The Tax Court and Expert Valuations
Nelson v. Comm’r, T.C. Memo. 2020-81 | June 10, 2020 | Pugh, J. | Dkt. Nos. 27313-13, 27321-13
Short Summary: Mrs. Nelson’s father cofounded Compressor Systems, Inc. (CSI). CSI sells and rents gas compression equipment to the oil and gas industry and provides financing and maintenance services in connection with that equipment. Mrs. Nelson’s father continued to expand his family businesses throughout his life, operating in Texas as a Caterpillar-approved dealer in certain territories.
As part of this expansion, Mrs. Nelson’s father organized Warren Equipment Co. (WEC), which was a holding company that owned 100% of seven other operating subsidiaries, including CSI. After his death, Mrs. Nelson indirectly through Longspar held most of the common and preferred stock in WEC. Longspar was formed as a Texas limited partnership to: (1) consolidate and protect assets; (2) establish a mechanism to make gifts without fractionalizing interests; and (3) to ensure that WEC remained in business and under family control.
On December 23, 2008, the taxpayers (Mr. and Mrs. Nelson) formed the Nelson 2008 Descendants Trust (Trust). Mr. Nelson is a beneficiary of the Trust, along with their four daughters. Thereafter, Mrs. Nelson made two transfers of limited partnership interests in Longspar to the Trust. The first transfer occurred on December 31, 2008, and was done via a Memorandum of Gift and Assignment of Limited Partner Interest for $2,096,000 “as determined by a qualified appraiser within ninety (90) days of the effective date of this Assignment.” The second transfer occurred on January 2, 2009, and was done via a Memorandum of Sale and Assignment of Limited Partner Interest for $20,000,000 “as determined by a qualified appraiser within one hundred eighty (180) days of the effective date of this Assignment.” In connection with the second assignment, the Trust executed a promissory note for $20 million.
After the assignments, the taxpayers hired an appraiser to value the limited partnership interests in Longspar. The appraiser concluded that, as of the valuation date, the fair market value of a 1% limited partnership interest in Longspar was $341,000. In arriving at this conclusion, the appraiser relied on a fair market valuation of WEC’s common stock completed by Ernst & Young. Thus, on the basis of his valuation, the appraiser determined that Mrs. Nelson’s December 31, 2008, and January 2, 2009, transfers equated to the rounded amounts of 6.14% and 58.65% limited partnership interests in Longspar, respectively.
The taxpayers filed separate Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Returns for 2008 and 2009. On their 2008 Forms 709 they each reported the gift to the Trust “having a fair market value of $2,096,000 as determined by independent appraisal to be 6.1466275% limited partner interest” in Longspar. They did not report the January 2, 2009, transfer.
The 2008 and 2009 gift tax years were audited by the IRS. Later, the IRS issued notices of deficiency determining that the taxpayers had undervalued the December 31, 2008, gift and that their halves of the gift were each worth $1,761,009 rather than $1,048,00 as of the valuation date. The IRS also determined that the taxpayers had undervalued the January 2, 2009, transfer by $13,607,038 and therefore concluded that each had made a split gift in 2009 of $6,803,519.
Key Issue: Whether the interests in Longspar Partners, Ltd. (Longspar), transferred on December 31, 2008, and January 2, 2009, were fixed dollar amounts or percentage interests; and (2) the fair market value of those interests.
- Nelson transferred 6.14% and 58.65% Longspar limited partnership interest to the Trust.
- The WEC common stock should be discounted 15% for lack of control and 30% for lack of marketability, resulting in a fair market value of $912 per share. Therefore, the controlling, marketable value of Longspar is $60,729,361.
- Discounts of 5% for lack of control and 28% for lack of marketability should apply to calculate the fair market value of a Longspar limited partnership interest. As a result, a 1% Longspar limited partnership interest has a fair market value of $411,235 and the 6.14% and 58.65% interests Mrs. Nelson transferred to the Trust have fair market values of $2,524,983 and $24,118,933, respectively.
Key Points of Law:
- Section 2501(a) imposes a tax on the transfer of property by gift. When property is transferred for less than an adequate and full consideration, then the amount by which the value of the property exceed the value of the consideration shall be deemed a gift. 2512(b). Generally, the valuation of property for federal tax purposes is a question of fact. Adams v. U.S., 218 F.3d 383, 385-86 (5th Cir. 2000).
- The fair market value of property transferred is the price at which it would change hands between a willing buyer and a willing seller, neither under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts. S. v. Cartwright, 411 U.S. 546, 551 (1973). The willing buyer and willing seller are purely hypothetical figures and valuation does not take into account the personal characteristics of the actual recipients of the property being valued. Estate of Newhouse v. Comm’r, 94 T.C. 193, 218 (1990).
- With respect to a closely held entity, a determination of its fair market value for federal gift tax purposes depends upon all of the relevant facts and circumstances. Estate of Smith v. Comm’r, 198 F.3d 515, 526 (5th 1999). These relevant facts and circumstances include whether discounts for lack of control and lack of marketability factor into the fair market value of a closely held entity’s stock. Estate of Newhouse, 94 T.C. at 249; Estate of Magnin v. Comm’r, T.C. Memo. 2001-31.
- To resolve valuation issues, the Tax Court may consider expert witness opinions properly admitted into evidence. Helvering v. Nat’l Grocery Co., 304 U.S. 282, 295 (1938). In doing so, the Tax Court will weigh each expert’s opinion in the light of the expert’s qualifications and other credible evidence. Estate of Newhouse, 94 T.C. at 217. The Tax Court has “broad discretion to evaluate the cogency of . . . [the] expert’s analysis.” Davis v. Comm’r, T.C. Memo. 2015-88. If the Tax Court finds one expert’s opinion persuasive, it may accept that opinion in whole or in part over that of the opposing expert. Estate of Davis v. Comm’r, 110 T.C. 530, 538 (1998). Alternatively, it may reach an intermediate conclusion as to value by drawing selectively from the testimony of various experts. Parker v. Comm’r, 86 T.C. 547, 562 (1986). For a value or discount it is not necessary that the value arrived at by the trial court be a figure as to which there is specific testimony, if it is within the range of figures that may properly be deduced from the evidence. Anderson v. Comm’r, 250 F.2d 242, 249 (5th 1957).
- But, property exchanged for “adequate and full consideration” does not constitute a gift for Federal gift tax purposes.Indeed, the regulations confirm that “the gift tax is not applicable to a transfer for full and adequate consideration in money or money’s worth, or to ordinary business transactions.” Reg. § 25.2511-1(g)(1). For these purposes, the regulations define a transfer in the ordinary course of business as “a transaction which is bona fide, at arm’s length, and free from any donative intent.” Treas. Reg. § 25.2512-8; Weller v. Comm’r, 38 T.C. 790, 805-06 (1962). A transaction meeting this standard will be considered as made for an adequate and full consideration in money or money’s worth. Treas. Reg. § 25.2512-8. However, a transaction between family members is subject to special scrutiny, and the presumption is that a transfer between family members is a gift. Frazee v. Comm’r, 98 T.C. 554, 561 (1992).
- The Tax Court looks to the transfer documents rather than subsequent events to decide the amount of property given away by a taxpayer in a completed gift. Estate of Petter v. Comm’r, T.C. Memo. 2009-280. And courts have rejected saving clauses because they relied on conditions subsequent to adjust gifts or transfers so the size of the transfer (as measured either in dollar amount or percentage) could not be known.
- The Tax Court has applied minority interest discounts for holding companies. See Estate of Litchfield v. Comm’r, T.C. Memo. 2009-21; Lappo v. Comm’r, T.C. Memo. 2003-258; Hess v. Comm’r, T.C. Memo. 2003-251.
Insight: As with many valuation issues in tax litigation, the Nelson case involved a battle of expert opinions. When large gifts are made, taxpayers are well advised to seek qualified appraisals of any gift transfers and document the transfers accordingly.
Need assistance in managing the Tax Compliance process? With our unique substantive and procedural knowledge, we can provide a comprehensive approach to the tax dispute resolution process, often collaborating with clients’ existing tax professionals to formulate creative solutions to the most complex tax problems. Freeman Law offers value-driven legal services and provides practical solutions to complex tax issues. Schedule a consultation now or call (214) 984-3410 to discuss your tax concerns and questions?