Valuation of Corporate Stock (Portfolio 831)

Tax Management Portfolio, Valuation of Corporate Stock, No. 831-4th, discusses the methods for valuing corporate stock when the value can be readily determined by reference to an established market.

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Tax Management Portfolio, Valuation of Corporate Stock, No. 831-4th, discusses the methods for valuing corporate stock when the value can be readily determined by reference to an established market. It also deals with the valuation of corporate stock when the value can not be readily determined by reference to an established market. It begins with the criteria used by the IRS for valuing stock, particularly Rev. Rul. 59-60, as well as the cases interpreting the IRS's standards. It also discusses the effect of buy-sell agreements on the value of stock, and delineates the requirements for an agreement that will be respected for transfer tax valuation purposes.
The portfolio reviews the impact of the Chapter 14 special valuation rules on the valuation process, particularly the effect of §§2701 and 2704. A portion of the portfolio is devoted to the various discounts available in valuing corporate interests, including lack of marketability, minority interests, and securities law restrictions. In addition, the portfolio sets forth the criteria for obtaining a discount from the quoted market value of large blocks of publicly traded securities, the so-called “blockage” discount. In discussing all these topics, the portfolio reviews the statutory basis for valuation discounts, the significant elements and factors considered by the courts in deciding the appropriateness of a discount, and the valuation techniques used to determine the amount of a discount. Other topics are also discussed as they relate to the concept of valuation of corporate stock.
The portfolio concludes with Worksheets, two of which are charts that summarize the significant discount and blockage court decisions.
For more detailed discussion of related topics, see 835 T.M., Transfers of Interests in Family Entities Under Chapter 14: Sections 2701, 2703 and 2704; 833 T.M., Section 2032A — Special Use Valuation, and 830 T.M., Valuation: General and Real Estate.
This portfolio may be cited as Mezzullo, 831-4th T.M., Valuation of Corporate Stock.

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Louis A. Mezzullo, University of Maryland (B.A. 1967, M.A. 1976), University of Richmond (J.D. 1976); Partner, Luce, Forward, Hamilton & Scripps LLP, 2006 to present; Partner, McGuireWoods LLP, Richmond, Virginia, 2003 to 2006; Member, Mezzullo & Guare, PLC, Richmond, Virginia, 2000 to 2003; Founding Member, Mezzullo & McCandlish, Richmond, Virginia, 1982 to 2000; Adjunct Professor, University of Miami School of Law, University of Richmond Law School; Author, 803 T.M., The Mobile Client: Tax, Community Property, and Other Considerations; 809 T.M., Estate Planning for Owners of Closely Held Business Interests; 812 T.M., Family Limited Partnerships and Limited Liability Companies; 814 T.M., Estate and Gift Tax Issues for Employee Benefit Plans; 835 T.M., Transfers of Interests in Family Entities Under Chapter 14: Sections 2701, 2703 and 2704. Author, An Estate Planner's Guide to Buy-Sell Agreements; An Estate Planner's Guide to Life Insurance; An Estate Planner's Guide to Qualified Retirement Plan Benefits; An Estate Planner's Guide to Family Business Entities; and Valuation Rules Under Chapter 14, all published by the American Bar Association, and Limited Liability Companies in Virginia, published by the Virginia Law Foundation; Co-author, Advising the Elderly Client, published by Clark, Boardman, Callaghan; Former Chair, American College of Tax Counsel; President-Elect, American College of Trust and Estate Counsel; Charter Fellow, American College of Employee Benefits Counsel; Past Chair, ABA Section of Real Property, Trust and Estate Law (2000–01); former Vice-Chair of Publications and Current Chair of the Chapter 14 Subcommittee of the Estate and Gift Taxes Committee of the ABA Section of Taxation; and Academician and Vice President, International Academy of Trust and Estate Law.


Detailed Analysis

I. Introduction

II. Valuation of Publicly Traded Stock

A. Introduction

B. Mechanics of the Regulations

C. Determining Whether the Market Is Free from Abnormal Influence

1. Controlling Interest Being Valued

2. Economic Factors

3. Public Knowledge

4. Market Manipulation

5. Effect of a Public Offering

D. Impact of Actual Transactions on Valuation Where Market Not Open

1. Determining Whether an Open Market Exists

a. Level of Market Activity

b. Proximity to Valuation Date

c. Volume of Shares

2. Additional Factors Influencing Weight Accorded Actual Transactions Where Market Not Open

a. Intra-Family Sales

b. Sales Involving Corporate “Insiders”

c. A Corporation's Purchase of Its Own Stock

d. Compulsion Sales

III. Blockage and Restricted Stock

A. Introduction

B. Authority for the Blockage Discount

C. Determining an Appropriate Blockage Discount and Building a Case

1. Importance of Evidentiary Support

2. Factors to Consider

a. Quoted Price

b. Degree of Market Depth and Activity

(1) Market Depth

(2) Market Activity

c. Size of the Block

d. The “Reasonable Time” Factor

e. Market Trend

f. Other Factors

D. Special Rule for Gift Tax Cases

E. Valuation Methods When a Blockage Discount Is Applicable

F. Restricted Securities

1. The Relationship of Blockage to Restricted Stock Discounts

2. Background Information

a. When a Security Is Considered “Restricted”

b. Synopsis of Rule 144

3. Estate Administration and Restricted Securities

IV. Valuation of Closely Held Stock

A. Introduction

B. Potential Valuation Methods

1. Book Value/Asset Value Approach

2. Earnings Approach

3. Dividend Approach

4. The Market Approach

5. Other Approaches

C. Revenue Ruling 59-60 and the Intrinsic Factors

1. The Nature and History of the Business

2. Economic Outlook

3. Book Value and Financial Condition

a. Adjusted Book Value of Significant Importance

b. Book Value of Minor Importance

4. Earning Capacity

5. Dividend-Paying Capacity

6. Goodwill and Intangibles

7. Sales of the Stock and the Size of the Block of Stock to Be Valued

8. Market Price of Comparables

9. Weight Accorded Various Factors

10. Capitalization Rates

11. Average of Factors

12. Restrictive Agreements

D. Practical Application of Revenue Ruling 59-60

E. The Role of the Subtraction Method

1. Introduction

2. Tax Court Rejection of Subtraction Method in the Newhouse Case

a. Factual Background

b. The Court's Valuation Approach

3. Impact of § 2701

4. Future of the Subtraction Method

F. Impact of Post-Valuation Date Facts

G. Role and Importance of Qualified Appraisers

V. Restrictive Agreements

A. Introduction

B. Estate Tax - Treasury Position

C. Interpretation of Estate Tax Regulation and Revenue Ruling 59-60

1. Obligation of Estate to Sell

2. Lifetime Transfers

3. Determination of Price

4. Bona Fide Business Arrangement

D. Restrictions Affecting (as Opposed to Controlling) Estate Tax Valuation of Shares

E. Restriction on a Portion of Decedent's Shares

F. Restrictive Agreements Contingent upon IRS Acceptance

G. Gift Tax

H. Effect of § 2703

1. Section 2703 Generally

2. Requirements

3. Using § 2703 to Ignore a Partnership Owning Corporate Stock

4. Effective Date

VI. Chapter 14 Special Valuation Rules - Sections 2701 and 2704

A. Introduction

B. Section 2701

1. Generally

2. Transfers Subject to § 2701

3. Family Members and Applicable Family Members

4. Applicable Retained Interests

5. Valuation of Applicable Retained Interests

6. Valuation of Gifts Subject to § 2701

7. Failure to Make Qualified Payments

C. Section 2704

1. Generally

2. Section 2704(a)

3. Section 2704(b)

4. Definitions and Effective Date

VII. Discounts and Premiums

A. Introduction

B. Minority Interest Discount

1. General Principle

2. Application of Discount to Normative Value

3. Historical Development

4. Interests to Which Minority Interest Discounts Apply

a. Definition of “Control”

b. Noncontrol Block Transferred by Controlling Stockholder with No One Thereafter Holding a Majority of the Shares

c. Controlling Block Transferred with No One Thereafter Holding a Majority of the Shares

d. Noncontrol Block Transferred to Controlling Stockholder or to Stockholder Who Acquires Control by Virtue of Transfer

e. Impact of Swing Vote on Minority Discount

5. Mitigation of Discount Due to State Law Protections

C. Control Premium

1. Introduction

2. What Is a Control Premium?

3. Effective Versus Actual Control

4. Attribution of Ownership Among Family Members in Determining Control

5. Impact of Community Property Laws on Determining Control

6. Varying Application of Control Premium for Estate Inclusion and Deduction Purposes

D. Lack of Marketability Discount

E. Special Use Valuation Under § 2032A

F. Family-Owned Business Deduction Under § 2057

G. Other Discounts

1. Key Employee Discount

2. Nonvoting Stock Discount

3. Regulatory and Litigation Discounts

4. Corporate Built In Gain Tax Discounts After General Utilities Repeal

H. Concerns Regarding the Appropriateness of Estate Planning to Create Discounts

VIII. Penalties


Working Papers


Worksheet 1 Summary of Discounts and Premiums in Selected Cases

Worksheet 2 Chart Analyzing Key Blockage Cases

Worksheet 3 Rev. Rul. 59-60, 1959-1 C.B. 237 Valuation of Stocks and Bonds

Worksheet 4 SEC Rule 144

Worksheet 5 Excerpt from IRS Valuation Training for Appeals Officers Coursebook - Restrictive Agreements/Buy-Sell Agreements (Training 6126-002 (Rev. 10-93))

Worksheet 6 Excerpt from IRS Valuation Training for Appeals Officers Coursebook - Restricted Securities and Investment Company Valuation (Training 6126-002 (Rev. 10-93))

Worksheet 7 Examination Technique Handbook for Estate Tax Examiners IRM 4350-31, Ch. 700 (12-16-87)

Worksheet 8 Business Valuation Guidelines, IRM 4.48.4 (7/1/06)






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