July, 2006 | Issue 4
In a recent Tax Court case, a successful showing of “arm’s-length” transactions helped buttress taxpayers’ use of an appraisal featuring a 50% lack-of-marketability discount.
Background
Members of the Huber family made gifts of stock of J. M. Huber Corp. during the period 1997 to 2000. The IRS believed that the value of the stock was under reported on the gift tax returns. The result was a Tax Court case called Huber, et al. v. Commissioner (T.C. Memo. 2006-960), decided May 9, 2006.
J. M. Huber Corp. (Huber) is a privately-held diversified company based in Edison, New Jersey. The company at the time in question had annual sales of in excess of $500 million and approximately 250 shareholders. It is one of the largest family-owned companies in America.
Appraisal
The donors of the Huber stock valued the stock for gift tax purposes based on a report prepared by an independent appraiser. The company had engaged this appraiser since 1993 to prepare annual valuations of its stock. These valuations were used for a variety of purposes, including; (1) valuing gifts of Huber shares made to non-profit organizations, (2) valuing stock options granted to the company’s CEO, (3) fixing the compensation of Huber’s board members, (4) evaluating the performance of Huber as a whole, (5) valuing shares that are bought back by Huber from its shareholders, and (6) valuing shares in transactions between Huber shareholders.
The appraiser had used a consistent method for preparing its valuation. It compared Huber to comparable publicly-traded companies. It then applied a 50% lack-of-marketability discount from the freely-traded value of the shares to arrive at its valuation.
IRS Position
The IRS agreed with the freely-traded values of Huber shares established by the appraiser. They took issue, however, with the 50% lack-of-marketability discount. They proposed discounts ranging from 25% to 45% during the years in question.
The IRS also rejected the appraiser’s values on the grounds that sales at these values were not arm’s-length transactions.
Court Analysis
The Court began its analysis based on the following premise: “In determining the value of unlisted stocks, actual arm’s-length sales of the stock in the normal course of business within a reasonable time before or after the valuation date are the best criteria of market value.”
The Court then proceeded to examine some of the more than 90 transactions that had taken place in Huber stock from 1994 to 2000, all based on the appraiser’s value. It examined the relationships between the parties, the presence or lack of compulsion on the part of the seller, the reasonableness of the shareholders’ reliance on the appraiser’s value, and the intent of the parties with respect to the sales.
The Court concluded that while there were close family relationships between parties in some of the sales, this is neutralized by the fact that many of the transactions took place between parties that were hardly related or unrelated and who had fiduciary obligations to obtain the best price.
The Court also satisfied itself as to the lack of compulsion on the part of the sellers, their intent, and the degree to which they were informed of the appraiser’s opinion.
Conclusion
Having satisfied itself on these matters, the Court expressed itself as follows; “We conclude that the sales of Huber stock established in the record are arm’s-length sales that demonstrate the best reference for the valuation of Huber shares on petitioners’ gift tax returns.”
