to enter into it.

The 1994 Agreement

Sometime in 1994 Mr. Hill agreed to sell his controlling

interest in Agri, as well as two other banks, to FABG. As

consideration, Mr. Hill received book value for his Agri shares

(which were exchanged for FABG shares at a ratio reflecting the

banks' respective book values), book value for the shares of the

other two banks, a 5-year employment contract at $218,000 per

year, a $314,000 signing bonus, retirement of certain capital

notes held by one of his other banks ($1.6 million), and an

option (FACC option) to exchange his FABG stock, 5 years hence,

for all of the stock in First American Credit Corp. (FACC), an

operating loan subsidiary of FABG. FABG's initial capital

funding of FACC exceeded $10.5 million, and Mr. Hill's FACC

option agreement required that FABG fund FACC with qualified
 - 10 -

assets11 worth a fair market value of $18.1 million by the time

the option was exercisable.

The final merger agreement between Agri and FABG was

executed on September 30, 1994. Under the terms of the merger,

Agri's minority shareholders were offered the option to either

redeem their Agri common stock for book value ($53.55) or

exchange their Agri common stock for FABG common stock at a ratio

reflecting the banks' respective book values (1.0 Agri share for

0.73597 share of FABG).

In its submission to the Federal Reserve Board concerning

the merger, FABG disclosed its obligation pursuant to the 1991

Agreement to pay decedent the same per-share consideration for

her minority interest as that offered to Mr. Hill.

The conservator exchanged decedent's Agri common stock at

the offered ratio for 6,657 shares of FABG common stock12 on

October 1, 1994, and negotiated an agreement (1994 Agreement) for

the postdeath sale of decedent's FABG stock to FABG for 1.25

times book value, or $118.23 per share plus 6 percent compounded

annually until decedent's date of death ($118 price). The 1994

11
Qualified assets were defined generally as cash, notes
receivable, and other investment assets.
12
In connection with the merger, FABG also redeemed all
outstanding shares of Agri preferred stock (including decedent's)
for par plus unpaid dividends through the date of the merger.
The conservator deposited the proceeds from this preferred stock
redemption into segregated accounts.
 - 11 -

Agreement was executed on October 31, 1994 (subject to approval

by the district court). The $118 price was intended to

compensate for the value of the stock as augmented by the Hill

Rights. Specifically, the 1994 Agreement prohibited the transfer

of decedent's FABG common stock without FABG's consent and

granted reciprocal put and call options to decedent's personal

representative and FABG, respectively, to sell or purchase

decedent's FABG stock within 60 days after notice of her death

for the $118 price.

Cognizant of its fiduciary duties as conservator, Boatmen's

Bank of Iowa, N.A. obtained advice from a valuation specialist

for closely held business interests at Boatmen's Trust Co., a

related entity, in connection with the negotiations resulting in

the $118 price. To reach an opinion regarding a fair price for

decedent's FABG stock, including the Hill Rights, the valuation

specialist reviewed "merger multiples"13 for other Iowa and

Midwest region commercial bank mergers or acquisitions, comparing

the size, location, and profitability of the acquired banks with

Agri in order to identify appropriate comparables. On the basis

of her review, the valuation specialist concluded that Agri was

not worth an acquisition premium to FABG, so that a price equal

13
A merger multiple is computed as the ratio of the
purchase price for a bank to that bank's book value at the time
of acquisition.
 - 12 -

to book value was appropriate for decedent's FABG stock, absent

the Hill Rights.

Taking into account the additional consideration received by

Mr. Hill, the valuation specialist concluded that Mr. Hill had

effectively received a price equal to 1.33 times book value for

his stock in Agri and his two other banks. However, in the

valuation specialist's view, a significant portion of the

additional consideration--namely, the retirement of $1.6 million

of the capital notes of one of the other banks--was not

consideration for Mr. Hill's Agri stock. The valuation

specialist also determined that the FACC option given to Mr. Hill

(which entitled him to convert his FABG stock to FACC stock in 5

years) had no value, because of the multiple variables that might

affect relative values of the FABG and FACC shares in the 5 years

prior to the option exercise date (in October 1999). On the

basis of her analysis, the valuation specialist concluded that

the $118 price (i.e., 1.25 times book value), coupled with the

right to defer the sale until after death to avoid capital gains
 - 13 -

taxes,14 constituted a fair price for decedent's FABG stock,

including the Hill Rights.

In addition to satisfying itself that the $118 price was

fair, the conservator also believed the 1994 Agreement was in

decedent's best interest because, in the conservator's judgment,

it was imprudent for such a substantial portion of decedent's net

worth to be held in the form of a minority interest in a closely

held bank. This concern was exacerbated by the merger of Agri

into FABG, which transformed decedent's holdings into an even

smaller minority interest in a venture with unfamiliar

management. In the conservator's view, the 1994 Agreement's

guarantee of a fixed price and buyer for decedent's FABG shares

established a hedge against decedent's downside risks of holding

a minority interest. The conservator also concluded that the

1994 Agreement benefited decedent by securing a right to defer

sale until after death to avoid capital gains taxes and to ensure

liquidity for decedent's estate to pay estate taxes.

14
Decedent's right under the 1991 Agreement to defer the
sale of her bank stock until after death contained an exception.
Whereas Agri's call option on decedent's stock under the 1991
Agreement was generally effective only upon decedent's death, in
the event of a sale of the controlling interest in Agri, the
purchaser of the controlling interest could require the immediate
sale of decedent's Agri shares. Thus, the 1994 Agreement secured
decedent's right to a postdeath sale of her bank stock, even
though the controlling interest in Agri had been sold.
 - 14 -

When the conservator sought approval of the district court

to enter into the 1994 Agreement, Rod (alone among the

prospective heirs) filed formal objections in which he claimed,

inter alia, that the proposed $118 price for decedent's FABG

stock failed to compensate adequately for the Hill Rights and

could result in a potential loss to decedent's estate of more

than $500,000. Pursuant to Iowa law, decedent's prospective

heirs received notice regarding all aspects of the proceedings

concerning approval of the 1994 Agreement.

A hearing was held at which conflicting expert testimony

concerning the fairness of the $118 price was received. The

experts' fundamental difference centered on the present value of

the FACC option given to Mr. Hill. The conservator's expert

contended that the present value of Mr. Hill's FACC option was

negligible, whereas the expert proffered by Rod testified that

the FACC option was worth as much as $500,000 (about $85 per

share). A representative of FABG testified that rejection of the

1994 Agreement would lead to further litigation, that decedent

would not be offered any option comparable to Mr. Hill's FACC

option, and that, if the 1994 Agreement were rejected, FABG would

take the position that it was entitled, as Agri's successor, to

purchase decedent's stock pursuant to the call option in the 1991

Agreement for book value.
 - 15 -

The district court found that the proposed $118 price failed

to compensate adequately for the Hill Rights, in particular the

FACC option. The court therefore concluded that the 1994

Agreement was not in decedent's best interest and declined to

approve it.

The 1995 Family Settlement Agreement

The conservator filed a motion for reconsideration of the

district court decision and, based on its belief that further

litigation as to either the 1991 or 1994 Agreements was not in

decedent's best interest, commenced negotiations with the

prospective heirs to obtain agreement with respect to a price at

which decedent's FABG stock could be sold.

The conservator continued to believe that it was imprudent,

and potentially a violation of its fiduciary obligations to

decedent, to continue to hold such a substantial portion of

decedent's net worth in the form of a minority interest in a

closely held bank that did not pay dividends. The conservator

likewise considered the deferred sale arrangement in the 1994

Agreement a significant benefit for decedent by virtue of the

capital gains tax savings, which might be lost were FABG to

successfully exercise any call option that might be available to

it under the 1991 Agreement. The prospective heirs other than

Rod preferred a guaranteed "floor" price for decedent's FABG

stock rather than the risks inherent in further negotiation
 - 16 -

and/or litigation with FABG over a better price; they, like the

conservator, were also concerned about liquidity to pay expected

estate taxes. The prospective heirs other than Rod were

therefore willing to accept the $118 price. Rod, however,

believed that the $118 price fell substantially short of the

consideration that should be paid for decedent's stock given the

Hill Rights, and consequently was unwilling to consent to a sale

at that price.

Because of the foregoing problems and concerns, the

conservator initiated, and played an integral role in,

negotiations among the prospective heirs to reach an agreement

under which a secure price for the FABG stock could be obtained

for decedent's estate. These negotiations culminated in

September 1995 when the prospective heirs executed a Family

Settlement Agreement (1995 FSA)15 that, in broad terms,

guaranteed decedent and the prospective heirs other than Rod the

$118 price for the FABG stock that was offered previously by

FABG.

More specifically, the 1995 FSA prohibited the conservator

and decedent from transferring the FABG stock without the consent

15
The agreement was signed by Rosemary Ahlerich; Thomas's
children, Susan Wendel and Thomas Robert Amlie; Rod, his wife,
and their children; and the three individuals nominated as
trustees in the codicil to decedent's will establishing the Rod
Amlie Trust.
 - 17 -

of Rod, his spouse, their children, and the Rod Amlie Trust

(collectively, the Rod Amlie Family). The 1995 FSA further

required that all bequests to the Rod Amlie Trust under

decedent's will be satisfied "in kind" with FABG stock, valued

for this purpose at the $118 price. The 1995 FSA then provided

that any FABG stock remaining in decedent's estate after

satisfaction of decedent's bequests to Rod would be subject to

reciprocal put/call options for a designated postdeath period

under which decedent's personal representative could require the

Rod Amlie Family to purchase, or the Family could require

decedent's personal representative to sell to the Family, the

remaining FABG stock at the $118 price. Finally, all rights of

the conservator under the 1991 Agreement with respect to

decedent's FABG stock (i.e., the Hill Rights) were assigned to

the Rod Amlie Family, with all expenses and benefits arising

therefrom to inure to the Family.

In addition, the parties to the 1995 FSA agreed that the

conservator should withdraw the motion for reconsideration of the

district court's decision rejecting approval of the 1994

Agreement, and that the conservator should reimburse (from

decedent's assets) litigation expenses of $30,000 incurred by the

Rod Amlie Family, $500 for Susan Wendel's time as an attorney,

and $500 for attorney's fees incurred by Rosemary Ahlerich, in
 - 18 -

connection with the dispute over approval of the 1994

Agreement.16

The conservator sought approval of the 1995 FSA, as well as

authority to effectuate its terms, from the district court. On

October 16, 1995, the court concluded that the 1995 FSA was in

decedent's best interest, approved it, and ordered that "the

Conservator is specifically authorized to perform such acts as

are necessary to effectuate the terms and conditions of the

Family Settlement Agreement"; i.e., the 1995 FSA.

The 1997 Agreements

In August 1997 the Rod Amlie Family reached an agreement

with FABG regarding the consideration they would accept for

decedent's FABG stock (including the Hill Rights) that the Family

would receive through bequest or purchase after her death

pursuant to the 1995 FSA. The price to be paid to the Rod Amlie

Family was $217.50 per share plus 4 percent per year after

February 28, 1998, compounded semiannually.17 FABG paid more for

decedent's FABG stock than it would have paid to other minority

shareholders in 1997 through 1999 because of the value FABG

assigned to the Hill Rights. Also, one of the principal reasons

16
It is undisputed that these amounts were paid in 1995 as
provided in the 1995 FSA.
17
The agreed price also included a comparable downward
adjustment in the event the stock transfer occurred before Feb.
28, 1998.
 - 19 -

FABG agreed to pay more for decedent's stock in 1997 than it

offered to pay in connection with the 1994 Agreement was the

higher value it assigned to the Hill Rights in 1997.

The agreement reached between the Rod Amlie Family and FABG

was effectuated by means of two written agreements: the 1997

Conservator Agreement (between the conservator and FABG) and the

1997 Rod Amlie Family Agreement (between the Rod Amlie Family and

FABG). Under the 1997 Conservator Agreement, the conservator

agreed not to transfer decedent's FABG stock without the written

consent of FABG, and, acknowledging the assignment of decedent's

rights under the 1991 Agreement to the Rod Amlie Family pursuant

to the 1995 FSA, the parties agreed to mutually release each

other from any liability arising from the 1991 Agreement (which

conferred the Hill Rights).

Under the 1997 Rod Amlie Family Agreement, the Rod Amlie

Family agreed to take all necessary steps to become the lawful

owners of all of decedent's FABG stock upon her death, and FABG

agreed to redeem thereafter the stock for $1,447,897.50; i.e.,

$217.50 per share plus 4 percent per year after February 28,

1998, compounded semiannually. The 1997 Rod Amlie Family

Agreement further provided that as part of the consideration for

the agreement, the parties mutually released each other from any

liability arising under the 1991 Agreement (which conferred the

Hill Rights). Finally, the 1997 Rod Amlie Family Agreement was
 - 20 -

made contingent upon the sale to FABG of certain FABG stock owned

by Rod's wife Sally individually.

Decedent's Death

Decedent died on October 18, 1998, at the age of 96. On

November 15, 1998, pursuant to the 1995 FSA, the Rod Amlie Trust

exercised its call option to purchase all the FABG stock

remaining in decedent's estate after satisfaction of the bequests

of such stock to the Trust.

On November 17, 1998, the FABG stock at issue was sold to

FABG for $1,489,724.93, the price derived under the formula in

the 1997 Rod Amlie Family Agreement. Upon receiving the check

for this amount from FABG, Rod endorsed it as executor of

decedent's estate and had the proceeds segregated into a check

made payable to the estate for $993,756.96, the price for the

FABG stock under the formula set forth in the 1995 FSA,18 and a

second check for the balance of $495,967.97, which was eventually

remitted to the Rod Amlie Trust.

18
Because the sale of decedent's FABG stock occurred within
30 days of decedent's death (as required by the 1997 Rod Amlie
Family Agreement), it had not yet been determined what portion of
the stock would pass to the Rod Amlie Trust by bequest (versus
exercise of the put/call options), because the size of the
bequests was dependent upon the value of decedent's farm land at
her death. Consequently, the estate initially received all the
proceeds from the sale to FABG (at the $118 price), subject to a
distribution of a portion of those proceeds to the Rod Amlie
Trust reflecting the shares to which the Trust was entitled by
bequest.
 - 21 -

Decedent's Farm Land

At her death, decedent's farm land consisted of five parcels

(Parcels 1, 2, 3, 4, and 5). Decedent had a 100-percent

undivided interest in Parcels 1 (135.83 acres), 4 (80 acres), and

5 (40 acres); a seven-twelfths undivided interest in Parcel 2

(160 acres); and a one-half undivided interest in Parcel 3 (200

acres).

Estate Tax Return

The estate filed a timely Form 706, United States Estate Tax

Return, on July 22, 1999. The estate elected to use alternate

valuation dates; namely, November 17, 1998 (the date on which

decedent's FABG stock was purchased by FABG), for the stock, and

April 18, 1999 (6 months after decedent's death), for the farm

land. On the return, decedent's FABG stock was valued at

$993,757. The additional $495,968 paid by FABG for the stock was

reported as capital gain on the 1998 Form 1041, Fiduciary Income

Tax Return, of the Rod Amlie Trust. The fair market value of

decedent's farm land was reported based on an appraisal by an

auctioneer, as follows:

Parcel 1 $254,681
Parcel 2 167,040
Parcel 3 159,000
Parcel 4 152,000
Parcel 5 20,000
Total 752,721
 - 22 -

Notice of Deficiency

On July 17, 2002, respondent timely mailed a notice of

deficiency to the estate. Therein respondent determined that the

value of decedent's FABG stock on the alternate valuation date

was $1,489,725 (its purchase price pursuant to the 1997 Rod Amlie

Family Agreement) and accordingly increased the taxable estate by

$495,968. In addition, respondent determined the underpayment

arising from undervaluation of the FABG stock was attributable to

fraud or, in the alternative, negligence or disregard of rules or

regulations under section 6662. With respect to decedent's farm

land, respondent determined that the fair market values on the

alternate valuation date were as follows:

Parcel 1 $308,544
Parcel 2 214,368
Parcel 3 209,936
Parcel 4 172,876
Parcel 5 26,000
Total 931,724

Respondent's determinations concerning the farm land increased

the taxable estate by an additional $179,003. Finally,

respondent determined that the estate failed to report $30,000 of

lifetime taxable gifts made by decedent.

Burden of Proof

The revenue agent conducting the examination in this case,

Keith Puntenney (Agent Puntenney), initially requested

information from the estate's accountant, Wesley Stille, and
 - 23 -

ultimately received approximately 280 pages of documents. After

reviewing this material, Agent Puntenney had additional

questions, and was referred by Mr. Stille to the estate's

attorney, David Jennett.

Mr. Jennett made additional materials available, and after

reviewing them Agent Puntenney requested an interview with Rod,

as executor of the estate. Agent Puntenney's request was not

satisfied.

OPINION

I. Burden of Proof

The estate contends that the burden of proof with respect to

the factual issues in this case has shifted to respondent

pursuant to section 7491(a). We disagree.

To be eligible for the burden-shifting benefits of section

7491(a), a taxpayer must show that the prerequisites set forth in

section 7491(a)(2) have been satisfied. Allnutt v. Commissioner,

T.C. Memo. 2004-239; Oatman v. Commissioner, T.C. Memo. 2004-236;

H. Conf. Rept. 105-599, at 239 (1998), 1998-3 C.B. 747, 993. In

particular, section 7491(a)(2)(B) requires taxpayers to cooperate

with all reasonable requests by the Commissioner for interviews,

documents, and the like.

Respondent contends, inter alia, that the estate failed to

cooperate because his request to interview Rod was denied. As

our findings indicate, we conclude that Agent Puntenney requested
 - 24 -

an interview with Rod, as the executor of decedent's estate, and

this request was denied. While Agent Puntenney's notes do not

record such a request, he gave credible testimony that he made

the request of Rod's advisers (Messrs. Stille and/or Jennett),

which is plausible in the circumstances. The estate's response

on this point was equivocal. That is, Rod testified that he was

not aware of any request that he be interviewed, but when Mr.

Stille was immediately thereafter called as a witness by the

estate's counsel, he was not questioned regarding whether a

request for an interview with Rod had been made to him. Cf.

Clifton v. United States, 45 U.S. 242, 247 (1846); Steiner v.

Commissioner, 350 F.2d 217, 223 (7th Cir. 1965) (adverse

inferences may properly be drawn from taxpayer's failure to call

witnesses who would otherwise be expected to be favorable to

him), affg. T.C. Memo. 1963-128. On this record, we are

persuaded that Agent Puntenney requested an interview with Rod

that was not satisfied. Accordingly, the estate has not

satisfied the requirements of section 7491(a)(2)(B), and the

burden of proof does not shift pursuant to section 7491(a)(1).

The estate therefore retains the burden of proof with respect to

all factual issues in this case. Rule 142(a).

II. Fair Market Value of Decedent's FABG Stock

On the estate's Form 706, decedent's FABG stock was valued

at $993,757 based on the 1995 FSA price term, which the estate
 - 25 -

contends fixed the value for Federal estate tax purposes.

Respondent determined that the FABG stock should be valued at the

price paid for it by FABG within a month after decedent's death

($1,489,725) and argues in this regard that the 1995 FSA should

be disregarded in ascertaining the stock's value for Federal

estate tax purposes.

Federal estate tax is imposed on the transfer of the taxable

estate of every citizen or resident of the United States. Sec.

2001(a). The taxable estate is defined as the gross estate less

allowable deductions. Sec. 2051. The gross estate includes the

value of all property owned by a decedent at the time of death.

Sec. 2031. In most instances, the value of the gross estate is

the fair market value of the included property as of either the

date of death, or the alternate valuation date under section 2032

if elected by the executor as is the case here. Sec. 20.2031-

1(b), Estate Tax Regs.

An exception to the general valuation rule exists when the

property in question is subject to an enforceable restrictive

agreement, such as a buy-sell arrangement. See, e.g., St. Louis

County Bank v. United States, 674 F.2d 1207, 1210 (8th Cir.

1982). For a restrictive agreement to control value for Federal

estate tax purposes, it must meet certain requirements set forth

in the regulations and the caselaw. Sec. 20.2031-2(h), Estate
 - 26 -

Tax Regs. We have previously summarized those requirements as

follows:

It is axiomatic that the offering price must be fixed
and determinable under the agreement. In addition, the
agreement must be binding on the parties both during
life and after death. Finally, the restrictive
agreement must have been entered into for a bona fide
business reason and must not be a substitute for a
testamentary disposition. * * * [Estate of Lauder v.
Commissioner, T.C. Memo. 1992-736; citations omitted.]

Agreements that fail to meet these requirements are disregarded

in determining value. See Estate of Weil v. Commissioner, 22

T.C. 1267, 1274 (1954); sec. 20.2031-2(h), Estate Tax Regs.

Section 2703, enacted in 1990, also governs restrictive

agreements. Omnibus Budget Reconciliation Act of 1990, Pub. L.

101-508, sec. 11602, 104 Stat. 1388-491. The general rule of

section 2703 is that any agreement to acquire property at less

than its fair market value will be disregarded for Federal estate

tax purposes unless the agreement satisfies the requirements

enumerated in the statute. Those requisites include the

requirements of preexisting law that the agreement be a bona fide

business arrangement and not be a testamentary device, as well as

a new requirement that the terms of the agreement be comparable

to those of similar arrangements entered at arm's length. Sec.

2703(b).
 - 27 -

Further, since section 2703 is meant to supplement, not

replace, prior case law,19 the pre-section-2703 rules requiring

that an agreement be binding during life and at death, and

contain a fixed and determinable price, continue to apply. Thus,

regardless of whether section 2703 applies to a restrictive

agreement, the agreement must satisfy the requirements of pre-

section-2703 law to control value for Federal estate tax

purposes. Estate of Blount v. Commissioner, T.C. Memo. 2004-116,

affd. on this issue 428 F.3d 1338 (11th Cir. 2005).

The estate contends that the 1995 FSA, with its requirement

that the estate satisfy the specific and residual bequests to the

Rod Amlie Trust with FABG shares valued at the $118 price, and

its reciprocal put/call options requiring the sale at the $118

price of the FABG stock not used to satisfy the bequests, fixed

the value of the stock for Federal estate tax purposes, because

it is a restrictive agreement that satisfies pre-section-2703

requirements as well as section 2703(b).20 Respondent raises

19
136 Cong. Rec. 30,488, 30,540-30,541 (1990) (Senate
Committee on Finance Explanatory Material in Senate Committee on
Budget report printed in the Congressional Record, without
separate publication, because of time constraints).
20
The estate also argues that the portion of the 1995 FSA
that made an assignment of the Hill Rights to the Rod Amlie
Family is not subject to sec. 2703 because it was a present
assignment that did not restrict the future value of the stock.
We doubt that a meaningful bifurcation can be made between
decedent's FABG stock and the Hill Rights, as the latter
(continued...)
 - 28 -

several arguments for disregarding the 1995 FSA, contending that

the 1995 FSA fails to satisfy either the pre-section-2703

requirements that it set a fixed and determinable price and be

legally binding, or the requirements of section 2703. We address

each issue in turn.

Pre-Section-2703 Requirements

Respondent argues that the 1995 FSA did not contain a fixed

and determinable price for decedent's FABG stock because it did

not give the Rod Amlie Trust "the right to buy any fixed amount

of the stock for the price set therein". Respondent observes

that the actual amount of decedent's FABG stock the Rod Amlie

Trust would acquire by purchase rather than bequest was

unknowable until after decedent died and her farm land was

valued, because the Trust was bequeathed such stock as would

equal one-half the value of the farm land, plus one-third of the

residual estate. Indeed, respondent contends, it was possible

that none of decedent's FABG stock would be sold pursuant to the

options in the 1995 FSA if the value of one-half the farm land

plus one-third of the residual estate exceeded the value of the

FABG stock (using the $118 price fixed in the 1995 FSA).

20
(...continued)
prescribed the consideration that was required to be paid for the
former. However, we need not consider this aspect of the
estate's argument, given our ultimate conclusion herein that sec.
2703 does not cause any element of the 1995 FSA to be disregarded
for Federal estate tax purposes.
 - 29 -

The estate argues that it is irrelevant what portion of

decedent's FABG stock was subject to sale under the put/call

options in the 1995 FSA because any portion passing by bequest

was also subject to the price restrictions of the 1995 FSA. That

is because the estate was required under the 1995 FSA to satisfy

the specific and residual bequests to the Rod Amlie Trust "in

kind" with FABG stock valued at the $118 price. (The Rod Amlie

Trust was likewise bound under the 1995 FSA to accept the stock

at this valuation in full satisfaction of the bequests.21) The

satisfaction of such pecuniary bequests with stock at the fixed

$118 price constitutes a sale or exchange for Federal tax

purposes, the estate argues, citing principles set forth in

section 1.661(a)-2(f)(1), Income Tax Regs.; Kenan v.

Commissioner, 114 F.2d 217 (2d Cir. 1940), affg. 40 B.T.A. 824

(1939); and Suisman v. Eaton, 15 F. Supp. 113 (D. Conn. 1935),

affd. per curiam 83 F.2d 1019 (2d Cir. 1936). Since decedent's

personal representative was required under the 1995 FSA to

exchange FABG stock at the $118 price in satisfaction of the

specific and residual bequests to the Rod Amlie Trust, the value

of the FABG stock transferred in this manner was also restricted

by the 1995 FSA, the estate contends.

21
In the absence of the 1995 FSA, decedent's will did not
address how decedent's FABG stock would be valued for purposes of
the Rod Amlie Trust's right to receive FABG stock equal in value
to one-half of decedent's farm land.
 - 30 -

We agree that the 1995 FSA operated to restrict the value of

all of decedent's FABG stock. Under the 1995 FSA, the

conservator and decedent were prohibited from transferring

decedent's FABG stock without the consent of the Rod Amlie

Family. At decedent's death, all of her FABG stock was required

to be transferred to the Rod Amlie Trust at the $118 price,

either in an exchange at that value to satisfy the bequests or by

sale at that price. The 1995 FSA therefore imposed the $118

price as a ceiling (and floor) on the value of decedent's FABG

stock. Pursuant to the agreement reached between the conservator

and the prospective heirs, the estate could receive no more (and

no less) than the $118 price for all shares of decedent's FABG

stock, thereby effecting a transfer of the risk of loss or

opportunity for gain on the shares from decedent and her estate

to the Rod Amlie Trust.

Respondent next argues that the 1995 FSA was not enforceable

because the conservator did not sign it. Thus, respondent

contends, decedent was not bound by the 1995 FSA, and

consequently the Rod Amlie Family had no enforceable right to

purchase decedent's FABG stock at the price set forth in the 1995

FSA.22 We disagree.

22
Respondent also attacks the validity of the 1995 FSA on
the grounds that the Rod Amlie Trust had not been created when
the agreement was executed. However, the 1995 FSA conferred the
(continued...)
 - 31 -

Although not a signatory, the conservator sought approval of

the 1995 FSA from the district court. In granting such approval,

the court found the agreement to be in decedent's best interest

and specifically authorized the conservator "to perform such acts

as are necessary to effectuate the terms and conditions" of the

agreement. The 1995 FSA prohibited the conservator and decedent

from transferring the FABG stock without the consent of the Rod

Amlie Family, and it required decedent's personal representative

to sell the stock at the price prescribed in the agreement if the

Rod Amlie Family exercised its option to purchase. Given the

district court's order and the foregoing terms of the 1995 FSA,

we are persuaded that decedent and the conservator were legally

bound to avoid transfer of the FABG stock without consent during

decedent's lifetime, and that the Rod Amlie Family had an

enforceable right against decedent's estate to purchase the FABG

stock (not passing to them by bequest) at the prescribed price.

See Iowa Code sec. 633.71 (1992) (court orders bind conservator);

Iowa Code sec. 633.637 (2003) (powers of ward under

conservatorship restricted); In re Harker's Estate, 85 N.W. 786,

22
(...continued)
purchase option on all members of the Rod Amlie Family, which
included Rod as well as the Rod Amlie Trust. Thus, we are
unpersuaded that the status of the Rod Amlie Trust at the time of
execution of the 1995 FSA defeated the creation of an enforceable
right in other members of the Rod Amlie Family (who could have
transferred such right to the Trust when it was created).
 - 32 -

787 (Iowa 1901) (actions taken on ward's behalf by conservator

under the direction of the probate court are binding on ward,

absent fraud).23

In sum, we conclude the 1995 FSA satisfies the pre-section-

2703 requirements that it set a fixed and determinable price, and

that it be legally binding during life and at death.

Section 2703 Requirements

Respondent further argues that, even if it is conceded that

the 1995 FSA created enforceable buy/sell options establishing a

price that bound decedent, the 1995 FSA is nonetheless

disregarded for Federal estate tax purposes under section

2703(a), because it fails to satisfy the requirements of section

2703(b) for exempting a restrictive agreement from the

"disregard" rule of section 2703(a). The estate contends that

all requirements of section 2703(b) have been satisfied, and we

agree.

Section 2703(b) provides that a restrictive option or

agreement will not be disregarded under section 2703(a) if it

meets each of the following requirements:

SEC. 2703(b). Exceptions.-- * * *

23
Respondent also argues that decedent was not bound by the
1995 FSA because she received no consideration for entering it.
We think the consideration received by decedent is patent;
namely, a fixed price for the FABG stock that was otherwise
contingent upon further negotiations and/or litigation with FABG.
 - 33 -

(1) It is a bona fide business arrangement.

(2) It is not a device to transfer such property to
members of the decedent's family for less than full and
adequate consideration in money or money's worth.

(3) Its terms are comparable to similar arrangements
entered into by persons in an arms' length transaction.

We consider each in turn.

Bona Fide Business Arrangement

To meet the requirement of section 2703(b)(1), a restrictive

agreement must further some business purpose. The 1995 FSA

represented the culmination of the conservator's efforts,

starting with the 1991 Agreement, to secure a guaranteed price

and buyer for decedent's minority interest in a bank. The

conservator had a fiduciary obligation to serve decedent's best

interest, and in the conservator's view, it was imprudent for

such a substantial portion of decedent's net worth to be invested

in the form of a minority interest in a closely held bank. The

1991 Agreement was the conservator's initial step designed to

mitigate the downside risks of decedent's minority stake.

Through that agreement, the conservator secured a fixed price and

buyer for decedent's Agri stock and a guarantee that, in the

event the controlling interest in Agri were sold, decedent would
 - 34 -

receive the same per-share consideration for her minority

interest as the controlling shareholder received.24

The failed 1994 Agreement represented the conservator's

continued pursuit of the same goals after the controlling

interest in Agri was in fact sold; namely, securing a fixed price

for decedent's interests from the new owner (FABG) that, in

addition, compensated decedent for her rights under the 1991

Agreement to receive the same consideration for her shares as

received by the controlling shareholder; i.e., the Hill Rights.25

The change in control had exacerbated the conservator's concerns

as a fiduciary regarding decedent's minority interest, since

decedent's interest in FABG was proportionally smaller than her

interest in Agri, and FABG was under unfamiliar management.

When the district court declined to approve the 1994

Agreement based on Rod's objections, the conservator commenced

24
Although the estate did not proffer the testimony of the
conservator who negotiated the 1991 Agreement, we are satisfied
from the successor conservator's testimony concerning decedent's
circumstances, and the 1991 Agreement itself, that the purpose of
the agreement was to benefit decedent by eliminating the downside
risks described above.
25
The conservator also sought to achieve an additional goal
in the 1994 Agreement to benefit decedent's interests; namely,
the avoidance of capital gains tax liability on the sale of the
FABG stock. The 1991 Agreement did not confer any right to defer
the sale (until death) of decedent's stock in the event of a sale
of the controlling interest in Agri. In providing that FABG's
call option was not exercisable until after decedent's death, the
1994 Agreement also implemented the conservator's goal regarding
capital gains tax liability.
 - 35 -

negotiations in an effort to avoid the expense to decedent of

future litigation with FABG over the price to be paid for

decedent's shares as enhanced by the Hill Rights.26 These

negotiations produced the 1995 FSA, under which decedent's stock

effectively would be sold to the Rod Amlie Family at her death

for the same price as FABG had offered in the 1994 Agreement (the

$118 price), and the Rod Amlie Family would pursue whatever price

it could obtain for the stock from FABG, at the Family's risk and

expense.

We are persuaded that the conservator, in securing the 1995

FSA, was seeking to exercise prudent management of decedent's

assets by mitigating the very salient risks of holding a minority

interest in a closely held bank, consistent with the

26
We agree with the conservator's view that decedent and/or
her estate faced significant litigation hazards in this regard.
We believe FABG possessed leverage on the basis of the 1991
Agreement provision under which decedent was required to sell her
minority stake to any purchaser of the controlling stake if the
purchaser conditioned his purchase of the controlling stake on
his acquisition of decedent's shares. Also, an official of FABG
testified in the proceedings concerning approval of the 1994
Agreement that if the 1994 Agreement were rejected, FABG would
take the position that it was entitled, as Agri's successor, to
purchase decedent's stock pursuant to the call option in the 1991
Agreement for book value. (This call option was exercisable at
decedent's death, and decedent was 92 at the time of the
proceedings concerning the 1994 Agreement.) Finally, further
negotiations and/or litigation with FABG jeopardized the
conservator's goal of avoiding capital gains taxes on the sale of
decedent's FABG stock. See supra note 25.
In addition, we are persuaded that the value of the Hill
Rights was especially uncertain, in light of the FACC option, the
value of which was the subject of conflicting expert testimony in
the district court proceedings concerning approval of the 1994
Agreement.
 - 36 -

conservator's fiduciary obligations to decedent.27 We think

these were "valid life oriented business reasons" akin to those

underlying the option agreement that passed muster in Cobb v.

Commissioner, T.C. Memo. 1985-208 (option agreement allowing

below-market purchase at decedent's death served business purpose

of encouraging effective management of, and reducing risk of

operating, decedent's rental property).

Respondent argues that the 1995 FSA cannot meet the

requirement of section 2703(b)(1) because the agreement's

subject, decedent's FABG stock, was not an actively managed

business interest but merely an investment asset. We rejected

such an argument in Estate of Bischoff v. Commissioner, 69 T.C.

32, 40-41 (1977), and find it equally unpersuasive here. In our

view, an agreement that represents a fiduciary's efforts to hedge

the risk of the ward's holdings may serve a business purpose

within the meaning of section 2703(b)(1). In addition, planning

for future liquidity needs of decedent's estate, which was also

one of the objectives underlying the 1995 FSA, constitutes a

business purpose under section 2703(b)(1). See 136 Cong. Rec.

30,539 (1990).

27
We note in this regard that the district court concluded
that the 1995 FSA was in decedent's best interest.
 - 37 -

Not a Testamentary Device

The second requirement of section 2703(b) is that the

restrictive agreement not be a device to transfer the property

subject to the agreement to members of the decedent's family for

less than full and adequate consideration in money or money's

worth. This requirement existed in pre-section-2703 law, which

provides guidance regarding its meaning. Whether a restrictive

agreement constitutes a testamentary device depends in important

respects on the fairness of the consideration received by the

transferor, judged at the time the agreement is entered. See,

e.g., Estate of True v. Commissioner, T.C. Memo. 2001-167, affd.

390 F.3d 1210 (10th Cir. 2004); Bommer Revocable Trust v.

Commissioner, T.C. Memo. 1997-380.

Respondent contends that decedent received no consideration

or benefit from the 1995 FSA, as she owned stock for which FABG

was willing to pay $118.23 per share before the agreement, and

after the agreement she owned stock that was to be sold for

$118.23 per share to Rod. In respondent's view, only Rod

benefited from the 1995 FSA as it allowed him to purchase

decedent's stock at a price that had been found inadequate by the

district court just a few months before.

We disagree with respondent's theory. As noted above, we

believe decedent received significant consideration under the

1995 FSA; specifically, a fixed price for a minority stock
 - 38 -

interest, the value of which was otherwise uncertain and subject

to substantial litigation hazards. Because of the circumstances

of the conservatorship, the 1994 Agreement could not be

consummated, leaving decedent's net worth exposed to risk that

the conservator did not consider prudent. The $118 price reached

in the 1994 Agreement and carried over into the 1995 FSA, which

approximated 1.25 times book value, was agreed to by the

conservator after receiving professional advice that it was a

fair price. In reaching that price term in the 1994 Agreement

and 1995 FSA, the conservator also had to take into consideration

the litigation hazards of a protracted dispute with FABG, as

noted above.

Moreover, the prospective heirs other than Rod also agreed

to the price in the 1995 FSA. Theirs was an arm's-length

decision. To the extent the price in the 1995 FSA undervalued

decedent's FABG stock, the prospective heirs other than Rod were

thereby penalized and Rod rewarded; that is, Rod would receive a

larger number of FABG shares pursuant to the initial bequest

under which he was to receive FABG stock equal to one-half the

value of decedent's farm land, and the other prospective heirs

would be paid less for the FABG stock they received as part of

the residual estate but were required to sell to Rod at the 1995

FSA price. These were siblings (including a deceased sibling's

adult children) who had a history of acrimonious disputes over
 - 39 -

decedent's assets. We do not believe the prospective heirs other

than Rod agreed to the 1995 FSA price in order to effect a

transfer to Rod for less than full and adequate consideration.

We believe they, like the conservator, were persuaded that the

security of a fixed price was preferable to the downside risk and

uncertainties of continued negotiations with FABG over the

appropriate value of the Hill Rights.

Respondent, with the hindsight knowledge that Rod secured an

agreement some 2 years later for FABG's purchase of the same

stock at $217.50 per share (plus 4 percent per year until

decedent's death, compounded semiannually), seeks to persuade the

Court that the 1995 FSA provision to sell at the $118 price must

have been a testamentary device to benefit Rod. The facts of

this case do not fit that theory. The conservator, in an effort

to fulfill fiduciary obligations, and the other prospective

heirs, in furtherance of their own interests, accepted a price

they believed (on the basis of professional advice) was fair at

the time and in the particular circumstances. The purpose of the

1995 FSA, therefore, was not as a testamentary device to benefit

decedent's family members.

Comparable Arm's Length Terms

The third requirement of section 2703(b) is that the

restrictive agreement's terms be comparable to similar

arrangements entered into by persons in an arm's-length
 - 40 -

transaction. To satisfy this requirement, the estate offered the

expert testimony of an attorney with extensive experience in the

purchase and sale of closely held equity interests. In the

expert's opinion, the 1995 FSA was comparable to arrangements

entered into by persons in arm's-length transactions because the

price and structure for the sale of the FABG stock in the 1995

FSA was virtually identical to the terms of the 1994 Agreement,

which had been reached in arm's-length negotiations between the

conservator and FABG. Respondent argues that the expert's

opinion is insufficient for purposes of section 2703(b)(3),

because it relies on an "isolated comparable" in contravention of

the legislative history of, and regulations under, section

2703(b).28

28
Sec. 25.2703-1(b)(4), Gift Tax Regs., provides:

(4) Similar arrangement.--(i) In general. A right
or restriction is treated as comparable to similar
arrangements entered into by persons in an arm's length
transaction if the right or restriction is one that
could have been obtained in a fair bargain among
unrelated parties in the same business dealing with
each other at arm's length. A right or restriction is
considered a fair bargain among unrelated parties in
the same business if it conforms with the general
practice of unrelated parties under negotiated
agreements in the same business. * * *
(ii) Evidence of general business practice.--
Evidence of general business practice is not met by
showing isolated comparables. * * * [Emphasis added.]

The legislative history of sec. 2703(b)(3) states:

(continued...)
 - 41 -

For the reasons discussed below, we conclude that the estate

has satisfied section 2703(b)(3). By its terms, the statute

requires only a showing that the agreement's terms are

"comparable" to similar arrangements entered at arm's length.

While the regulations caution against using "isolated

comparables", we believe that in context the regulations

delineate more of a safe harbor than an absolute requirement that

multiple comparables be shown.

In any event, the price terms reached in the 1994 Agreement,

and incorporated in the 1995 FSA, were in fact based on a survey

of comparables. The conservator sought professional advice from

within Boatmen's, and was advised that the $118 price (1.25 times

book value) was a fair price for decedent's FABG stock and Hill

Rights, when coupled with the deferred sale feature of the 1994

Agreement. The deposition of the valuation specialist who

advised the conservator (taken in connection with the district

court proceedings) is in the record, and it indicates that the

28
(...continued)
In addition, the bill adds a third
requirement, not found in present law, that
the terms of the option, agreement, right or
restriction be comparable to similar
arrangements entered into by persons in an
arm's length transaction. This requires that
the taxpayer show that the agreement was one
that could have been obtained in an arm's
length bargain. * * * It is not met simply by
showing isolated comparables but requires a
demonstration of the general practice of
unrelated parties. [136 Cong. Rec. 30,541
(1990); emphasis added.]
 - 42 -

specialist considered the merger multiples for all Midwest region

banks sold in the prior year and determined that, given the size,

location, and profitability of Agri, book value represented the

market value of Mr. Hill's FABG shares, and that the additional

consideration received by Mr. Hill for his shares represented

payment of a premium of 0.33 times book value. In the analyst's

view, given that a portion of the premium was attributable to

another of Mr. Hill's banks and certain other factors, a premium

of 0.25 times book value represented fair, equivalent

consideration for the Hill Rights. Thus, several comparables

were in fact considered in determining the $118 price for

decedent's stock in the 1995 FSA.

Several other indicia in the record support the conclusion

that the terms of the 1995 FSA were comparable to arrangements

entered into at arm's length. The 1994 Agreement and the 1995

FSA (with their identical price terms) were not agreements

reached between decedent and a member of her family. Rather,

they were entered into by decedent's conservator, who had a

fiduciary duty to safeguard decedent's interests. The

conservator and FABG negotiated at arm's length to reach the 1994

Agreement, and the 1995 FSA adopted that agreement's price terms.

On this record, we are satisfied that the negotiations among the

prospective heirs to reach the 1995 FSA were also arm's length;

the interests of the prospective heirs other than Rod were
 - 43 -

adverse to Rod's with respect to the price terms for the stock.

As discussed above, an understated price in the 1995 FSA would

have penalized the other prospective heirs.

Obviously, the fact that the district court concluded in

1995 that the $118 price was inadequate, and the fact that Rod

was able to secure a price of $217.50 per share from FABG in

1997, raise questions concerning whether the $118 price in the

1995 FSA was comparable to similar arrangements entered at arm's

length. However, on the facts of this case, we are persuaded

that the 1995 FSA price terms were arm's length. The prospective

heirs other than Rod agreed to the $118 price even though they

were aware of the district court proceedings where it was found

inadequate. In our view, the other prospective heirs and Rod

simply disagreed regarding the potential risks and rewards of

further negotiation or litigation with FABG over the value of the

Hill Rights.29 In the circumstances, the other prospective heirs

struck a bargain for the proverbial "bird in the hand" of a

guaranteed price, transferring to Rod the benefits and burdens of

the pursuit of the possible "two in the bush". It may have been

a bad bargain in hindsight, but we are persuaded it was arm's

length when made.

A second factor also bears on our conclusion. The nub of

the differing judgments on the value of the Hill Rights concerned

29
See supra note 26.
 - 44 -

the FACC option given to Mr. Hill. The valuation specialist

consulted by the conservator concluded (in the fall of 1994) that

the FACC option had no value, because of the multiple variables

that might affect the relative values of the FABG and FACC stock

during the 5-year period before the FACC option was exercisable

(in October 1999). This view of the value of the FACC option

figured prominently in the valuation specialist's conclusion that

the $118 price was fair. Rod's experts disagreed and convinced

the district court that the FACC option had significant value.

We are persuaded that the value of the FACC option became

easier to discern over time, as the exercise date drew nearer,

and that later in the 5-year option period it became clear that

FACC stock would be more valuable than FABG stock on the exercise

date, rendering the FACC option more valuable. Indeed, the

parties have stipulated that FABG was willing to pay more for

decedent's FABG stock in 1997 than it offered in connection with

the 1994 Agreement because of the higher value FABG assigned to

the Hill Rights in 1997. Thus, the disparity in the $217.50 per-

share price obtained for the stock by Rod in August 1997 and the

$118 per-share price in the 1995 FSA is attributable, at least in

part, to the passage of time and the apparent appreciation of the

FACC stock in relation to the FABG stock over that period, and

not to any deliberate undervaluing of the stock in the 1995 FSA.

This factor bolsters the conclusion that the terms of the 1995
 - 45 -

FSA are comparable to similar arrangements that would have been

entered at arm's length. The value of the FACC option was less

clear in 1995, and the conservator (as decedent's fiduciary) and

the prospective heirs other than Rod preferred to secure an

agreement in 1995 rather than risk a protracted dispute with

FABG, for the reasons previously discussed.

Finally, FABG's purchase of the FABG stock from the Rod

Amlie Family pursuant to the 1997 Rod Amlie Family Agreement was

conditioned upon the sale by Rod's wife Sally of certain other

FABG stock that she owned in her own right, suggesting that the

1997 price was also affected by FABG's desire to obtain

additional stock in the hands of another minority holder.

Conclusion

We accordingly find on this record that the estate has shown

that the requirements of section 2703(b) are satisfied, so that

section 2703(a) does not provide a basis for disregarding the

1995 FSA. As a consequence, we conclude that the value of

decedent's FABG stock as of the alternative valuation date was

limited as a result of the 1995 FSA to $993,757, the value

reported by the estate.

III. Fair Market Value of Farm Land

Background

The estate reported values for decedent's farm land based on

an appraisal by an auctioneer. Respondent determined
 - 46 -

deficiencies with respect to Parcels 1-5.30 The estate

thereafter retained an expert appraiser of agricultural real

property, Dennis Reyman, and proffered his expert reports31 and

testimony at trial concerning the fair market value of decedent's

farm land. The fair market values asserted in the return, notice

of deficiency, and Mr. Reyman's expert report (without regard to

any fractional interest discounts for decedent's interests in the

parcels at issue) were as follows:

Estate Tax Respondent's Estate's
Return Determination Expert
Parcel 1 $254,681 $308,544 $281,800
Parcel 2 (7/12 interest) 167,040 214,368 195,300
Parcel 3 (1/2 interest) 159,000 209,936 185,000
Parcel 4 172,000 198,876 198,000
Total 752,721 931,724 860,100

For Federal estate tax purposes, property is generally

included in a decedent's estate at its fair market value. Sec.

20.2031-1(b), Estate Tax Regs. The fair market value "is the

price at which the property would change hands between a willing

30
Because Parcels 4 and 5 are contiguous, the estate's
expert witness treated them as a single parcel, as did the
parties thereafter. We hereinafter refer to Parcels 4 and 5
combined as Parcel 4.
31
Mr. Reyman prepared two reports regarding decedent's farm
land. The first report documented the results of his appraisal
of the fair market value of decedent's farm land without any
fractional interest discounts. Mr. Reyman's second appraisal
report contained his conclusions regarding fractional interest
discounts for decedent's partial interests in Parcels 2 and 3.
 - 47 -

buyer and a willing seller, neither being under any compulsion to

buy or to sell and both having reasonable knowledge of relevant

facts". See, e.g., United States v. Cartwright, 411 U.S. 546,

551 (1973); sec. 20.2031-1(b), Estate Tax Regs.; sec. 25.2501-1,

Gift Tax Regs.

The determination of fair market value is a question of fact

to be resolved from all the evidence. Estate of Ford v.

Commissioner, 53 F.3d 924, 926 (8th Cir. 1995), affg. T.C. Memo.

1993-580. Valuation is necessarily an approximation and is, in

great part, a question of judgment rather than math or formula.

Hamm v. Commissioner, 325 F.2d 934, 940 (8th Cir. 1963), affg.

T.C. Memo. 1961-347. As the estate has not demonstrated that

section 7491(a) applies, the estate bears the burden of proving

that the values determined by respondent are incorrect. Rule

142(a).

Evaluation of Expert Testimony

At trial respondent offered the testimony of Agent

Puntenney, purportedly as a fact witness, to explain the

methodology he employed in reaching the values determined for

decedent's farm land in the notice of deficiency. The estate

objected on the grounds that such testimony necessarily involved

the presentation of expert opinion, which was impermissible given

that respondent had neither established Agent Puntenney's

qualifications as an expert nor offered an expert report in
 - 48 -

compliance with Rule 143(f). We sustained the objection insofar

as we required Agent Puntenney to confine his testimony to a

description of his methodology.

Upon review of Agent Puntenney's testimony and related

documents, we find his valuation methodology theoretically sound.

We note that his basic approach was similar to that of the

estate's expert; namely, a comparison of sales of comparable

properties with adjustments for corn suitability ratings

(discussed infra). We also note, however, that Agent Puntenney's

sales comparison approach required the selection of comparable

properties, an exercise of judgment involving the application of

specialized knowledge generally considered expert opinion. The

comparables chosen by Agent Puntenney indicated an average per-

acre value of $1,513, whereas the comparables chosen by the

estate's expert indicated an average value of $1,397 per acre.

The selection of comparables involves real estate valuation

expertise that Agent Puntenney was not shown to possess. Thus,

while his conclusions are supportable, we conclude that they are

less reliable than those of the estate's expert.

The estate bears the burden of proving that the valuation

determinations in the notice of deficiency are incorrect. Rule

142(a). The estate relies on the expert reports and testimony of

Mr. Reyman. Mr. Reyman concluded that, in light of the active

market in agricultural real estate in Iowa, the sales comparison
 - 49 -

approach provided the best indication of value. Respondent does

not challenge this point. Mr. Reyman based his appraised values

on his analysis of the sales of six comparable properties, the

selection of which respondent also does not challenge.

In reaching his valuations for Parcels 1, 2, and 3, Mr.

Reyman made certain adjustments to the sales prices of the

selected comparables to account for differences from the subject

parcels being valued. First, he made a "land mix adjustment" to

reflect the differences in the soil composition of the comparable

properties as compared to each subject property, based on the

county-adjusted corn suitability ratings32 (CSRs) of each of five

classes of soil that might be present in a parcel. Using

formulas that allocated a comparable property's purchase price to

its various soil types based on their relative values (in

accordance with their CSRs), the land mix adjustment employed by

Mr. Reyman resulted in adjustments to a comparable property's

sale price based upon whether it had a superior or inferior soil

composition in comparison to the subject parcel.

Respondent argues that Mr. Reyman's land mix adjustments

were overly complex and therefore unreliable, but we find the

32
A corn suitability rating (CSR) is a State government
estimate of Iowa soil production potential stated as a
standardized index number. The CSR index rates each kind of soil
in Iowa for its row-crop production potential; county-adjusted
CSR ratings, which provide more precision than State CSR ratings,
account for local differences in climate and rainfall.
 - 50 -

methodology persuasive. The algorithms employed in the formulas

were discernible and result in adjustments between the comparable

and subject properties that appear appropriate.

Mr. Reyman also made another set of adjustments to the

comparables for Parcels 1, 2, and 3 to account for "conditions of

sale" and location. We are also generally persuaded of the

appropriateness of those adjustments, with one exception. In the

case of one comparable, Mr. Reyman opined that the sale occurred

as a result of a public auction where two bidders, both desiring

the property because of its proximity to their other holdings,

drove the sale price up. In Mr. Reyman's view, this factor

necessitated a $150 per acre downward adjustment in the sales

price of the comparable. Respondent objects,33 and we agree, in

that we are not persuaded that such an adjustment is justified.

As this comparable was averaged with five others, elimination of

this $150 downward adjustment raises the indicated per acre value

for Parcels 1, 2, and 3 by $25 ($150/6).

We find one other element of Mr. Reyman's methodology

troublesome. Whereas with respect to Parcels 2, 3, and 4, Mr.

Reyman took the average of the adjusted per acre values of the

six comparables in reaching an indicated value for each subject

33
While respondent contends that the downward adjustment
made was $200 per acre, we are satisfied upon review of Mr.
Reyman's report that $50 of the adjustment was attributable to
the comparable's location rather than the bidders'
characteristics.
 - 51 -

property, in the case of Parcel 1 he instead selected the

adjusted per acre value of a single comparable in reaching his

indicated value, on the grounds that this comparable was "the

least adjusted comparable sale". Had Mr. Reyman taken the

average of the six, his indicated value for Parcel 1 would have

been approximately $2,150 per acre, rather than the $2,075 per

acre value he derived from using a single comparable. Other than

the bald claim that the single comparable he chose was "least

adjusted", Mr. Reyman provides no explanation for his departure

from the methodology used for the three other parcels. We are

not persuaded that such a departure, which reduces the value

estimate for Parcel 1 by more than $10,000, is justified. We

accordingly conclude that the best indication of Parcel 1's value

from this record results from averaging the adjusted values of

the six comparables identified by Mr. Reyman.

Values Before Fractional Discounts

Mr. Reyman concluded that Parcel 4 had a value of $198,000

on the valuation date, whereas respondent determined the value at

$198,876. Given the proximity of these results, we conclude the

estate has not met its burden of showing respondent's

determination to be incorrect and therefore sustain it.

Mr. Reyman estimated that Parcel 1 had a value of $281,800

on the valuation date. As discussed above, we conclude that Mr.

Reyman should not have made a $150 downward adjustment to one of
 - 52 -

the comparables for Parcels 1, 2, and 3, and the elimination of

this adjustment raises the indicated value by $25 per acre, or

$3,396 for Parcel 1. We also conclude that Mr. Reyman should

have utilized the average of the adjusted values of his six

comparables for Parcel 1, rather than adopting one comparable. A

modification to employ the average raises the indicated value for

Parcel 1 by $75 per acre, or $10,187. We accordingly find that

the estate has shown respondent's determination to be incorrect,

and that the value of Parcel 1 on the valuation date was

$295,383.

Mr. Reyman estimated that decedent's seven-twelfths interest

in Parcel 2, without regard to any discount for a fractional

interest, had a value of $195,300 on the valuation date. He

further estimated that decedent's one-half interest in Parcel 3,

without any fractional interest discount, had a value of $185,000

on the valuation date. After removing the unjustified $150

downward adjustment to one comparable, the value of Parcel 2

increases $2,325 (7/12 of $25 per acre) to $197,625, and the

value of Parcel 3 increases $2,917 (1/2 of $25 per acre) to

$187,917. We consider the impact of any fractional interest

discounts below.

Impact of Fractional Interests

Since decedent held only seven-twelfths and one-half

interests in Parcels 2 and 3, respectively, the estate argues
 - 53 -

that fractional interest discounts are warranted because of

problems of control, lack of marketability, unavailability of

financing, and costs of partition relating to partial undivided

ownership interests. This Court has found fractional interest

discounts to be appropriate where supported by the evidence.

See, e.g., Estate of Campanari v. Commissioner, 5 T.C. 488, 492

(1945); Estate of Henry v. Commissioner, 4 T.C. 423, 447 (1944),

affd. 161 F.2d 574 (3d Cir. 1947); Estate of Baird v.

Commissioner, T.C. Memo. 2001-258; Estate of Busch v.

Commissioner, T.C. Memo. 2000-3; Estate of Pillsbury v.

Commissioner, T.C. Memo. 1992-425.

In his first report Mr. Reyman noted that, while fractional

interest discounts for Parcels 2 and 3 were appropriate, he

lacked adequate information from which he could determine what

rate of discount to apply. Mr. Reyman subsequently submitted a

second report in which he identified certain fractional interest

data he had found which formed a basis for an opinion regarding

fractional interest discounts for Parcels 2 and 3. Mr. Reyman

acknowledged that his data was remote as to time (consisting of

sales in 1996-1998) and location (being from eastern rather than

northwest Iowa). He nonetheless believed that the data supported

a substantial discount "to compensate potential buyers for the

lack of control, limited marketability, and low financing

potential characteristic of such interests", and concluded that a
 - 54 -

25-30 percent fractional interest discount was appropriate for

Parcel 2, and a higher, 30-35 percent discount was appropriate

for Parcel 3 because decedent lacked a majority interest in that

parcel.

Respondent argues that no fractional interest discount

should apply in this case, as the estate has not satisfied its

burden of proving that a discount is appropriate. Respondent

claims that shortcomings in the comparables that informed Mr.

Reyman's analysis demonstrate he is not an expert in the matter

of fractional interest discounts. Respondent contends we should

therefore accord Mr. Reyman's fractional interest analysis no

weight. We disagree.

Respondent presented no evidence from which we could

conclude that no discount is appropriate. See Mooneyham v.

Commissioner, T.C. Memo. 1991-178. The estate has offered

evidence, consistent with common sense and precedent, that some

fractional interest discount is appropriate. Mr. Reyman concedes

there are considerable shortcomings in his supporting data, and

we agree.

The estate's return and petition are admissions that should

be binding on the estate absent cogent proof that those reported

values were erroneous. See, e.g., Estate of Hall v.

Commissioner, 92 T.C. 312, 337-338 (1989); Estate of True v.

Commissioner, T.C. Memo. 2001-167; Mooneyham v. Commissioner,
 - 55 -

supra. Considering the unsatisfactory record before us, we

conclude that the estate has shown entitlement to a fractional

interest discount no greater than that which would reduce the

values of Parcels 2 and 3 to the amounts reported on the return.

The evidence of fractional interest discounts supplied by Mr.

Reyman is too fraught with infirmities to constitute cogent proof

that the reported values are erroneous. See Estate of Pillsbury

v. Commissioner, supra. We accordingly conclude on this record

that the values of Parcels 2 and 3 are subject to fractional

interest discounts of approximately 15 percent, which reduces

those values to the amounts reported on the return. We so hold.

IV. $30,000 Gift

As part of the negotiations that produced the 1995 FSA, it

was agreed that the conservator would reimburse various Amlie

family members for a portion of the legal expenses each incurred

in connection with the proceedings concerning approval of the

1994 Agreement. As ordered by the district court approving the

1995 FSA, the conservator paid $30,000 to Rod to effectuate the

terms of the 1995 FSA. Respondent determined that the

conservator's payment was a gift made by decedent prior to her

death.34 The estate disagrees, contending that the payment was

34
The conservator was also required to pay $500 each to
Rosemary Ahlerich and Susan Wendel in partial reimbursement for
legal expenses they incurred in connection with the proceedings
for approval of the 1994 Agreement. Respondent, considering
(continued...)
 - 56 -

part of the consideration provided to the Rod Amlie Family to

enter into, and accept the responsibilities imposed on them

under, the 1995 FSA. We agree with the estate.

Section 2501(a) imposes a tax on the transfer of property by

gift; for purposes of this section, a gift is any transfer of

property for less than a full and adequate consideration in money

or money's worth. Sec. 2512(b). A transfer of property made in

the ordinary course of business will be considered as made for an

adequate and full consideration in money or money's worth. Sec.

25.2512-8, Gift Tax Regs. A transfer in the ordinary course of

business is one that occurs as part of "a transaction which is

bona fide, at arm's length, and free from any donative intent".

Id.

In deciding the section 2703 issue in the estate's favor, we

found that the 1995 FSA was a bona fide business arrangement with

terms comparable to those that might be agreed to by persons

negotiating at arm's length. We further held that the agreement

was not a device to transfer property to members of decedent's

family for less than full and adequate consideration in money or

money's worth. The $30,000 payment by the conservator to the Rod

34
(...continued)
these payments de minimis, determined not to recharacterize them
as gifts.
 - 57 -

Amlie Family was part of the consideration for the 1995 FSA.35

Analyzing the 1995 FSA as whole, taking into consideration all

the facts and circumstances surrounding the making of that

agreement, we conclude that this payment was a transfer in the

ordinary course of business and not a gift. We accordingly do

not sustain respondent's determination that the payment resulted

in a $30,000 increase in decedent's adjusted taxable gifts.

V. Section 6662(a) Negligence Penalty

Respondent determined that the estate was liable for an

accuracy-related penalty under section 6662 with respect to the

portion of the underpayment of estate tax attributable to the

value reported for decedent's FABG stock. Because we have held

that the value of the FABG stock as reported by the estate is

correct, there is no underpayment attributable thereto.

Accordingly, we do not sustain respondent's determination with

respect to the section 6662 accuracy-related penalty.

VI. Conclusion

In reaching our holdings in this case, we have considered

all the remaining arguments made by the parties for results

contrary to those expressed herein. To the extent not discussed

35
Respondent argues that the conservator was under no legal
obligation to make this reimbursement to Rod. This is incorrect.
Under Iowa law, once the 1995 FSA was approved by the district
court, as a fiduciary of the ward, the conservator was bound to
take those actions required to effectuate the terms of that
agreement on her ward's behalf. Iowa Code sec. 633.71 (1992)
(court orders bind conservator).
 - 58 -

herein, we conclude those arguments are moot, without merit, or

unnecessary to reach.

To reflect the foregoing,

Decision will be entered

under Rule 155.