September 2011 | Issue 54
Introduction
Estate of Giustina v. Commissioner, T. C. Memo. 2011-141 (June 22, 2011), is a US Tax Court case involving the value, for estate tax purposes, of a 41.128 % limited partner interest in Giustina Land & Timber Co. LP (“GLT”) owned by Natale Guistina at his death on August 13, 2005. GLT owned and operated 48,000 acres of timberland in the area of Eugene, Oregon.
The estate valued the holding at $12,995,000 for estate tax purposes. The IRS contended that the value was $33,515,000. The IRS issued a notice of deficiency determining a $12,657,506 deficiency in estate tax and a $2,531,501 accuracy-related penalty under section 6662 of the Internal Revenue Code.
Taxpayer’s Approach to Value
Both the taxpayer and the IRS employed experts to determine the value of the GLT holding. The estate’s expert employed four methods, two that were based on the expected cash flow of GLT as an operating entity, one method based on the asset value of the timber holdings, and one method based on the price of shares of publicly-traded timber companies. These values were used to calculate a weighted average value of $12,995,000.
IRS Approach to Value
The IRS’s appraiser also calculated a cash flow value, an asset based value, and a value based on the price of shares of publicly-traded companies. His approach produced a weighted-average value of $33,515,000.
The stark difference between the value conclusions of the two appraisers was primarily attributable to two factors. First, the IRS appraiser assigned considerably more weight to the asset value approach, as compared to the cash flow approach. The asset value was considerably higher than the cash flow value. By comparison, the estate’s appraiser gave more weight to the cash flow approach than to the asset approach. Furthermore, the estate’s appraiser applied a 25% haircut to the cash flow approach value to reflect the fact that the limited partners of GLT would have to pay income taxes on the partnership’s income.
The Court’s Value Conclusion
Judge Morrison performed a valuation calculation of his own. He rejected the analyses based on publicly-traded companies because he believed that they were not sufficiently similar to the subject company. He confined himself to utilizing the cash flow and the asset approach. He rejected the 25% tax adjustment employed by the estate’s appraiser in his cash flow analysis on the grounds that his cash flow discount rate was a pretax rate, which should be matched to pretax cash flows.
Finally, the judge assigned a 25% weight to the asset approach and a 75% weight to the cash flow approach, producing a value of $27,454,115. He felt that the cash flow approach was the appropriate method to value GLT as an operating timber company, and that a 75% weighting represented the probability that GLT would continue to be operated as a timber company.
The Underpayment Penalty
Sec. 6662 provides for a penalty of 20% of any underpayment attributable to a “substantial estate *** tax valuation understatement.” At the time this return was filed, there was considered to be a substantial understatement if the value of the property shown on the return was 50% or less of the correct value. In this case, the value claimed on the tax return was $12,678,117. This is less than 50% of the correct value of $27,454,115. Therefore there was a substantial estate-tax valuation understatement.
There is, however, no underpayment penalty imposed with respect to an underpayment if there is reasonable cause for the underpayment and if the taxpayer acted in good faith.
The judge took into account in this case that the executor of the estate (Larry Giustina, the decedent’s son) hired a lawyer to prepare the estate tax return. The lawyer hired an independent appraiser to value the LP interest. The judge felt that it was reasonable for the executer to rely on the appraisal. He felt that the valuation was made in good faith and with reasonable cause, and that therefore the estate was not liable for a section 6662 underpayment penalty.
IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction(s) or tax-related matter(s) addressed herein.
