1 All section references are to the Internal Revenue Code

in effect at the date of decedent's death, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

T.C. Memo. 1999-76

UNITED STATES TAX COURT

ESTATE OF WILLIAM J. DESMOND, DECEASED, 

DONN KEMBLE, EXECUTOR, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 26237-96. Filed March 10, 1999. 

Donn Kemble, for petitioner.

Jeffrey A. Schlei and Michael H. Salama, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

VASQUEZ, Judge: Respondent determined a deficiency of

$1,055,053 in, and a section 6662(b)(1) penalty of $211,011 on,

the Federal estate tax of the estate of decedent William J.

Desmond.1
- 2 -

2 The parties stipulated that petitioner is not liable for

the negligence penalty under sec. 6662. Additionally, on brief,

respondent conceded that petitioner is entitled to deductions

related to administrative expenses and for interest paid. 

3 References to "petitioner" are to the executor of

decedent's estate.

After concessions,2 the sole issue for decision is the fair

market value of: (1) Decedent's interest in Deft, Inc. (Deft),

and (2) real property located at 12 Rue Verte, Newport Beach,

California (the Newport property) and at 45-550 Navajo Road,

Indian Wells, California (the Indian Wells property).

FINDINGS OF FACT

William J. Desmond, decedent, died on June 17, 1992. At the

time of his death, decedent resided in Orange County, California.

On or about September 22, 1993, an estate tax return on his

behalf was filed. For purposes of valuing his gross estate,

petitioner3 elected to use the alternate valuation date, December

17, 1992. At the time the petition was filed, petitioner resided

in Newport Beach, California.

At the time of his death, decedent, as trustee, held 136,000

shares of Deft stock. This represented 81.93 percent of Deft's

total outstanding shares. 

The Deft stock is closely held, unlisted stock. All stock

in Deft was subject to a restrictive share agreement which

provided that a shareholder could transfer his or her stock to a

nonshareholder only after the shareholder offered the shares to

the remaining shareholders. 
- 3 -

 Deft is an S corporation that manufactures and sells

industrial coatings for military and commercial aircraft, heavy

duty trucks, and construction equipment. Deft also manufactures

and sells finishes and wood stains. 

Deft, like other paint companies, is a hazardous waste

producer. From 1974 until 1991, Deft disposed of its hazardous

waste at three disposal sites. As a result of its waste

disposal, Deft faced large potential environmental liabilities.

On decedent's estate tax return, petitioner reported that

the fair market value of decedent's interest in Deft was

$6,160,576. This included a $2,306,250 reduction for Deft's

potential environmental liabilities. KPMG Peat Marwick (KPMG)

computed this figure for purposes of preparing the estate tax

return. 

In addition to owning Deft stock, decedent also owned two

pieces of real property at his death. On the estate tax return,

petitioner reported that on the alternate valuation date the fair

market value of the Newport property was $800,000. On or about

May 6, 1994, the Newport property was sold for a net sales price

of $699,933. 

On the estate tax return, petitioner reported that on the

alternate valuation date the fair market value of the Indian

Wells property was $280,000. On or about July 29, 1994, the

Indian Wells property was sold for a net sales price of 

$267,782.
- 4 -

OPINION

I. Value of Decedent's Interest in Deft

A. Valuation of Closely Held, Unlisted Stock

Property is included in a decedent's gross estate at its

fair market value as of the date of the decedent's death or, if

the executor elects, as of the alternate valuation date. See

secs. 2031(a), 2032(a); sec. 20.2031-1(b), Estate Tax Regs. 

Under section 2032(a)(2), the alternate valuation date is the

date 6 months after the decedent's death. 

Fair market value is the price at which property would

change hands between a willing buyer and a willing seller,

neither being under any compulsion to buy or sell and both having

reasonable knowledge of relevant facts. See United States v.

Cartwright, 411 U.S. 546, 551 (1973); Estate of Gilford v.

Commissioner, 88 T.C. 38, 48 (1987); sec. 20.2031-1(b), Estate

Tax Regs. The willing buyer and the willing seller are

hypothetical persons. See, e.g., Estate of Newhouse v.

Commissioner, 94 T.C. 193, 218 (1990). 

Determining the fair market value of closely held, unlisted

corporate stock is difficult because it involves property that

has no public market. The valuation of such stock is a matter of

judgment rather than of mathematics. See Hamm v. Commissioner,

325 F.2d 934, 940 (8th Cir. 1963), affg. T.C. Memo. 1961-347. 

The best method for valuing closely held, unlisted stock is by

reference to actual arm's-length sales of the stock in the normal

course of business within a reasonable time before or after the
- 5 -

valuation date. See Estate of Andrews v. Commissioner, 79 T.C.

938, 940 (1982); sec. 20.2031-2(b), Estate Tax Regs.

In the absence of arm's-length sales, the Court decides the

stock's fair market value by considering factors such as the

company's net worth, prospective earning power, dividend-paying

capacity, management, goodwill, position in the industry, the

economic outlook in its industry, and the values of publicly

traded stock of comparable corporations. See sec. 2031(b);

Estate of Hall v. Commissioner, 92 T.C. 312, 336 (1989); Estate

of Andrews v. Commissioner, supra. There is no fixed formula for

applying these factors. The weight accorded each factor is

determined by the facts and circumstances of each case. See

Messing v. Commissioner, 48 T.C. 502, 512 (1967). As the trier

of fact, the Court has broad discretion in weighing the various

factors. See Estate of O'Connell v. Commissioner, 640 F.2d 249,

251 (9th Cir. 1981), affg. on this issue T.C. Memo. 1978-191.

When valuing unlisted stock, it is sometimes appropriate to

apply a lack of marketability discount to the price in order to

reflect the absence of a recognized market for closely held stock

and to account for the fact that closely held stock is generally

not readily transferable. See Mandelbaum v. Commissioner, T.C.

Memo. 1995-255, affd. 91 F.3d 124 (3d Cir. 1996); Estate of

Trenchard v. Commissioner, T.C. Memo. 1995-121; Rev. Rul. 77-287,

1977-2 C.B. 319, 320-321. This discount also may reflect the

expense of registering the unlisted stock for public sale. See
- 6 -

Mandelbaum v. Commissioner, supra; Estate of Trenchard v.

Commissioner, supra.

Some of the factors examined by courts in determining the

amount of an appropriate lack of marketability discount are: (1)

The cost of a similar corporation's public and private stock; (2)

an analysis of the subject corporation's financial statements;

(3) the corporation's dividend-paying capacity, its history of

paying dividends, and the amount of its prior dividends; (4) the

nature of the corporation, its history, its position in the

industry, and its economic outlook; (5) the corporation's

management; (6) the degree of control transferred with the block

of stock to be valued; (7) any restriction on the transferability

of the corporation's stock; (8) the period of time for which an

investor must hold the subject stock to realize a sufficient

profit; (9) the corporation's redemption policy; and (10) the

cost of effectuating a public offering of the stock to be valued. 

See Estate of Gilford v. Commissioner, supra at 60; Mandelbaum v.

Commissioner, supra; Rev. Rul. 77-287, supra.

Additionally, a control premium may be appropriate when

valuing a large block of stock. A control premium represents the

additional value associated with the shareholder's ability to

control the corporation through his dictation of its policies,

procedures, or operations. See Estate of Chenoweth v.

Commissioner, 88 T.C. 1577, 1581-1582 (1987); Estate of Trenchard

v. Commissioner, supra; Rev. Rul. 59-60, 1959-1 C.B. 237, 242. 

This premium for control is distinct and separate from any
- 7 -

discount applied for lack of marketability. See Estate of

Trenchard v. Commissioner, supra.

B. Expert Reports Regarding the Fair Market Value

 of the Deft Stock

In deciding valuation cases, courts often look to expert

opinions. The Court is not bound by the opinion of any expert,

and we may accept or reject in full or in part experts' opinions

proffered by the parties. See Helvering v. National Grocery Co.,

304 U.S. 282, 294-295 (1938); Seagate Tech., Inc., & Consol.

Subs. v. Commissioner, 102 T.C. 149, 186 (1994); Estate of

Newhouse v. Commissioner, supra at 217; Parker v. Commissioner,

86 T.C. 547, 562 (1986); Chiu v. Commissioner, 84 T.C. 722, 734

(1985). Moreover, the Court is free to value property at a

figure for which there is no specific testimony as long as it is

within the range of figures that can be adduced from the

evidence. See Silverman v. Commissioner, 538 F.2d 927, 933 (2d

Cir. 1976), affg. T.C. Memo. 1974-285; Estate of Davis v.

Commissioner, 110 T.C. 530, 537 (1998).

The parties herein rely on experts' opinions to establish

the fair market value of decedent's interest in Deft and whether

and in what amount any discount or premium should be applied to

that interest. Petitioner bears the burden of proof on these

issues. See Rule 142(a).

1. Petitioner's Expert

Petitioner relies on a report compiled by Higgins, Marcus &

Lovett, Inc. (HML), to establish that the fair market value of
- 8 -

4 Petitioner also submitted a report prepared by Tuerk &

Associates analyzing the impact of the potential environmental

liabilities on the marketability of the Deft shares. We find

that report unhelpful, and we do not rely on it.

5 These liabilities did not include Deft's potential

environmental liabilities.

the decedent's interest in Deft on the alternate valuation date

was $6,266,000.4

Initially, HML determined the value of a 100-percent

interest in Deft without any discount using three methods of

valuation (the unadjusted values): (1) The adjusted net worth

method (the asset method), (2) the discounted cash flow method

(the income method), and (3) the guideline public companies

method (the market method). 

Under the asset method, HML determined the unadjusted value

on the alternate valuation date was $12,070,000. In making this

determination, HML restated Deft's tangible assets from book

value to fair market value. HML then subtracted Deft's

liabilities5 from the fair market value of Deft's tangible

assets. Next, HML determined the value of Deft's intangible

assets by capitalizing the excess, if any, of Deft's current

sustainable earning power over the normal expected return of

Deft's tangible assets. HML determined there was no excess;

therefore, HML attributed no value to Deft's intangible assets. 

Lastly, HML added the net market value of Deft's tangible assets

($12,070,000) to the value of their intangible assets ($0) to

derive the unadjusted value under this method. 
- 9 -

HML determined the unadjusted value under the income method

was $8,109,000. Under this method, HML determined the present

value of Deft's future cash flows for the 5 years following the

valuation date ($4,271,000) and the present value of a terminal

value computed for the fifth year ($3,838,000) using a 19-percent

discount rate. HML added these present values together to find

the unadjusted value under this method. 

Under the market method, HML examined eight publicly traded

companies primarily engaged in the manufacture and sale of paint

and coatings. These companies had similar distribution channels

to Deft, earned a profit over the last fiscal year, and possessed

similar business and financial characteristics to Deft. HML

focused on the two companies that were most similar to Deft--Grow

Group and Pratt & Lambert. HML determined the average price to

earnings multiple for each of the two companies.

Although these two companies were the most similar to Deft,

they were significantly larger than Deft in terms of sales, total

assets, and total market capitalization. Given these

differences, HML applied a 30-percent downward adjustment to the

average market multiple of the two guideline public companies. 

HML also added a 25-percent control premium to account for the

fact that HML derived the multiples from information pertaining

to minority interests. HML determined that the unadjusted value

under the market method was $10,410,000. 

After determining the unadjusted value under each of the

above methods, HML weighted each of the methods equally and found
- 10 -

the weighted average of the unadjusted values was $10,196,000

(the weighted average unadjusted value). 

HML then applied a lack of marketability discount of 25

percent to the weighted average unadjusted value. In arriving at

this percentage, HML considered several studies of typical

marketability discounts used for minority interests in privately

held entities. Based on its review of this empirical evidence,

HML concluded that a reasonable range for a lack of marketability

discount for closely held common stock was 25 percent to 45

percent. 

HML then looked at the following factors to determine where

Deft's lack of marketability discount should fall within this

range: (1) The availability of public market; (2) the company's

recent financial performance; (3) the future outlook for the

company and industry; (4) the company's distribution policy; (5)

the restrictions on the transferability of the stock; (6) the

expected holding period of the stock; (7) the cost or expectation

of a public offering; (8) the number of existing shareholders;

(9) the size of the interest and the control inherent in the

interest; and (10) the potential environmental liabilities. 

Based on HML's analysis of the foregoing factors, HML concluded

that Deft's lack of marketability discount should fall at the low

end of the range. HML stressed the importance of the size of the

interest being valued (which favored a lower discount) but noted

that there was considerable uncertainty surrounding Deft's

potential environmental liabilities (which favored a higher
- 11 -

discount). Based on the factors in toto, HML concluded the lack

of marketability discount should be 25 percent. 

HML deducted the 25-percent marketability discount from the

weighted average unadjusted value and concluded that the fair

market value of a 100-percent interest in Deft on the alternate

valuation date was $7,647,000. HML then divided the fair market

value of a 100-percent interest by the number of outstanding

shares (166,000) and found that Deft's fair market value per

share was $46.07. HML multiplied Deft's fair market value per

share by the number of shares held by decedent at his death

(136,000) and concluded the fair market value of the decedent's

interest in Deft on the alternate valuation date was $6,266,000.

2. Respondent's Expert

Respondent relies on a report compiled by Business Valuation

Services, Inc. (BVS). BVS's analysis was limited to determining

an appropriate lack of marketability discount for the decedent's

interest in Deft. BVS did not determine the unadjusted value of

Deft. 

Respondent instructed BVS to assume that the unadjusted

value, including consideration of the potential environmental

liabilities, was $10,200,000. BVS determined that an appropriate

lack of marketability discount for decedent's interest should be

between 0 percent and 5 percent. As instructed by respondent,

BVS did not consider Deft's potential environmental liabilities

in determining the appropriate discount. 
- 12 -

C. Court's Analysis and Conclusions

As noted earlier, we are free to accept or reject in full or

in part experts' opinions proffered by the parties. See

Helvering v. National Grocery Co., 304 U.S. at 294-295; Seagate

Tech., Inc., & Consol. Subs. v. Commissioner, 102 T.C. at 186; 

Estate of Newhouse v. Commissioner, 94 T.C. at 217. Each of the

experts' reports is susceptible to criticism. We however believe

the fair market value reached in the HML report better represents

the fair market value of decedent's interest. Because of the

limitations imposed by respondent on BVS, we reject the BVS

report and adopt in part, as explained infra, the HML report. 

1. Valuation Methods Accepted by Court

The HML report determined the weighted average unadjusted

value based on the three different valuation methods was

$10,196,000. HML's application of the asset method was vague and

generally unhelpful. Furthermore, we believe HML may have

improperly applied that method. We do not rely on this method to

determine the value of decedent's interest.

Respondent does not object to HML's computations of the

unadjusted value under the income method and the market method. 

We find HML's conclusions as to the unadjusted values under these

two methods reasonable, and we conclude that the unadjusted value

under the income method is $8,109,000 and under the market method

is $10,410,000. Furthermore, we conclude each method deserves

equal weight.
- 13 -

2. Lack of Marketability Discount

 a. Availability of the Discount

A lack of marketability discount reflects the absence of a

recognized market for closely held stock. See Mandelbaum v.

Commissioner, T.C. Memo. 1995-255; Estate of Trenchard v.

Commissioner, T.C. Memo. 1995-121; Rev. Rul. 77-287, 1977-2 C.B.

319. Neither party disputes that the Deft stock is closely held

stock which is not readily tradable. We therefore shall apply a

lack of marketability discount to the unadjusted values under

both methods.

b. Proper Elements in the Discount

HML applied a 25-percent lack of marketability discount to

the weighted average unadjusted value. HML considered numerous

factors, including Deft's potential environmental liabilities, in

determining the amount of the discount. 

Courts have consistently recognized that potential

liabilities can affect the value of corporate stock. See Estate

of Davis v. Commissioner, 110 T.C. at 552, 553, 560; Estate of

Hall v. Commissioner, 92 T.C. at 329, 341-342; Payne v.

Commissioner, T.C. Memo. 1998-227; Estate of Mitchell v.

Commissioner, T.C. Memo. 1997-461; Sackett v. Commissioner, T.C.

Memo. 1981-661; Richards v. Commissioner, T.C. Memo. 1976-380. 

We believe a hypothetical buyer of decedent's interest in Deft

would consider these potential liabilities when negotiating a

purchase price. We find that these potential liabilities must be

taken into account in the valuing of decedent's interest. 
- 14 -

Respondent argues that applying a discount for Deft's

potential environmental liabilities is improper because these

liabilities have already been included in the unadjusted value

calculation under the income method and the market method. We

agree with respondent as to the market method but disagree as to

the income method.

Under the income method, HML discounted Deft's future cash

flows to present value using a discount rate determined by the

Capital Asset Pricing Model (CAPM). The discount rate represents

the company's expected rate of return on equity. 

The CAPM uses several variables including a variable

representing the company's volatility relative to market returns

(Beta). Deft's Beta was determined based upon the Betas of eight

similar paint and finishing companies. Respondent contends that

these paint and finishing companies had Betas considerably higher

than other companies’ because most paint and finishing companies

have potential environmental liabilities that make the return on

investment in these companies more volatile. Respondent argues

that these Betas already include the potential environmental

liabilities of these companies; therefore, it is improper to also

consider these liabilities in determining the proper discount.

We disagree with respondent. Respondent provided no

evidence at trial that the Betas of the eight comparable paint

companies were higher than normal due to potential environmental

liabilities faced by these companies. 
- 15 -

We conclude that the unadjusted value under the income

method did not include Deft's potential environmental

liabilities, and HML's consideration of Deft's potential

environmental liabilities within the lack of marketability

discount was proper. Thus, we shall apply a discount to the

unadjusted value under the income method for the potential

environmental liabilities. 

Under the market method, HML utilized the average price to

earnings multiple for two similar paint and finishing companies

in determining the unadjusted value. Respondent contends that

these multiples already include the potential environmental

problems faced by the similar companies; therefore, it is

improper to also consider these liabilities in determining the

proper discount. 

Respondent's expert testified that paint and finishing

companies trade at lower multiples as a result of the potential

environmental liabilities associated with the industry. 

Petitioner did not provide any other explanation for the lower

multiples. We conclude that the multiples used by HML took into

account the potential environmental liabilities of the comparable

companies; therefore, we shall not apply a discount to the

unadjusted value under the market method for the potential

environmental liabilities.

c. Computing the Discount

We must determine an appropriate lack of marketability

discount for decedent's interest. We base our finding on a
- 16 -

consideration of all of the evidence in the record, paying

special attention to the presence or absence of the factors

discussed in Rev. Rul. 77-287, 1977-2 C.B. 319.

The following factors favor a high lack of marketability

discount: (1) There was no public market for Deft's stock; (2)

Deft's profit margins were below the industry average; (3) all

stock in Deft was subject to a restrictive share agreement which

provided that a shareholder could transfer his or her stock to a

nonshareholder only after the shareholder offered the shares to

the remaining shareholders; (4) given the size and low

profitability of Deft, a public offering of the stock was

unlikely in the future; (5) the size of the interest is so large

that it may be hard to find potential buyers in the future who

could finance such a purchase; and (6) where not already

considered, Deft has large potential environmental liabilities.

Only one factor favors a low lack of marketability discount: 

Deft had an historical favorable distribution policy (it

distributed most of the company's earnings to its shareholders

through higher-than-market compensation in the past). 

We conclude that a 30-percent lack of marketability discount

is appropriate for the Deft stock. Of this 30-percent discount,

10 percent is attributable to Deft's potential environmental

liabilities. We shall apply the 30-percent lack of marketability

discount to the unadjusted value we determined under the income

method. We however shall apply only a 20-percent lack of

marketability discount to the unadjusted value we determined
- 17 -

under the market method because as discussed supra, the

environmental liabilities have already been included in the

unadjusted value under that method.

3. Control Premium

A control premium may be necessary when valuing an interest

which gives its holder unilateral power to direct corporate

action, select management, decide the amount of distributions,

rearrange the corporation's capital structure, and decide whether

to liquidate, merge or sell assets. See Estate of Newhouse v.

Commissioner, 94 T.C. at 251-252. Petitioner's expert testified

that a holder of decedent's interest would have the power (under

California law) to sell all of Deft's assets, dissolve the

company, and do virtually anything he or she wanted to do with

Deft. Decedent's 81.93-percent interest is a controlling

interest. HML applied a control premium of 25 percent in its

calculations under the market method only.

Whether or not a control premium is appropriate depends on

the valuation method employed in reaching the unadjusted value of

the stock. Where the method used values the stock as if it were

a controlling interest, no control premium is necessary because

the control aspect has already been accounted for within the

unadjusted value. See Pratt et al., Valuing A Business: The

Analysis and Appraisal of Closely Held Companies 303-306 (3d ed.

1996). 
- 18 -

6 HML already included the control premium in its

unadjusted value determined under the market method; therefore,

we shall not apply a separate control premium to the unadjusted

value under that method.

The income method assumed the continuation of Deft's present

policies and did not account for a change in control. This

method therefore produced an unadjusted value based on a minority

interest. Id. at 195. Thus, it would be proper to apply a

control premium to the unadjusted value under this method. Id.

The market method is based on comparisons with publicly

traded stocks. This method produces an unadjusted value which

represents the value of a minority interest, and it generally

would be proper to apply a control premium to the unadjusted

value under this method. Id. at 162.

HML determined that a 25-percent control premium was

appropriate under the market method. We find HML's determination

reasonable, and we conclude that a control premium of 25 percent

is appropriate. We shall apply this premium to the unadjusted

value we determined under the income method.6

4. Conclusion

Utilizing the income method and the market method, we find

the fair market value of decedent's interest in Deft on the

alternate valuation date was:
- 19 -

 Income Market

Unadjusted Value $8,109,000 $10,410,000

Less Marketability

 Discount:

 Nonenvironmental 20% (1,621,800) 20% (2,082,000)

 Environmental 10% ( 810,900) 0%

Add Control Premium 25% 2,027,250 

1 0% 

Fair Market Value of

 100 percent Interest 7,703,550 8,328,000

x Decedent's

 Interest 81.93% 6,311,519 81.93% 6,823,130

x Weight Given 50% 50% 

 3,155,759 + 3,411,565 =

Fair Market Value of

 Decedent's Interest 6,567,324

1 See supra note 6.

II. Value of Real Properties

A. Generally

On decedent's estate tax return, petitioner reported that on

the alternate valuation date the fair market values of the Newport

property and the Indian Wells property were $800,000 and $280,000,

respectively. Within 20 months of the alternate valuation date,

both properties were sold for amounts less than the fair market

values reported on decedent's estate tax return. Petitioner claims

that the fair market values for the Newport property and the Indian

Wells property should be $699,933 and $267,782, respectively, based

on their actual sales prices. 

Values submitted by a taxpayer on the estate tax return are

admissions by the taxpayer, and lower values cannot be substituted
- 20 -

without cogent proof that the reported values are erroneous. See

Estate of Hall v. Commissioner, 92 T.C. at 337-338.

B. The Newport Property

At trial, Mark Cardelucci, a real estate broker, testified

about the real estate market conditions in Newport from the time

the Newport property was valued for decedent's estate tax return

until the property was later sold (the interim period). Mr.

Cardelucci testified that, with regard to the Newport property, he

believed no material change in circumstances occurred during the

interim period. Furthermore, Mr. Cardelucci testified that he

believed that the Newport property had been overvalued on the

estate tax return. 

Respondent did not produce any evidence contradicting Mr.

Cardelucci's conclusions. We conclude the fair market value of the

Newport property on the alternate valuation date was $699,933. 

C. The Indian Wells Property

Conversely, petitioner failed to produce any evidence that on

the alternate valuation date the fair market value of the Indian

Wells property equaled its sales price 20 months later. We

conclude that petitioner has failed to provide cogent proof showing

that the amount reported on decedent's estate tax return was

erroneous. We conclude the fair market value of the Indian Wells

property as of the alternate valuation date was $280,000. 

In reaching all of our holdings herein, we have considered all

arguments made by the parties, and, to the extent not mentioned

above, we find them to be irrelevant or without merit. 
- 21 -

To reflect the foregoing, 

Decision will be entered

under Rule 155.