By David Rudman, CPA/ABV, CVA – Sigma Valuation Consulting, Inc.
Synopsis: In Grieve v. Commissioner (T.C. Memo. 2020-28) published March 2, 2020, the IRS found a deficiency in the petitioner’s 2013 Federal gift tax and applied an unusual valuation theory in an attempt to minimize valuation discounts where the entity’s ownership was split between voting and non-voting interests. The tax court subsequently rejected the IRS’ valuation theory.
Introduction Pierson M. Grieve, the petitioner, was the Chairman and CEO of Ecolab, Inc. and during his tenure at the Company (1983 to 1996), he accumulated wealth through the acquisition of Ecolab stock. The petitioner was married to Florence Grieve and had three children. After the death of Florence Grieve, the Grieve’s eldest daughter, Margaret took over the full-time role of managing the family’s wealth. The petitioner established the Grieve Family Limited Partnership and Pierson M. Grieve Management Corp (PMG) was the general partner of the Limited Partnership. Margaret worked with a law firm to develop an updated estate plan and two companies were created: Rabbit and Angus. Both of these companies were formed under Delaware law in July and August of 2012.
The Gift The petitioner commenced two gifts during 2013: one gift to a GRAT (Rabbit) and a single-life private annuity agreement to an irrevocable trust (Angus). The assets in the two gifting transactions included promissory notes, securities, investments, cash and cash equivalents. The petitioner filed his United States Gift Tax Return along with valuation appraisal reports prepared by an independent valuation firm.
Gift Tax Valuation Dispute The valuation firm applied a discount for lack of control (DLOC) of 13.4% for Rabbit and a 12.7% DLOC for Angus. For the discount for lack of marketability (DLOM), the valuation firm reported a discount of 25% for both companies. The IRS opposed these discount valuations and its expert, Mr. Mitchell, took a unique approach by calculated a premium that non-voting members would need to pay to the Class A 0.2% voting members as inducement to acquire the voting interests.
The IRS’ business valuation expert supported the IRS’ valuation theory by providing reports on the net asset value (NAV) of both Rabbit and Angus corporations. Rather than attacking the discounts put forth by the taxpayer’s valuation expert, the IRS took the position that the non-voting member would desire to buy the Class A voting interests at a premium (albeit one far smaller than the dollar amount of the valuation discounts put forth in the taxpayer’s valuation report). Mr. Mitchell stated that any willing seller of the Class B non-voting interests would look to acquire control of the 0.2% voting interest held by the Class A unit holder. This stance was the key in supporting the IRS’ valuation theory. He calculated that reasonable premiums for interests in Rabbit and Angus would be $130,000 and $450,000, respectively.
Margaret, who was the sole owner of the Class A units, testified that she had no intention of selling the Class A units. She further explained that if she were to sell any of the Class A units, she would demand a much greater premium than what the IRS estimated.
Additionally, she stated that if the Class B units were sold outside of her family, she would require a management fee.
Court opinion The Tax Court concluded that Mr. Mitchell’s reports did not provide enough evidence for the valuation estimates he claimed for both Rabbit and Angus, and the Court also expressed concern about the assumption of subsequent events in the determination of value. In its analysis of the facts, the Tax Court also stated that “the reports provided no details on how the discounts were determined”. Without information showing how Mr. Mitchell arrived at his calculations, the Court did not support adopting any of his proposed estimates. The Court ruled in favor of the petitioner and accepted the taxpayer’s discounts for lack of control and lack of marketability. The Court was persuaded that the valuations provided by the taxpayer’s expert were the most accurate and reliable and had no reason to object the discounts presented.
Comments The Fair Market Value (FMV) standard is defined as, “the price at which property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, and both parties have reasonable knowledge of the relevant facts.” Valuation as of a specified date is based on facts that are known or knowable as of that date.
In the subject case, we believe the IRS’ argument fails the definition of FMV, as there was no evidence (and actually evidence to the contrary) that a willing seller existed as of the date of valuation under the IRS’ valuation theory. Additionally, as the Tax Court highlighted, the consideration of a hypothetical subsequent event also fails the ‘known or knowable’ test.
A correct decision for the taxpayer!