[PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT FILED
________________________ U.S. COURT OF APPEALS
ELEVENTH CIRCUIT
October 31, 2005
No. 04-15013 THOMAS K. KAHN
________________________ CLERK
U.S. Tax Court No. 540-02
ESTATE OF GEORGE C. BLOUNT, Deceased,
FRED B. AFTERGUT, Executor,
Petitioner-Appellant,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
________________________
Petition for Review of a Decision of the
United States Tax Court
_________________________
(October 31, 2005)
Before BIRCH, CARNES and FAY, Circuit Judges.
BIRCH, Circuit Judge:
Confronting the verisimilitude of American life, death and taxes, this appeal
asks us to decide a recurring issue of asset valuation for estate tax purposes and
whether a stock-purchase agreement meets the requirements of a tax code
exception to the general valuation-at-fair-market-value rule. The estate of Blount
was required to sell Bount’s shares when he died, and Blount’s family business
owned an insurance policy to ensure that it would have sufficient liquidity to
accomplish the contractual buyout. We AFFIRM the Tax Court’s determination
that the stock-purchase agreement does not fall within the statutory exception,
which would allow the parties to conclusively establish the value of the
corporation for taxation purposes at an agreed upon purchase price. Because the
Tax Court should not have added the insurance proceeds to the value of the
corporation when calculating its fair market value, we REVERSE the court’s
computation of that value.
I. BACKGROUND
Blount Construction Company (“BCC”) is a closely held Georgia
corporation that constructs roads and similar projects for private entities and
Georgia municipalities. In 1981, the corporation’s only shareholders, William C.
Blount and James M. Jennings, and BCC entered into a stock-purchase agreement
that required shareholder consent to transfer stock and established that BCC would
purchase the stock on the death of the holder at a price agreed upon by the parties
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or, in the event that there is no agreement, for a purchase price based on the book
value of the corporation.
In the early 1990s, BCC purchased insurance policies solely for the purpose
of ensuring that the business could continue operations, while fulfilling its
commitments to purchase stock under the agreement. These policies would
provide roughly $3 million, respectively, for the repurchasing of Jennings and
Blount’s stock. In 1992, BCC also began an employee stock ownership program
(“ESOP”) to which the company made annual contributions, either by purchasing
stock from Blount and Jennings or by new issuances. Annual valuations were
completed by a third party to facilitate the ESOP purchases. For example, as of
January 1995, BCC was valued at roughly $7.9 million.1
In January 1996, Jennings died owning 46% of BCC’s outstanding shares.
BCC received about $3 million from the insurance proceeds, and paid a little less
than $3 million to Jennings’s estate. BCC used the previous year’s book value to
determine the amount to be paid to Jennings’s estate.
In October 1996, Blount was diagnosed with cancer, and his doctor
predicted only a few months to live. Concerned that the buyout requirement of the
1
For purposes of this opinion, we round the relevant numbers. We defer to the factual
findings of the Tax Court for the establishment of share values to four decimal places and the
accurate breakdown of dollars and cents. See Estate of Blount v. Comm’r, 87 T.C.M. 1303
(2004).
3
1981 stock-purchase agreement would deprive BCC of the liquidity it needed to
function, he commissioned several studies regarding the amount of money his
estate could receive for his shares and still leave the company in a healthy financial
condition. Apparently, Blount was not concerned about his family, because they
were wealthy independent of the proceeds from the sale of his BCC stock.
In November 1996, Blount executed an amendment to the 1981 stock-
purchase agreement that bound himself and BCC to exchange $4 million for the
shares that Blount owned at his death.2 The 1996 agreement was substantially
similar to the subsection in the 1981 agreement regarding the purchase of shares
upon the death of the holder. Unlike the 1981 agreement, however, the 1996
agreement did not provide for future price adjustments in accordance with book
value, which functionally locked the price at the January 1996 value of BCC. The
1996 agreement also differed from the 1981 agreement by removing the ability of
BCC to pay its obligation in installments.
When Blount died in September 1997, he owned 43,080 shares, or roughly
83% of BCC. BCC paid $4 million to the estate of Blount (“Taxpayer”) in
2
The Tax Court noted that Blount realized that he was undervaluing his shares by a third.
See Estate of Blount, 87 T.C.M. at 1307. The court observed that Blount “was aware when he
signed the 1996 agreement setting the price for his shares at $4 million ($92.85/share) that the
most recent [Business Valuation Services, Inc.] appraisal had valued BCC at approximately $8
million ($155.32/share), suggesting that [Blount’s] shares had a fair market value of
approximately $6.7 million.” Id.
4
November of that year “in accordance with the November 11, 1996 Shareholders
Agreement.”
In 1997, the Taxpayer filed a return declaring $4 million as the value of the
shares, and the IRS filed a notice of deficiency claiming that the stock was worth
$7,921,975. Implicit in this valuation of Blount’s shares is a claim that BCC’s fair
market value exceeded $9.5 million. The Tax Court held that the 1981 agreement,
as modified by the 1996 amendment, was to be disregarded for the purpose of
determining the value of the shares. Estate of Blount v. Comm’r, 87 T.C.M. 1303,
1312 (2004). The court also held that the amount of tax should have been
calculated by adding the insurance proceeds to the other assets of BCC in order to
arrive at the fair market value of the corporation. Id. at 1322.
Three experts testified concerning the value of the stock. First, John Grizzle
was offered by the Taxpayer solely on the issue of comparability, that is, whether
the method and result of valuing BCC in the 1996 amendment was comparable to
the method and results within the industry. He concluded it was, because
construction companies that engaged in arm’s length negotiations had recently
been valued in the industry at four times their adjusted cash flow. Averaging five
years of BCC cash flows, Grizzle determined that BCC was worth roughly $4.5
million. Because Blount owned 83% of the company, Grizzle determined that
BCC should have paid $3.8 million for Blount’s stock. The Tax Court found that
5
no weight could be given to Grizzle’s valuation estimate because he only used a
cash flow approach and failed to account for BCC’s large nonoperating assets. Id.
at 1316.
On the issue of the fair market value of BCC, each party offered one expert.
The IRS’s expert, James Hitchner, concluded that the company was worth $7
million, and the Taxpayer’s expert, Gerald Fodor, computed the value at $6
million. Both experts used a blend of asset-based and income-based approaches to
determine fair market value, as opposed to Grizzle’s cash flow-only approach,
which also focused only on the issue of comparability.
Fodor determined that the income-based value of the company was $5.8
million and that the asset-based value was $7.9 million, which he blended at a ratio
of 3:1. This resulted in Fodor’s $6 million estimate. The Tax Court noted in
passing that Fodor did not account for the insurance proceeds, nor did he account
for the premium usually associated with a controlling 83% interest in a company.3
Id. at 1308–09. The Tax Court, nonetheless, adopted Fodor’s estimate as a starting
point.
3
The Tax Court, however, completely ignored the significant value Blount represented to
the corporation. There is no discussion of the effect on BCC of losing Blount’s leadership,
connections, and general know-how. Because the Tax Court’s conclusion is within the range of
values suggested by the experts in the case, the result is not clearly erroneous.
6
Hitchner determined that the income-based value of BCC was in the range of
$4.8 to $6.4 million and that the asset-based value ranged from $7.5 to $7 million
over two years. Hitchner then weighted the asset-based value over the income-
based value in an undisclosed ratio to establish his value for BCC at $7 million.
Hitchner, unlike Fodor, determined that the $3 million in proceeds of the life
insurance policy should then be added to the base value. Hitchner set the value of
BCC at $10 million.
The Tax Court began with Fodor’s estimate but concluded that the expert
should not have offset the value by the ESOP buyout obligation—for which Fodor
made a $750,000 downward adjustment—and that BCC, therefore, was worth
$6.75 million. The court found that Hitchner overvalued BCC’s cash reserves and
that, when this overvaluation was corrected, Hitchner’s analysis also would value
the company near $6.75 million. Thus, the Tax Court concluded that both experts
essentially reached the same base value for the corporation.
Taking this base value of $6.75 million, the Tax Court found that the proper
value of the stock was $9.85 million, adding the insurance proceeds of $3.1 million
to compute the fair market value of the company Id. at 1322. This meant that the
value of Blount’s stock for estate tax purposes was $8.2 million, but the Tax Court
limited the amount assessed to the value determined by the IRS in its original
notice of deficiency, that is, just less than $8 million. Id. As a result of the Tax
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Court’s valuation of the BCC stock, additional taxes of approximately $1.36
million were paid by the Taxpayer to cover the deficiency.
II. DISCUSSION
We review de novo the Tax Court’s rulings on the interpretation and
application of the tax code. Roberts v. Comm’r, 329 F.3d 1224, 1227 (11th Cir.
2003) (per curiam). The Tax Court’s fact findings are reviewed for clear error.
Davenport Recycling Assocs. v. Comm’r, 220 F.3d 1255, 1258 (11th Cir. 2000).
In this case, we conclude that the $6.75 million valuation for BCC is not clearly
erroneous. However, we find the conclusion of the Tax Court, that the insurance
proceeds of $3.1 million should be added to the value of BCC, to be in error.
The federal estate tax applies to the transfer of a citizen’s taxable estate.
I.R.C. § 2001(a). The value of the taxable estate generally is the fair market value
of the decedent’s property at the date of death. See I.R.C. §§ 2031(a); 2033.
Consequently, the IRS has promulgated regulations to define the calculation of fair
market value. See Treas. Reg. § 20.2031-2. Courts have refined the guidance in
the regulations into an exception to the general rule for property that is subject to a
valid buy-sell agreement. See generally True v. Comm’r, 390 F.3d 1210,1218
(10th Cir. 2004) (collecting cases). The exception has three requirements: (1) the
offering price must be fixed and determinable under the agreement; (2) the
agreement must be binding on the parties both during life and after death; and (3)
8
the restrictive agreement must have been entered into for a bona fide business
reason and must not be a substitute for a testamentary disposition. Id.
This exception was codified and further limited in the Omnibus Budget
Reconciliation Act of 1990, Pub. L. 101-508, 104 Stat. 1388 (“OBRA”). This law
applies to all agreements created or substantially modified after 8 October 1990.
See OBRA § 11602(e). Under OBRA, the agreement also must (1) have a bona
fide business purpose, (2) not permit a wealth transfer to the natural objects of the
decedent’s bounty, and (3) be comparable to similar arrangements negotiated at
arm’s length.4 See I.R.C. § 2703; Treas. Reg. § 25.2703-1(b).
The Tax Court found that the stock-purchase agreement in this case was
unilaterally changeable during Blount’s lifetime, thereby violating the second
prong of the True test and Treas. Reg. § 20.2031-2(h). The court also determined
that the terms of the agreement and resulting calculation were not comparable to
similar transactions in the industry. Because the Tax Court concluded that the
agreement did not appropriately provide the value of the stock for estate tax
purposes, the court computed the fair market value of BCC. The Taxpayer
4
Citing the congressional record, courts generally agree that the limitation in I.R.C. §
2703 should be read in conjunction with the court-created rule. See Blount, 87 T.C.M. at 1310
(citing 136 Cong. Rec. S15683 (daily ed. Oct. 18, 1990)). The redundancy of “bona fide
business purpose” stands out, but under this construction, OBRA clarifies the third prong of the
case law exception: the buy-sell agreement must have a business purpose, not be a testamentary
disposition, and must be comparable to other transactions in the industry.
9
challenges each of the decisions of the Tax Court. First, we address whether the
1981 agreement, as amended by the 1996 modification, created a valuation that
was binding on the IRS. Next, we address the Tax Court’s fair market value
computation for the BCC shares held by Blount at the time of his death.
A. The 1981 Agreement
We agree with the Tax Court’s determination that the 1981 agreement was
substantially modified in 1996, thereby making the agreement subject to the tax
code changes in 1990 under OBRA. A substantial modification is one “that results
in other than a de minimis change to the quality, value, or timing of the rights of
any party.” Treas. Reg. § 25.2703-1(c)(1). The parties challenge neither the
application of Georgia law to the construction of the contract nor the result that the
document signed by Blount in 1996 constituted a modification of the 1981
agreement. Therefore, we must determine whether that modification was
“substantial” within the terms of the regulation.
The Tax Court concluded, from several perspectives, that the valuation
difference in the two agreements was substantial. First, the valuation under the
1996 agreement implicitly limited the value of BCC, at least with regard to
Blount’s stock, to $4.8 million—which is computed by dividing the amount to be
paid, $4 million, by Blount’s interest in BCC, 83%. The 1997 appraised value
established a book value of $8.5 million, which would have established the value
10
for the buyout without the 1996 agreement. Thus, one of the parties to the
agreement, BCC, would have substantially different requirements in the event of
performance after the modification versus before it.
The Tax Court pointed to other changes provided by the modification as
substantial changes in the rights of the parties to the contract. For example, BCC
lost the ability to pay the buyout in installments, a significant change in the seller’s
rights under the original contract. Further, by setting the price at $4 million
dollars, both parties lost the ability to have the price adjust according to the book
value or to an annually agreed-upon valuation. For these reasons, we conclude that
the 1996 agreement did substantially modify the 1981 agreement making the
modified agreement subject to OBRA. Because the 1981 agreement was
substantially modified after 8 October 1990, we review the Tax Court’s
determinations that the agreement failed to meet the exception to the general tax-
at-market-value rule under two alternative theories, as discussed in the next two
sections.
1. The Binding During Life Requirement
In order to qualify for the exception to the general rule that stock be valued
at its fair market value, the restrictive agreement must be binding during the life of
the decedent. See Treas. Reg. § 20.2031-2(h). The 1981 agreement provided that
it could only be modified by the “parties thereto.” Exh. 14-J at 6. Thus, by the
11
time the 1996 agreement was consummated, the only remaining parties were BCC
and Blount. Blount owned an 83% interest in BCC, was the only person on BCC’s
board of directors, and was the president of the company. The only parties to the
contract who were needed to change it were Blount and BCC, an entity that he
completely controlled.
The Taxpayer argues that the ESOP’s approval was required and was given
by the ESOP’s later consent. The ESOP, however, was not a party to the stock-
purchase agreement, and its consent was not necessary to modify that contract.
The ESOP, as a shareholder of BCC, had to be notified of any transfer or sale of an
interest in BCC, but the 1996 agreement did not transfer or sell any interest, so the
ESOP’s approval was not required. Blount essentially had the unilateral ability to
modify the 1981 agreement during his life, and, in fact, he did modify it during his
life. The 1981 agreement, therefore, does not meet the exception to the general
rule, and the value of the shares in Blount’s estate must be determined using a fair-
market valuation per I.R.C. § 2703.
2. The Comparability Requirement
The Tax Court, reasoning in the alternative, completed the I.R.C. § 2703(b)
analysis. It observed that the first two prongs of the test were not at issue.
Whether the Taxpayer proved that the agreement was comparable to similar
arrangements entered into at arm’s length was examined. Similar arrangements are
12
those that “could have been obtained in a fair bargain among unrelated parties in
the same business dealing with each other at arm’s length,” where a fair bargain is
one that “conforms to with the general practice of unrelated parties under
negotiated agreements in the same business.” Treas. Reg. § 25.2703-1(b)(4)(i).
The Tax Court observed that Grizzle, the Taxpayer’s witness on the issue of
comparability, established that the basis of his comparison was the sale/purchase
prices of similarly situated businesses. The court reviewed Grizzle’s testimony for
an indication that he considered noneconomic factors that would lead to truly
comparable transactions, but found none. The court noted from the outset that
Grizzle did not factor anything other than price into his equation of comparability.
Estate of Blount, 87 T.C.M. at 1315.
The court concluded that Grizzle’s estimate of BCC’s fair market value was
erroneous because he used only a cash flow-based calculation and failed to account
for $1.9 in liquid assets, and, as a result, he valued BCC at $2 million less than
other experts on the issue of fair market value. The Tax Court rejected Grizzle’s
conclusion that industry values were comparable and concluded that the agreement
price was not sufficiently close the other experts’ determinations for the agreement
to satisfy the statutory comparability exception. Based upon the record before us,
we find no error with the Tax Court’s conclusion. Because the stock-purchase
agreement did not establish the value of the stock for tax purposes, the Tax Court
13
properly concluded that it must establish the fair market value of BCC, on the
record before it, in order to discern the value of the Taxpayer’s interest.
B. The Fair Market Value of BCC
To establish the fair market value of BCC, the Tax Court blended the
analyses of the experts to arrive at a value of $6.75 million. The IRS and the
Taxpayer, albeit alternatively, agree that this is the base value for the assets and
liabilities of BCC as of the date of Blount’s death. We accept the accuracy of this
value as not clearly erroneous. The Tax Court then added the insurance proceeds
that BCC would receive on Blount’s death to the value of the company, concluding
that the value of BCC would have been $9.85 million. In doing so, the Tax Court
erred.
In valuing the corporate stock, “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 that such nonoperating assets have not
been taken into account in the determination of net worth.” Treas. Reg. § 20.2031-
2(f)(2). The limiting phrase, “to the extent that such nonoperating assets have not
been taken into account,” however, precludes the inclusion of the insurance
proceeds in this case. In Cartwright v. Commissioner, the Ninth Circuit approved
deducting the insurance proceeds from the value of the organization when they
were offset by an obligation to pay those proceeds to the estate in a stock buyout.
14
183 F.3d 1034, 1038 (9th Cir. 1999)5; see also Huntsman v. Comm’r, 66 T.C. 861,
875 (1976) 6.
The rationale in Cartwright is persuasive and consistent with common
business sense. BCC acquired the insurance policy for the sole purpose of funding
its obligation to purchase Blount’s shares in accordance with the stock-purchase
agreement. Even when a stock-purchase agreement is inoperative for purposes of
establishing the value of the company for tax purposes, the agreement remains an
enforceable liability against the valued company, if state law fixes such an
obligation.7 Here the law of Georgia required such a purchase.
5
The Ninth Circuit observed that the Tax Court “properly determined that [the] insurance
policy would not necessarily affect what a willing buyer would pay for the firm’s stock because
it was offset dollar-for-dollar by [the] obligation to pay out the entirety of the policy benefit’s to
[the] estate.” Cartwright, 183 F.3d at 1038.
6
The Tax Court focused on the word “consideration” to make its judgment about
including life insurance proceeds: “The Commissioner argues that our interpretation of section
20.2031-2(f), Estate Tax Regs., frustrates the clear intent of Congress to include
corporate-owned life insurance in the estate of its sole shareholder. See H. Rept. No. 2333, 77th
Cong., 1st Sess. (1942), 1942-2 C.B. 372, 491; S. Rept. No. 1631, 77th Cong., 2d Sess. (1942)
1942-2 C.B. 504, 677. However, the statements in the legislative history relied upon by the
Commissioner indicate only that Congress believed that a sole shareholder was deemed to have
the incidents of ownership possessed by his corporation on insurance policies on his life. The
regulations now provide that the incidents of ownership held by a corporation are not to be
attributed to its shareholder, and no indication is included in the committee reports that Congress
intended property owned by a decedent to be includable in his gross estate at other than its fair
market value. Consequently, our interpretation of such section does not frustrate a congressional
intent. In accordance with section 20.2031-2(f), Estate Tax Regs., we must determine the fair
market value of the decedent's stock in the two corporations by applying the customary
principles of valuation and by giving ‘consideration’ to the insurance proceeds.” Huntsman, 66
T.C. at 875–76.
7
Other courts have found—when the restrictive agreement is an attempt to effect a
testamentary transfer and avoid the estate tax—that honoring a restrictive element in determining
15
Thus, we conclude that the insurance proceeds are not the kind of ordinary
nonoperating asset that should be included in the value of BCC under the treasury
regulations. To the extent that the $3.1 million insurance proceeds cover only a
portion of the Taxpayer’s 83% interest in the $6.75 million company, the insurance
proceeds are offset dollar-for-dollar by BCC’s obligation to satisfy its contract with
the decedent’s estate. We conclude that such nonoperating “assets” should not be
included in the fair market valuation of a company where, as here, there is an
enforceable contractual obligation that offsets such assets. To suggest that a
reasonably competent business person, interested in acquiring a company, would
ignore a $3 million liability strains credulity and defies any sensible construct of
fair market value.
III. CONCLUSION
The Tax Court properly determined that the 1981 agreement, as amended by
the 1996 agreement, had no effect for purposes of determining the value of the
BCC shares in Blount’s estate and that the fair market value of the corporation was
the proper basis for tax assessment. The Tax Court erred when it ignored the
fair market value would be improper. See True v. Comm’r, 390 F.3d 1210, 1239–41 (10th Cir.
2004) (listing cases that honor restrictive clauses in determining value and cases that do not
honor such restrictive clauses). The IRS urges us to adopt the broadest rule that, when an
agreement is ignored for valuation purposes, the agreement plays no role in determining the fair
market value. We decline to do so because, as proved by this case, such a rule is overinclusive
and represents a manifest departure from common business (i.e., market) sense.
16
amended agreement’s creation of a contractual liability for BCC, which the
insurance proceeds were committed to satisfy. We reject the Tax Court’s inclusion
of the insurance proceeds paid upon the death of the insured shareholder as
properly included in the computation of the company’s fair market value. We
remand for disposition consistent with this opinion.
AFFIRMED IN PART AND REVERSED IN PART.
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