T.C. Memo. 2014-26

UNITED STATES TAX COURT

ESTATE OF HELEN P. RICHMOND, DECEASED, AMANDA ZERBEY,

EXECUTRIX, Petitioner v. COMMISSIONER OF INTERNAL REVENUE,

Respondent

Docket No. 21448-09. Filed February 11, 2014.

At the time of her death, D owned a 23.44% interest in a

family-owned personal holding company (“PHC”), whose assets

consisted primarily of publicly traded stock. D’s estate tax return

reported the fair market value of D’s interest in PHC as $3,149,767,

using a capitalization-of-dividends method to value the asset. R used

instead a net asset value (“NAV”) method and determined a

deficiency in D’s estate tax as well as an accuracy-related penalty

under I.R.C. sec. 6662.

Held: The fair market value of D’s 23.44% interest in PHC is

better determined by an NAV method and is $6,503,804.

Held, further, P is liable for a 20% accuracy-related penalty

under I.R.C. sec. 6662(a), (b)(5), and (g).

 
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[*2] Peter Samuel Gordon and John W. Porter, for petitioner.

Warren P. Simonsen, for respondent.

CONTENTS

FINDINGS OF FACT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Pearson Holding Company. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

PHC’s maximizing of dividends.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

PHC’s BICG tax liability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

PHC stock transactions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Ms. Richmond’s ownership and bequest of PHC stock. . . . . . . . . . . . . . . . . 9

Financial information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

The estate tax return. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

The notice of deficiency and the petition. . . . . . . . . . . . . . . . . . . . . . . . . . . 14

The Commissioner’s expert. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

The estate’s expert.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Ultimate findings.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

OPINION.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

I. Introduction.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

II. General principles of estate tax valuation. . . . . . . . . . . . . . . . . . . . . 20

III. Choice of valuation method. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

IV. The value of the decedent’s interest in PHC. . . . . . . . . . . . . . . . . . . 27

A. Discount for BICG liability. . . . . . . . . . . . . . . . . . . . . . . . . . . 28

1. Notice of deficiency: a zero discount. . . . . . . . . . . . . . 28

2. The estate’s expert: 100% of the BICG tax. . . . . . . . . 29

3. The Commissioner’s expert: 

43% of the BICG tax. . . . . . . . . . . . . . . . . . . . . . . . . . . 32

4. Our conclusion: 

present value of the BICG tax liability. . . . . . . . . . . . . 35
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[*3] B. Discount for lack of control. . . . . . . . . . . . . . . . . . . . . . . . . . . 39

C. Discount for lack of marketability. . . . . . . . . . . . . . . . . . . . . . 42

D. Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

V. Accuracy-related penalty. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

 MEMORANDUM FINDINGS OF FACT AND OPINION

GUSTAFSON, Judge: By a statutory notice of deficiency dated June 12,

2009, the Internal Revenue Service (“IRS”) determined a deficiency of $2,854,729

in Federal estate tax due from the Estate of Helen P. Richmond. The IRS also

determined an accuracy-related penalty of $1,141,892 due under section 6662.1

The estate commenced this suit by filing its petition to challenge those

determinations. The issues for decision are:

(1) whether the 23.44% interest (consisting of 548 shares) in Pearson

Holding Co. (“PHC”) that was included in the value of the gross estate for

purposes of Federal estate tax had a fair market value of $5,046,500 (as the estate

Unless otherwise indicated, all section references are to the Internal 1

Revenue Code (26 U.S.C.) in effect at the date of the decedent’s death, and all

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

amounts appearing in this opinion are sometimes rounded.
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[*4] now asserts) or any other amount less than the $7,330,000 that the

Commissioner now asserts (we find it had a value of $6,503,804); and

2

(2) whether there is an underpayment of estate tax attributable to a

substantial estate tax valuation understatement for purposes of the 20% accuracyrelated penalty imposed by section 6662(a), (b)(5), and (g), and, if so, whether

3

any portion of the underpayment was attributable to “reasonable cause” under

section 6664(c) (we find a substantial valuation understatement for which there

was no reasonable cause).

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. At the time of her

death, Ms. Richmond resided in Pennsylvania. At the time the petition was filed,

The IRS’s notice of deficiency determined that the asset at issue had a fair

2

market value not of $3,149,767 as the estate had reported on its return but rather

$9,223,658--i.e., an increase of $6,073,891. The Commissioner now contends it

had a value of $7,330,000 (i.e., about 20% less than on the notice of deficiency,

and a concession of about 31% of the original increase). The estate tax return

reported a value of $3,149,767, but the estate now contends it had a value of

$5,046,500 (i.e., about 60% more than on the return).

In the notice of deficiency, the IRS calculated the amount of the penalty

3

using the 40% rate that generally applies to gross valuation misstatements. See

sec. 6662(h). On brief, however, the Commissioner concedes that the 40% gross

valuation misstatement penalty does not apply; and he asserts instead that the

underpayment is attributable to a substantial valuation understatement under

section 6662(b)(5) and (g), thus incurring a 20% penalty. 
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[*5] the two co-executors of the estate resided in Pennsylvania (where the will was

probated) and New Jersey.

4

Pearson Holding Company

PHC was incorporated in Delaware in January 1928. It originated as and

continues to be a family-owned investment holding company. PHC is a

subchapter C corporation. Its business purpose as stated in its certificate of

incorporation is “to guarantee, purchase, hold, sell, assign, transfer, mortgage,

pledge or otherwise dispose of shares of capital stock, or any bonds, securities or

other evidence of indebtedness created by anyone in the corporation or 

corporations organized under the law of the state of government”. PHC’s

approach, as described by its current chairman and president, is “to preserve

Under section 7482(b)(1)(A) this case would be reviewed on appeal by “the

4

United States court of appeals for the circuit in which is located * * * the legal

residence of the petitioner”. To the extent the estate “reside[s]” where its coexecutors reside or where the will was probated, this case would be reviewed on

appeal by the Court of Appeals for the Third Circuit. Neither party has suggested

any reason that appeal might lie in the Court of Appeals for the Fifth Circuit or the

Court of Appeals for the Eleventh Circuit, both of which, see Estate of Jelke v.

Commissioner, 507 F.3d 1317 (11th Cir. 2010), vacating and remanding T.C.

Memo. 2005-131; Estate of Dunn v. Commissioner, 301 F.3d 339, 353 (5th Cir.

2002), rev’g and remanding T.C. Memo. 2000-12, have held that a holding

company’s net asset value should be discounted by 100% of the built-in capital

gains tax for which the holding company would eventually be liable. See

part IV.A.2 below.
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[*6] capital, to grow capital where possible, and to maximize dividend income for

the family shareholders”.

As of December 2005 PHC had 2,338 shares of common stock outstanding. 

Those shares were held by 25 members whose interests ranged from 0.17% to

23.61%. The three largest shareholders (which included the decedent) owned a

total of 59.20% of the shares.

PHC’s maximizing of dividends

Through the date of the decedent’s death, PHC followed its stated

philosophy of maximizing dividend income. As a holding company subject to tax

on undistributed income, see sec. 541, PHC has a strong incentive to pay out most

of the dividend income generated by the securities held in its portfolio, and the

ultimate objective of the company was to provide a steady stream of income to the

descendants of Frederick Pearson while minimizing taxes and preserving capital.

PHC has paid dividends reliably at a rate that, in the years from 1970 through

2005, had grown slightly more than 5% per year. In the seven years preceding the

decedent’s death, PHC paid out dividend distributions as follows:
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[*7]

Year Dividend distribution Decedent’s share

2005 $1,077,000 $252,436

2004 1,047,658 245,559

2003 1,016,469 238,248

2002 947,030 221,973

2001 922,575 216,241

2000 1,185,974 277,979

1999 835,578 195,850

The turnover of PHC’s securities has been slow--for the period from 2000 to

2005, 1.1% per year; and for the 10-year period ending December 31, 2005, 1.4%

per year. At that 1.4% rate, a complete turnover of the securities would take 70

years. 

However, in 2005 a potential investor would have observed that, with the

passing decades, the ownership of PHC stock had become more diffuse--and

would continue to become more diffuse--among heirs and legatees with less and

less identification with Frederick Pearson and his philosophy and goals, and with

less and less knowledge of and affinity for one another. The mindset of the

shareholders as owning a family company would more and more give way to an

attitude that regards the PHC shares simply as an investment, and the company
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[*8] would be increasingly likely to follow the financial advice of diversifying its

holdings. We find that, as the Commissioner’s expert witness testified, a potential

investor who considered purchasing PHC would likely expect that approximately

20-30 years would pass before a complete turnover of the portfolio or a liquidation

of the company would occur.

PHC’s BICG tax liability

When securities or any other assets appreciate in value, the owner becomes

liable for tax--but only upon the occurrence of an income tax recognition event,

such as the sale of the assets. A holding company that owns securities that both

produce dividends and appreciate may prefer to hold the securities, rather than sell

them, because it can thereby defer payment of the tax and accrue dividends from a

larger portfolio, undiminished by payment of tax liabilities. This has been PHC’s

approach. As a result, the value of its portfolio has grown to consist more and

more of untaxed appreciation. As of December 2005, 87.5% of the value of

PHC’s portfolio consisted of appreciation on which capital gain tax had not yet

been paid but would eventually become due upon sale of the appreciated

securities. (This deferred liability that inheres in appreciated assets is referred to

as “built-in capital gain tax” (“BICG tax”).)
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[*9] From time to time, Wilmington Trust Co., as PHC’s financial adviser, has

suggested that PHC sell substantial amounts of its securities in order to diversify

its portfolio. However, PHC never acted on this advice because of the large BICG

tax attributable to the appreciation of its securities. PHC has preferred not to incur

that tax liability, the payment of which would diminish its total assets and

therefore its ability to generate dividends.

PHC stock transactions

From 1971 through 1993, there were nine transactions involving the sale or

redemption of PHC stock by a shareholder. It appears that the value of the stock

for those transactions was determined using the dividend model. In addition,

when another shareholder died in 1999, the estate used the dividend model to

value his interest in PHC.

Ms. Richmond’s ownership and bequest of PHC stock

As of December 2005, Helen P. Richmond owned 548 shares in PHC. She

was PHC’s second largest shareholder, holding a 23.44% interest. As the owner

of less than a majority of PHC’s stock, Ms. Richmond could not unilaterally

change the management or investment philosophy of the company; nor could she

unilaterally gain access to the corporate books, increase distributions from the

company, or cause the company to redeem its stock. She could not force PHC to
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[*10] make an S election or to diversify its holdings. She had no rights to “put”

her stock to the company (i.e., to force it to buy her shares), and the company

could not “call” her stock (i.e., could not demand to buy it).

On February 10, 2004, Ms. Richmond executed a codicil to her will that

named John W. Lyle and Amanda Zerbey as co-executors of her estate. Mr. Lyle

graduated in the 1950s from LaSalle University in Philadelphia and was a certified

public accountant (C.P.A.) in the State of Delaware. Mr. Lyle served as an

accountant for PHC from 1970 until 2008. Before working at PHC, Mr. Lyle had

been employed as an accountant at Haskin & Sells in their Philadelphia office. 

Ms. Zerbey attended business school at the Keystone School of Business from

1977 to 1978. Ms. Zerbey has been employed as an Internet operations quality

control manager at Eastwood Co. in Pottstown, Pennsylvania, since 1993. Before

her position at Eastwood Co., Ms. Zerbey was employed from 1973 to 1993 in

Malvern, Pennsylvania, as a buyer for Cottage Craft, where she met

Ms. Richmond.

Ms. Richmond died on December 10, 2005. The parties stipulate that on

that date she still owned her PHC stock, so it is not disputed that the value of that

stock is included in her taxable estate. 
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[*11] Financial information

The parties have stipulated that, as of December 10, 2005, PHC held a

portfolio with a value of $52,159,430, as follows:

Asset Fair market value

Government bonds and notes $976,939

Preferred stocks 188,449

Common stocks 50,690,504 1

Cash and equivalents 294,161

Receivables 8,868

Security deposit 509

 Total 52,159,430

PHC’s common stocks were invested in 10 major industries with 42.8% of

1

the stock concentrated in four companies: Exxon Mobil (15.7%), Merck & Co.,

Inc. (11%), General Electric Co. (8.1%), and Pfizer, Inc. (8%).

As is noted above, approximately 87.5% of the $52,159,430 of PHC’s total

assets--i.e., $45,576,677--consists of unrealized appreciation. The parties agree

that the capital gain tax liability “built in” to that appreciation (but not yet due)

was $18,113,083.

As of the date of the decedent’s death, PHC had outstanding liabilities

(apart from any BICG tax liability) of $45,389. Accordingly, PHC had a net asset

value (“NAV”) of $52,114,041 (i.e., $52,159,430 in total assets less $45,389 in

liabilities).
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[*12] The estate tax return

On September 20, 2006, the co-executors of the decedent’s estate, Amanda

Zerbey and John W. Lyle, filed a Form 706, “United States Estate (and

5

Generation-Skipping Transfer) Tax Return”. Before doing so, the estate retained a

law firm to prepare the estate tax return and retained the certified public

accounting firm of Belfint, Lyons & Shuman, P.A. (“Belfint”), to value the PHC

stock for purposes of the estate tax return. The accountant who did the valuation

was Peter Winnington. 

Mr. Winnington graduated with a bachelor of science degree in accounting

from the University of Delaware in 1971, and he received his master of science

degree in taxation from Widener University in 1983. Mr. Winnington has been

employed as an accountant with Belfint since October 1986, and he currently

chairs the firm’s corporate service department and sits on the firm’s executive

committee. Mr. Winnington has experience in public accounting involving audits,

management advisory, litigation support and tax planning, and preparation

services. Mr. Winnington became a C.P.A. in the State of Delaware in 1975 and a

certified financial planner in 1988, and is a member of the American Institute of

Ms. Zerbey is the surviving executrix of the decedent’s estate as Mr. Lyle 5

died on January 8, 2010.
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[*13] Certified Public Accountants (AICPA), the Delaware Society of Certified

Public Accountants (DSCPA), and the Wilmington Tax Group. Mr. Winnington

has appraisal experience (i.e., having written 10-20 valuation reports and having

testified in court), but he does not have any appraiser certifications. 

The co-executors provided to Mr. Winnington information about stock

transactions in the 1990s, as well as some valuations for prior estates that included

PHC stock, which Mr. Winnington used to value the decedent’s interest in PHC.

Using this information, together with additional information already in Belfint’s

possession (i.e., audit reports, corporate tax returns, and investment reports of

PHC, as well as knowledge of the history of the company and the pattern for its

shareholders to hold their stock long term), Mr. Winnington prepared a draft

report that valued the decedent’s interest in PHC at $3,149,767, using a

capitalization-of-dividends method. He provided the unsigned draft of the

valuation report to the executors and to the return preparer, and he was never

asked to finalize his report. Without further consultation with Mr. Winnington,

the estate reported the value of Ms. Richmond’s interest in PHC as $3,149,767 on

the Federal estate tax return filed with the IRS. 
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[*14] The notice of deficiency and the petition

On June 12, 2009, the IRS issued a statutory notice of deficiency to the

estate, determining an upward valuation of the decedent’s interest in PHC to

$9,223,658. This adjustment increased the estate tax liability by $2,854,729. In 6

addition, the notice of deficiency determined a 40% gross valuation misstatement

penalty of $1,141,892 pursuant to section 6662(h). The notice of deficiency made

no other adjustments to the gross estate besides the valuation of the decedent’s

interest in PHC.

The estate timely filed a petition with this Court, seeking a redetermination

of the deficiency and the penalty determined in the notice of deficiency.

The Commissioner’s expert

At trial the Commissioner offered John A. Thomson as an expert in business

valuation. The Court accepted Mr. Thomson as a business valuation expert and

received his written report into evidence as his direct testimony. Mr. Thomson

valued the decedent’s interest in PHC by the cost approach, using a discounted net

asset method. Using PHC’s stipulated NAV of $52,114,041, Mr. Thomson 

The notice of deficiency does not specify what valuation method the IRS 6

auditor used to value the decedent’s interest in PHC and does not explain to what

extent, if any, his method allowed discounts (for tax attributable to built-in gain,

for lack of control, or for lack of marketability).
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[*15] calculated the decedent’s 23.44% interest of PHC’s NAV to be $12,214,925

7

(i.e., 23.44% of the total NAV). He then applied a discount of 6% to adjust for the

fact that the decedent held only a minority interest, and he applied a discount of

36% to adjust both for the lack of marketability of non-publicly traded shares and

for the BICG tax. Overall, Mr. Thomson applied a 40% discount, resulting in the

8 9

value of the decedent’s 23.44% interest in PHC being reduced to $7,330,000.

10

7Although the Court independently calculates the decedent’s 23.44%

interest to be $12,215,531 (i.e., $52,114,041 times 0.2344) instead of $12,214,925,

we ignore this difference as de minimis.

Of Mr. Thomson’s 36% “marketability” discount, 15% was a discount for 8

BICG tax. In his report prepared before trial, Mr. Thomson’s discount for lack of

marketability (including BICG tax) was set at 35%, but at trial he increased it to

36%.

Mr. Thomson’s overall discount can be expressed by this equation: 9

discount for lack of control + [(1 - discount for lack of control) x (discount for

lack of marketability)] = 0.06 + [(1-0.06) x (0.36)] = 0.3984, or 40%.

The Commissioner’s expert report asserts a value of $7,451,104, rounded 10

to $7,450,000. However, the adjustment in the lack of marketability discount

made at trial (i.e., increasing it from 35% to 36%) reduced the Commissioner’s

asserted value of the decedent’s 23.44% interest in PHC to $7,330,000.
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[*16] The estate’s expert

The estate offered Robert Schweihs as an expert in valuation. The Court

11

accepted him as an expert in business valuation and received his written report

into evidence as his direct testimony. Mr. Schweihs valued the decedent’s interest

in PHC by relying primarily on the capitalization-of-dividends method, an income

approach. In so doing, Mr. Schweihs used a dividend growth model, which 12

computes a principal value (“PV”) as follows:

PV = E0(1 + g) / [k - g]

where:

E0 = Expected amount of economic income in the period

immediately past

k = Discount rate (or required rate of return)

g = Expected growth rate of earnings, annually compounded

into perpetuity

In addition to calling Mr. Schweihs as an expert witness, the estate also 11

called as a fact witness Mr. Winnington, the accountant who prepared PHC’s

valuation report for the estate tax return. Although Mr. Winnington gave factual

testimony about his valuation report, which formed the basis for the value reported

on the estate tax return, the estate did not proffer Mr. Winnington as a valuation

expert and instead requests that we adopt Mr. Schweihs’s appraised value.

The Commissioner does not dispute that the capitalization-of-dividends 12

method can sometimes be used to value stock, and does not dispute

Mr. Schweihs’s equation, but does dispute both the appropriateness of using that

method in this instance and the appropriateness of some of the values

Mr. Schweihs used. See part III below.
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[*17] Using a discount rate (k) of 10.25%, a long-term growth rate (g) of 5%, and

0

the decedent’s share of PHC’s dividends in 2005, see p. 6 above, as the E ,

Mr. Schweihs valued the decedent’s interest in PHC as of December 10, 2005, to

be $5,046,500, as follows:

PV = $252,436 (1 + 0.05) / [0.1025 -0.05]

= $265,058 / .0525

= $5,048,72413

Therefore, notwithstanding the estate’s starting valuation of $3,149,767 (as

reported on the estate tax return) and the Commissioner’s starting valuation of

$9,223,658 (as determined in the notice of deficiency)--with a difference of more

than $6 million--by the time of trial, the difference in valuations had narrowed

considerably: The decedent’s interest in PHC was worth $5,046,500 according to

the estate and $7,330,000 according to the Commissioner--a difference of not

quite $2.3 million.

As an alternative to his capitalization-of-dividends valuation, Mr. Schweihs

also valued the decedent’s interest in PHC using the net asset valuation method

(i.e., proposing corrections to Mr. Thomson’s net asset valuation) and reached a

We are unable to reconcile Mr. Schweihs’s value of $5,046,500 with the

13

calculation above of $5,048,724. We assume that the discrepancy is due at least in

part to rounding, and we do not consider it to be material.
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[*18] value of only $4,721,962. Starting with the same NAV as the

Commissioner’s expert--$52,114,041--Mr. Schweihs reduced PHC’s NAV by

$18,113,083--i.e., 100% of PHC’s BICG tax (rather than the BICG discount of

$7,817,106--i.e., 15% of $52,114,041--that Mr. Thomson allowed). Mr. Schweihs

then applied an 8% discount for lack of control (as compared to Mr. Thomson’s

6%), as well as a 35.6% discount for lack of marketability (as compared to

Mr. Thomson’s 21%). This method valued PHC’s net assets, after these discounts

and the dollar-for-dollar reduction for BICG tax, at $20,144,888. The decedent’s

23.44% interest was therefore valued by the estate’s expert at $4,721,962 using the

net asset value method.

Ultimate findings

We find that, in order to account for the capital gain tax liability built in to

its assets, PHC’s net asset value of $52,114,041 should be discounted by

$7,817,106 (i.e., the Commissioner’s concession of 15% of PHC’s NAV) to

$44,296,935. We further find that the decedent’s 23.44% interest therein (i.e.,

$10,383,202) should be further discounted by 7.75% for lack of control and by

32.1% for lack of marketability, so that the decedent’s interest in PHC had a fair

market value of $6,503,804 at the decedent’s date of death.
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[*19] OPINION

I. Introduction

We must determine the fair market value of the decedent’s interest in PHC

as of the date of her death. The value of the decedent’s interest was included in

the value of her gross estate and was reported on the estate tax return at

$3,149,767. Relying on Mr. Schweihs’ testimony, the estate now concedes a

higher amount and argues that the correct fair market value is $5,046,500 (almost

$2 million more).

In his notice of deficiency, the Commissioner valued the decedent’s interest

in PHC at $9,223,658. Relying on Mr. Thomson’s expert testimony, the

Commissioner now argues that the fair market value is $7,330,000 (almost

$2 million less), which we regard as a partial concession. See Estate of Hinz v.

Commissioner, T.C. Memo. 2000-6 (finding that the Commissioner conceded his

valuation position as determined in the notice of deficiency by arguing for a lower

fair market value on brief).

In general, the IRS’s notice of deficiency is presumed correct, “and the

petitioner has the burden of proving it to be wrong”, Welch v. Helvering, 290 U.S.

111, 115 (1933); see also Rule 142(a); Crispin v. Commissioner, 708 F.3d 507,

514 (3d Cir. 2013), aff’g T.C. Memo. 2012-70; but in this case the estate argues
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[*20] that the burden of proof has shifted. However, both sides put on expert

testimony as to the value of the property at issue, and we are able to decide that

value on the preponderance of the evidence. We therefore need not address the

allocation of the burden of proof with respect to the valuation issue.

II. General principles of estate tax valuation

Section 2001(a) imposes a tax on “the transfer of” a decedent’s taxable

estate, and section 2001(b) provides that the tax is imposed on “the amount of the

taxable estate”. The value of the gross estate includes the value “at the time of his

death of all [the decedent’s] property, real or personal, tangible or intangible,

wherever situated.” Sec. 2031(a); United States v. Cartwright, 411 U.S. 546, 550-

551 (1973). For this purpose, “value” means “fair market value”, which is defined

as “the price at which the property would change hands between a willing buyer

and a willing seller, neither being under any compulsion to buy or to sell and both

having reasonable knowledge of relevant facts.” 26 C.F.R. sec. 20.2031-1(b),

Estate Tax Regs.

Valuation is ultimately a question of fact. Estate of Newhouse v.

Commissioner, 94 T.C. 193, 217 (1990). If the property to be valued is stock of a

closely held corporation, “actual arm’s-length sales of such stock in the normal

course of business within a reasonable time before or after the valuation date are
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[*21] the best criteria of market value.” Estate of Andrews v. Commissioner, 79

T.C. 938, 940 (1982); see also 26 C.F.R. sec. 20.2031-2(a) through (c). If it is not

possible to value the stock by such sales, “then the fair market value is to be

determined by taking * * * into consideration * * * the company’s net worth,

prospective earning power and dividend-paying capacity, and other relevant

factors”; and “the weight to be accorded such * * * evidentiary factors * * *

depends upon the facts of each case.” Id. para. (f)(2). “[I]n general, an

asset-based method of valuation applies in the case of corporations that are

essentially holding corporations, while an earnings-based method applies for

corporations that are going concerns.” Estate of Smith v. Commissioner, T.C.

Memo. 1999-368; see also Rev. Rul. 59-60, sec. 5(a), 1959-1 C.B. 237, 242. The

parties disagree about whether that generality is correct in this case.

The parties rely principally on expert testimony to establish the fair market

value of the decedent’s interest in PHC. Courts routinely consider expert

witnesses’ opinions in deciding such issues; however, we are not bound by the

opinion of any expert witness and may accept or reject such testimony in the

exercise of our sound judgment. Helvering v. Nat’l Grocery Co., 304 U.S. 282,

295 (1938); Estate of Newhouse v. Commissioner, 94 T.C. at 217. Although we

may accept an expert’s opinion in its entirety, we may instead select what portions
-22-

[*22] of the opinion, if any, to accept. Parker v. Commissioner, 86 T.C. 547, 562

(1986); Buffalo Tool & Die Mfg. Co. v. Commissioner, 74 T.C. 441, 452 (1980). 

Because valuation involves an approximation, “the figure at which we arrive need

not be directly traceable to specific testimony if it is within the range of values that

may be properly derived from consideration of all the evidence.” Estate of Heck

v. Commissioner, T.C. Memo. 2002-34.

The parties disagree over: (1) the appropriate valuation method to be used--

either the capitalization-of-dividends approach or the NAV approach--and (2) the

appropriate discounts if the NAV approach is used. We now address those issues.

III. Choice of valuation method

 To value the decedent’s interest in PHC, the Commissioner used the netasset-value approach and the estate used the capitalization-of-dividends approach. 

We believe that the NAV approach better determines PHC’s value.

The theory behind the income capitalization valuation method is that if an

asset produces a predictable income stream, the market value of the asset can be

ascertained by calculating the present value of that future income stream. PHC did

have a history of reliably paying out dividends, and over the preceding 35 years its

distributions had increased by about 5% per year. Predictable annual dividend

payments were PHC’s stated goal (and would presumably be the subjective
-23-

[*23] primary investment goal of someone purchasing a minority interest in PHC),

so the estate used this method. The estate’s expert assumed that that 5% annual

increase in dividend payments would continue indefinitely. He determined that

the market rate of return for a company with a comparable risk profile was 10.27%

(rounded to 10.25%), and he assumed that PHC would realize that rate of return

indefinitely. The estate’s expert calculated the capitalization rate of 5.25% by

subtracting the 5% annual dividend growth rate from the 10.25% market rate of

return for a comparable risk investment. The estate’s expert then divided the

decedent’s expected dividend return for the following year (i.e., $265,000

($252,400 x 1.05)) by the capitalization rate (i.e., 5.25%), to calculate, for those

future dividends, a present value of $5,046,500.

Dividend capitalization is one method for valuing a business; and this

method may be entirely appropriate where a company’s assets are difficult to

value. For example, a company that does not hold a portfolio of publicly traded

securities but instead operates a business may have assets--i.e., a conglomeration

of tangible assets acquired and depreciated over a period of years and intangible

assets (customer lists, assembled work force, know-how, etc.)--that are difficult to

value. The business may seem to be more than the sum of its parts. In such a
-24-

[*24] case, the value of the business may be better determined by projecting its

income stream (and discounting it to present value).

However, by definition, the capitalization-of-dividends valuation method is

based entirely on estimates about the future--the future of the general economy,

the future performance of PHC, and the future dividend payouts by PHC--and

even small variations in those estimates can have substantial effects on the value

determined. The estate’s valuation method therefore ignores the most concrete

14

 and reliable data of value that are available--i.e., the actual market prices of the

publicly traded securities that constituted PHC’s portfolio. Of course, the netasset-value method comes with its own difficulties and uncertainties (in this case,

determining the amounts of the discounts discussed below), but the NAV method

does begin by standing on firm ground--stock values that one can simply look up.

In Shannon P. Pratt, Robert F. Reilly, and Robert P. Schweihs, Valuing a 14

Business: The Analysis and Appraisal 210 (4th ed. 2000), Mr. Schweihs and his

colleagues state that the dividend capitalization approach to value is sensitive to

the “constant annual income stream in perpetuity or a constant annualized rate of

growth (or decline) in the economic income variable being capitalized in

perpetuity. Obviously, this constant growth rate projection is rarely met in the real

world.” They observe, id. at 208, that the Gordon growth model is extremely

sensitive to growth rate assumptions and that “[c]hanges in the growth rate

projected, sometimes seemingly small, can result in striking changes.” In the

example given in the estate’s expert’s book, a 1% change in assumed growth rate

can result in more than an 11% change in the indicated value. 
-25-

[*25] Moreover, the estate’s valuation method assumes that the only thing a

potential investor will consider when contemplating whether to buy PHC stock is

the present value of the dividend stream that the stockholder can expect to receive. 

However, in December 2005 a potential investor would have known that--as the

parties have stipulated--PHC’s portfolio consisted primarily of securities whose

values could have been computed without controversy to total $52 million, i.e.,

PHC’s net asset value (before discounts) with which the Commissioner’s method

begins. Where the assets themselves are thus easily valued, valuing the holding

company instead by the income approach would essentially overlook that fact,

surely a relevant and helpful fact, which we think an investor was not likely to

overlook but was instead likely to take as his starting point.

In addition, the Commissioner criticized the estate’s use of a 10.25%

expected rate of return, because the Ibbotson’s study from which he derived that

rate used a period (i.e., 1926-2004) that was different from the period

Mr. Schweihs had used to calculate PHC’s dividend growth rate (i.e., 1970-2004),

and we believe the criticism is valid. To correct for this discrepancy, the Court

independently calculated the actual rate of return (i.e., asset growth plus dividends

paid) for PHC using PHC’s historic data and found the compound annual growth

rate to be not 10.25% but rather only 9.414%. We believe that in December 2005
-26-

[*26] a potential investor in PHC would have considered the post-1970 data most

relevant and would have expected this rate of return, not the 10.25% rate of return

assumed by the estate. When we correct the estate’s calculation by using an

expected rate of return of 9.414% and keeping the annual dividend growth rate

constant at 5%, the present value of future dividends is about $1 million higher--

i.e., $6,005,000 (rounded) --than as calculated by the estate. This confirms the

15

sensitivity inherent in using the capitalization-of-dividends valuation method,

which in our opinion makes it less reliable.

For such reasons, courts are overwhelmingly inclined to use the NAV

method for holding companies whose assets are marketable securities. See, e.g.,

Estate of Litchfield v. Commissioner, T.C. Memo. 2009-21 (“With respect to stock

in closely held real estate holding companies and investment companies such as

LRC and LSC, the net asset valuation method is often accepted as the preferred

method. Estate of Smith v. Commissioner, T.C. Memo. 1999-368; Estate of Ford

v. Commissioner, T.C. Memo. 1993-580, affd. 53 F.3d 924 (8th Cir. 1995); Rev.

Rul. 59-60 at sec. 5(b), 1959-1 C.B. 243”). 

We note that the value of the decedent’s interest in PHC calculated using 15

the net asset value method ($6,354,519), as discussed below, is relatively close to

the value of the decedent’s interest in PHC using the capitalization-of-dividends

method ($6,005,000), using the rate of return as corrected by the Court.
-27-

[*27] The estate cites three cases to support its income capitalization valuation of

holding companies--Kohler v. Commissioner, T.C. Memo. 2006-152; Barnes v.

Commissioner, T.C. Memo. 1998-413; and Estate of Campbell v. Commissioner,

T.C. Memo. 1991-615--but those cases are clearly distinguishable from the instant

case. In each of those cases, the company to be valued held stock in a closely held

operating company (not publicly traded stock) or was itself an operating company. 

As a result, the underlying assets of those companies were difficult to value.

PHC’s primary assets, on the other hand, are marketable securities, which

have ascertainable market values. Moreover, those market values inherently

reflect the market’s judgment as to the projected income streams of each stock and

therefore reflect the future income stream of PHC. For that reason, a properly

discounted net asset valuation of PHC indirectly takes into account the expected

dividend stream that underlies the estate’s valuation method. We therefore follow

this Court’s consistent precedent of using net asset valuations for companies with

holdings like PHC.

IV. The value of the decedent’s interest in PHC

The parties agree on the $52 million net asset value of PHC in

December 2005; and although the estate does not agree that the NAV method is

the more appropriate method, both parties agree in principle that, if the NAV 
-28-

[*28] method is used, there must be discounts from that $52 million net asset

value to account for (a) the BICG tax for which PHC would eventually be liable,

(b) the lack of marketability of PHC’s non-publicly traded shares, and (c) the lack

of control inherent in the decedent’s 23.44% interest in PHC.

A. Discount for BICG liability

The parties agree that PHC’s unrealized appreciation on its assets was

$45,576,677, which if the assets had been sold on the date of death would have

given rise to a capital gain tax liability of $18,113,083, assuming a 39.74%

combined Federal and State tax rate. The parties further agree that the value of

PHC should be discounted to some extent to account for the BICG tax attributable

to that unrealized appreciation. However, the quantum of that discount is in

dispute.

1. Notice of deficiency: a zero discount

The IRS’s notice of deficiency seems to make no discount for the BICG

tax--a position that the Commissioner does not defend, and for good reason: An

investor could have easily replicated PHC in December 2005 by contributing

$52 million to his own new holding company and then having it purchase the very

same types of securities that were in PHC’s portfolio. No investor interested in

owning such a company would have been indifferent to the fact that acquiring
-29-

[*29] PHC meant acquiring an eventual liability of $18.1 million. An investor

would therefore have insisted on paying less than $52 million to acquire PHC; if

PHC had offered no discount, an investor would simply buy the stocks and be

better off. That is, the market would have required a discount, and any fair market

valuation must reflect a discount.

2. The estate’s expert: 100% of the BICG tax

On the other end of the spectrum, the estate contends that PHC’s value

should be discounted by 100% of the $18,113,083 BICG liability. To support this

contention the estate relies on opinions by the Courts of Appeals for the Fifth and

Eleventh Circuits that have held that in a net asset valuation the value should be 16

reduced dollar for dollar by the amount of a BICG tax liability. The Court of

Appeals for the Fifth Circuit reasoned that “the starting point for the asset-based

approach in this case is the assumption that the assets are sold, the starting point

for the earnings-based approach is that the Corporation’s assets are retained--are

not sold”, so consistent with that asset-based starting point, the built-in gain would

See Estate of Jelke v. Commissioner, 507 F.3d 1317; Estate of Dunn v. 16

Commissioner, 301 F.3d at 353; Estate of Jameson v. Commissioner, 267 F.3d 366

(5th Cir. 2001) (finding that the Tax Court improperly determined only a partial

discount for capital gains tax liability inherent in a bequest of stock because the

Tax Court failed to use a truly hypothetical willing buyer), vacating and

remanding T.C. Memo. 1999-43.
-30-

[*30] give rise to a current tax liability reducing value. Estate of Dunn v.

Commissioner, 301 F.3d 339, 353 (5th Cir. 2002), rev’g and remanding T.C.

Memo. 2000-12.

However, other Courts of Appeals and this Court have not followed this

17 18

100% discount approach, and we consider it plainly wrong in a case like the

present one. The relevant inquiry is, of course, what price a willing buyer and

seller would agree to; and it is clear that they would not agree to a 100% discount. 

To demonstrate this fact, PHC (with assets worth $52 million but burdened by an

$18.1 million BICG tax) can be compared to a hypothetical holding company

(“HHC”) that is identical to PHC except that HHC is burdened not by any BICG

tax but by an $18.1 million note payable that is due tomorrow. No investor would

be indifferent to this distinction and treat PHC and HHC as if they were

equivalent. The investor knows that, if he buys HHC, then tomorrow he must pay

Estate of Eisenberg v. Commissioner, 155 F.3d 50, 59 n.16 (2d Cir. 1998) 17

(“Where there is a relatively sizable number of potential buyers who can avoid or

defer the tax, the fair market value of the shares might well approach the pre-tax

market value of the real estate”), vacating and remanding T.C. Memo. 1997-483;

Estate of Welch v. Commissioner, 208 F.3d 213, 2000 WL 263309, at *6 (6th Cir.

2000) (approving “the Eisenberg method of valuation”), rev’g and remanding

without published opinion T.C. Memo. 1998-167.

See e.g., Estate of Davis v. Commissioner, 110 T.C. 530 (1998); Estate of 18

Jensen v. Commissioner, T.C. Memo. 2010-182.
-31-

[*31] off the $18.1 million note and have a portfolio not of $52 million worth of

stock but only $34 million; and in the future--beginning tomorrow--he will receive

the capital gains and the dividends generated by that smaller $34 million portfolio. 

On the other hand, the investor also knows that if instead he buys PHC, then he

may defer the payment of the $18.1 million BICG tax as long as he retains the

appreciated stock; in the future--until he sells off the appreciated stock over time

and incurs the tax piecemeal over that period--he will receive the capital gains and

dividends generated by the entire $52 million portfolio. PHC is simply worth

more than HHC, because a prospective BICG tax liability is not the same as a debt

that really does immediately reduce the value of a company dollar for dollar. A

100% discount, on the other hand, illogically treats a potential liability that is

susceptible of indefinite postponement as if it were the same as an accrued liability

due immediately. We do not adopt this approach.

19

We do not face here a circumstance in which the facts about the assets and

19

the market would make it inevitable that any informed buyer would expect to

liquidate the company immediately and thus immediately bear the tax liability for

the built-in gain. Even if, in such a hypothetical case, the appropriate discount

might be argued to be as much as 100% of the BICG tax, the facts in this case

show that a rational buyer might intend (as PHC did intend) to continue to hold at

least some the portfolio for a period of years, in order to benefit from the dividends generated by and the further appreciation experienced by the appreciated

stock. In a case like this one, therefore, a dollar-for-dollar discount is

unwarranted.
-32-

[*32] It stands to reason that a potential buyer would be willing to pay more for a

company with a contingent liability of $18.1 million than he would pay for a

company otherwise equivalent but that had an unconditional liability of

$18.1 million payable now. Likewise, the seller of the company with the

contingent future liability would demand a higher price than the seller of a

company with the unconditional current liability. As a result, despite contrary

holdings by some courts, we find that a 100% discount would be unreasonable,

because it would not reflect the economic realities of PHC’s situation.

3. The Commissioner’s expert: 43% of the BICG tax

The Commissioner’s expert (Mr. Thomson) proposes a 15% discount for

BICG tax, which at the entity level equates to $7,817,106 (i.e., 15% of the net

asset value of $52,114,041 and 43% of the BICG tax liability of $18,113,083).20

We note that the Commissioner’s expert included the BICG discount as 20

part of the lack of marketability discount that was applied at the individual level. 

We do not find that approach especially helpful in this case. As the BICG tax

liability is a liability of the entity, which affects its net asset value, we find it

appropriate to determine the BICG tax liability at the entity level. When

subsequently applying the other discounts, we apply them seriatim (as

Mr. Thompson did and as we approved in Estate of Magnin v. Commissioner,

T.C. Memo. 2001-31, 81 T.C.M. (CCH) 1126, 1141 & n.35 (2001)), rather than

simply adding the discount percentages together as a combined discount (as

Mr. Schweihs did).
-33-

[*33] For reasons we now explain, we find his method to be problematic, but we 21

find his $7.8 million bottom line--which we take as a concession by the

Commissioner--to be reasonable, for reasons different from those he advances. 

To reach this $7.8 million BICG tax discount, Mr. Thomson analyzed the

correlation between unrealized appreciation (i.e., built-in gain) and NAV

discounts for closed-end funds as of December 31, 2004. He compiled data from

closed-end funds with unrealized appreciation accounting for 11% to 46% of the

total net asset value, and he was unable to find any statistical correlation between

the BICG discount that could be observed on sales and the unrealized appreciation

of the seven closed-end funds he examined. He therefore concluded that in the

case of companies with unrealized appreciation that consists of as much as 46% of

the company’s value (which he rounds up to 50%), buyers are indifferent to the

BICG tax liabilities on that appreciation when purchasing an interest in a

closed-end fund. By Mr. Thomson’s reckoning, then, a potential buyer would be

indifferent to PHC’s BICG tax to the extent it is attributable to the portion of its

The Commissioner characterizes Mr. Thomson’s method as “the method

21

that was accepted in Estate of Davis” v. Commissioner, 110 T.C. 530 (1998). 

Mr. Thomson was the expert in Estate of Davis; he did use there a formula similar

to what he uses here; and in Estate of Davis the Court did ultimately adopt a

valuation close to that offered by Mr. Thomson. However, we see nothing in the

Estate of Davis Opinion to endorse the particulars of Mr. Thomson’s method.
-34-

[*34] unrealized appreciation that is equal to 50% of its $52,114,041 NAV (i.e.,

tax attributable to $26,057,021). PHC’s unrealized appreciation accounts for

$45,576,677 of its value (i.e., approximately 87.5% of the total NAV of

$52,114,041), so the remaining appreciation (i.e., the amount of unrealized

appreciation above 50% of NAV, or $45,576,677 less $26,057,021) is

$19,519,656 (i.e., approximately 37.5% of NAV).

Mr. Thomson concluded that “a dollar-for-dollar discount over 50% of the

tax exposure” was appropriate. This seems to mean that Mr. Thomson allowed a

dollar-for-dollar discount for the tax attributable to the appreciation over 50% of

PHC’s NAV (i.e., a dollar-for-dollar discount for the tax attributable to

$19,519,656 in appreciation, i.e., a discount of $7,757,111 when using a 39.74%

combined Federal and State capital gains tax rate). Applying an effective tax rate

of 39.74% to this gain equal to 37.5% of PHC’s NAV (i.e., the portion of PHC’s

unrealized appreciation for which the tax liability would be afforded a dollar-fordollar discount), Mr. Thomson figured that the allowable discount for BICG

should be 14.9% (i.e., 39.74% times 37.5%), rounded up to 15%.22

Since Mr. Thomson rounded this discount to 15%, we treat a BICG 22

discount equal to 15% of PHC’s NAV--or $7.8 million--as the Commissioner’s

concession.
-35-

[*35] This reasoning is not supported by the evidence. We are unconvinced that a

buyer would be wholly indifferent to the tax implications of built-in gain that

constitutes up to half of a company’s assets. Furthermore, Mr. Thomson points to

no data to show that, once a fund’s unrealized appreciation exceeds 50% of its

NAV, there would then begin to be a correlation between NAV discount and the

unrealized appreciation above 50%; nor is there evidence that the discount would

simply be dollar for dollar for the portion in excess of 50% and not something

more--e.g., an increase in elasticity (price sensitivity) for BICG liability once it

reaches a certain point. He presented no data at all concerning funds with built-in

gain constituting more than 50% of NAV. As a result, we cannot endorse

Mr. Thomson’s approach to calculating the BICG discount, but we view the

resulting discount amount--$7,817,106--to be a concession on the Commissioner’s

part.

4. Our conclusion: present value of the BICG tax liability

If (as we hold) the BICG tax liability cannot be disregarded in valuing PHC,

but if (as we also hold) PHC’s value cannot be reasonably discounted by that

liability dollar for dollar, then the most reasonable discount is the present value of

the cost of paying off that liability in the future. See Estate of Jensen v.

Commissioner, T.C. Memo. 2010-182; Estate of Litchfield v. Commissioner, T.C.
-36-

[*36] Memo. 2009-21. The Commissioner’s expert did not use this present value

approach, because he observed that at PHC’s historic rate for turning over its

securities, it would take 70 years before all the stock had been sold and all the

built-in gain had been taxed. If the $18.1 million of BICG tax were discounted

over that period, on the assumption that PHC’s stocks would be gradually sold and

its BICG tax would be gradually incurred over 70 years (on an average of

$258,758 per year), then the present value of the $18.1 million liability would be

only $3,664,119 (assuming a 7% discount rate). However, this 70-year

assumption would mistakenly allow PHC’s unique, subjective investment goals to

dictate the value of the company, whereas what we seek is a fair market value--the

price at which PHC would change hands between a willing buyer and a willing

seller, not the price that a particular seller might demand or that a particular buyer

might be willing to pay, and therefore not a price that assumes subsequent

management of the company by a specific owner. As the estate rightly 23

Admittedly, what we ultimately value here is not the entirety of PHC but

23

rather a minority 23.44% interest in it; and it can be observed that the acquirer of a

mere minority interest is bound to the investment decisions of the majority, and he

might therefore suppose that PHC’s philosophy and history portended a 70-year

turnover period (and therefore a long deferral of the BICG tax, yielding a very

small discount). However, this observation about the minority shareholder’s being

bound to the majority’s investment decisions properly pertains to the quantum of

the discount that must be made on account of the lack of control that a minority

(continued...)
-37-

[*37] acknowledged, “The willing buyer and the willing seller are hypothetical,

not actual persons, and each is a rational economic actor; that is, each seeks to

maximize his advantage in the context of the market that exists at the valuation

date.” The advice that PHC received to diversify its portfolio (i.e., to sell stock 24

more quickly than its 70-year trend would call for) indicates that a rational actor

would expect a turnover period shorter than 70 years. PHC’s decision not to

follow that advice was not irrational, but it was particular to PHC’s subjective

goals. Even assuming that the PHC management would indefinitely follow its

traditional philosophy and would sell stock only at the 70-year pace, and assuming

that PHC shareholders would refuse to sell at prices that presumed a shorter

turnover, that refusal would not affect the fair market value of PHC; it would

(...continued) 23

owner will experience (discussed below). The BICG tax for which we now

determine a discount is, on the other hand, an entity-level attribute of PHC as a

whole, and not of a particular interest in PHC. A purchaser of PHC stock might

later owe capital gains tax if he sells that stock at a gain; but he will never be

liable for tax on PHC’s gains from the sale of its holdings.

The Commissioner similarly explained: “For this purpose, fair market 24

value is the price that a hypothetical willing buyer would pay a hypothetical

willing seller * * *. The particular characteristics of these hypothetical persons

are not necessarily the same as those of any specific individual or entity, and are

not necessarily the same as those of the actual buyer or the actual seller.”
-38-

[*38] instead indicate that PHC’s particular managers and owners were willing to

forfeit or forgo some of PHC’s fair market value in order to pursue other aims.

The estate put on no evidence as to the length of the period that a typical

investor would consider likely or optimal for turning over PHC’s stock (apart from

the general fact that PHC’s advisors repeatedly suggested that PHC sell stock in

order to diversify) but asserted only PHC’s particular historic rate (yielding a

70-year turnover period and, to the estate’s detriment, a relatively small

$3.6 million BICG tax liability discount). Mr. Thomson’s testimony on this

score--i.e., that, notwithstanding PHC’s historic turnover rate, a potential investor

would expect that a portfolio like PHC’s would turn over within a period of 20 to

30 years--is not rebutted, and we find it reasonable. A present-value approach that

uses either a 20-year or a 30-year holding period and uses the different discount

rates employed in various contexts in this case yields the following range of

present values for the $18.1 million BICG:
-39-

[*39] 

Discount rate 20 years 30 years

10.27% 

(as calculated by P using

Ibbotson’s data) $7,570,358 $5,565,937

10.25% 

(as used by P in the

capitalization of

dividend model)

 7,580,584

 5,575,086

9.414% 

(as calculated by the

Court using PHC’s

historic data)

 

 8,029,070 5,982,097

7% 

(generally accepted rate

of return) 9,594,513 7,492,200

Since the Commissioner’s $7.8 million concession falls comfortably within this

range of $5.5 to 9.6 million, we use that figure. As a result, on the basis of these

findings and the record before us, we find a $7,817,106 BICG discount to be

reasonable in this case.

B. Discount for lack of control

A minority discount is a discount that a buyer would demand for the lack of

control the buyer will have over how his investment will be managed (e.g., 
-40-

[*40] disposition of assets, payment of distributions, or appointment of

25

management). The parties agree that a discount for lack of control is proper if a

net asset valuation is used in this case. However, the measure of that discount

remains in dispute.

The Commissioner’s expert used a data set consisting of the net asset values

and trading prices of 59 closed-end funds for the week of December 9, 2005. He

then analyzed the percentage difference between the net asset value and trading

price (if negative, a discount; if positive, a premium). Overall, this methodology is

sound and appears to be a reasonable way to calculate an appropriate discount

associated with lack of control (though we find a correctable flaw in the data set

itself). 

The Commissioner’s expert found the mean (i.e., the average) of the

premiums and discounts of all 59 data points to be -6.7%. However, he did not

use this number as the discount. Rather, he observed that the decedent and one

A potential purchaser of a minority interest in PHC would observe certain 25

disadvantages that might result from lack of control, such as an inability to

overcome PHC’s historic devotion to maximizing dividends when that approach

might cause it to miss other opportunities that would produce not steady dividends

but capital growth. Likewise, a minority shareholder in PHC would be unable to

compel the company to follow professional advice and diversify optimally (though

this approach has the corresponding advantage of deferring the BICG tax on

PHC’s appreciated holdings).
-41-

[*41] other owner each owned about 23% of PHC, and that the next largest

holding was only about 12%. His expert report therefore concluded that, even

though the decedent did not control the company, the decedent’s 23.44% interest

was a large and influential block of PHC’s stock, so that its lack of control was

somewhat mitigated, and he reduced the discount to -6.0% because of the “low

dispersion of the remaining ownership interest [in PHC] and ease of

management”. He did not explain how he chose -0.7% as the amount of the 26

appropriate reduction, and it appears to be simply a visceral reduction, for which

we do not see the justification.

The estate’s expert used the same data but simply selected the median (i.e.,

the middle value) of the data set, -8.0%, as the appropriate discount because the

Commissioner’s expert “incorrectly selected a number based upon

misinterpretation of the Factors identified in [Mr. Thomson’s] * * * report”, for

which he cited as a supposed example that “the holder of this interest cannot be a

The phrase “ease of management” in his report may be shorthand for

26

Mr. Thompson’s reckoning (as explained in his testimony) that, because PHC

engaged Wilmington Trust as its investment advisor, “we have a professional

management here [at PHC] too, so it’s not as if we just have a family doing

everything by themselves”. However, in pursuit of its distinctive (not to say

eccentric) investment philosophy, PHC disregarded Wilmington Trust’s

professional advice to further diversify. It therefore appears that lack of control of

PHC might indeed have had visible, continuing effects that might concern an

investor (and might require a greater discount).
-42-

[*42] Director.” However, this example apparently reflects the estate’s expert’s

erroneous assumption--corrected by the time of trial--that a PHC director must be

a member of the Pearson family. Such a restriction might indeed aggravate lack of

control (and might increase the appropriate discount), but it did not exist here.

An examination of the data set shows that among the 59 funds there are

three outliers that skew the mean and whose relevance or reliability Mr. Thomson

did not show. Removing these outliers--i.e., the highest two values and the lowest

value --yields a mean minority discount of -7.75%, which is comfortably close to 27

the estate’s 8.0% median. As a result, we conclude that a discount for lack of

control of 7.75% is reasonable in this case.

C. Discount for lack of marketability

A prospective investor is likely to pay more for an asset that will be easy to

sell and less for an asset that may be difficult to sell. In this case, PHC owns easyto-sell publicly traded stocks; but we value an interest in PHC itself, which is a

The highest two values reflect premiums of 28.3% and 38.2%, with the

27

next highest premium being only 10.9%. These two remarkable premiums are

unexplained in our record, and we cannot tell how they relate to the remainder of

the data set nor what, if anything, they could suggest about the appropriate

minority discount for a company like PHC. We therefore disregard them as

outliers. At the other end of the spectrum, the lowest value reflects a discount of

25.9%. We disregard it as an outlier, since the next highest discounts are 17.1%,

17.0%, 16.7%, 16.5%, 16.4%, and 15.3%.
-43-

[*43] family-owned, non-publicly traded company the stock of which has no ready

market. The parties agree that a marketability discount--i.e., a discount

attributable to the cost and difficulty of finding a willing buyer for a non-traded

closely held interest--is appropriate here if PHC is valued by a net asset valuation

method. However, the quantum of that discount remains in dispute.

To determine the appropriate discount for lack of marketability, the

Commissioner’s expert examined seven studies of restricted stock, which is

identical to freely traded stock of a public company except that it is restricted from

being traded on an open market for a certain period of time. The studies 28

compared two types of data: (1) the selling prices of the restricted stocks with the

selling prices of the corresponding unrestricted shares, and (2) the selling prices of

shares in closely held companies at their pre-IPO level versus their subsequent

post-IPO price, and measured the difference between its restricted value and its

The Commissioner’s expert also examined but did not rely on studies 28

comparing the sale price of closely held company shares to the prices of shares at

subsequent initial public offerings of the same companies. The estate argues that

the Commissioner’s expert is therefore subject to criticism as in Estate of Davis v.

Commissioner, 110 T.C. 530, in which we discussed the limitations of restricted

stock studies and gave more weight to IPO studies. However, there is no absolute

rule that, for purposes of determining a marketability discount, IPO studies are

superior to restricted stock studies, since in other circumstances we have preferred

the latter. See Estate of Giustina v. Commissioner, T.C. Memo. 2011-141. The

estate’s expert presented no analysis of IPO studies or of what discount they might

suggest here, so the estate’s argument does not convince us.
-44-

[*44] non-restricted value to quantify a discount for lack of marketability. The

seven studies produce lack-of-marketability discounts ranging from 26.4% to

35.6%, with an average discount of 32.1%.

Mr. Thomson chose to use the very bottom of this range--26.4%--as his

starting point for determining lack of marketability for PHC stock, because most

of the studies dealt with stock in operating companies (inherently more risky than

stock in a company that holds publicly traded shares). Mr. Thomson then further

reduced the discount to 21% for various reasons--e.g., PHC paid consistent

dividends; PHC had a very small amount of debt; and PHC was managed by

professional investors. Although these reasons would likely warrant

consideration, Mr. Thomson provided no basis for the quantum of the adjustment

attributable to each. Furthermore, we are unconvinced that Mr. Thomson’s low

starting point--26.4%--was warranted because of his summary observation that

most of the studies dealt with riskier operating companies.

Again, the estate’s expert did not perform an independent analysis for lack

of marketability. Instead, Mr. Schweihs accepted Mr. Thomson’s general

approach and data, but he simply chose the very top of the range of the study’s

marketability discounts--i.e., 35.6%--arguing that the seven studies that were used

to derive this discount are based on entities whose stock (unlike PHC’s) would
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[*45] relatively soon be freely marketable. He contended that stock (like that in

the seven studies) whose public trading is restricted for only a defined period

(during which private trades may be made) may be less discounted in value than

stock (like PHC’s) whose non-public status is of indefinite duration.

The parties seem to agree that the general range of marketability discounts

relevant for consideration in this case is 26.4 to 35.6%, with an average discount

of 32.1%, and we are unconvinced by either party’s rationale for deviating from

this generality. We therefore find that a marketability discount of 32.1%--i.e., the

average of the data sets--is reasonable in this case.

D. Conclusion

On the basis of the foregoing, we find that the value of the decedent’s

23.44% interest in PHC at the time of her death is $6,503,804, figured thus:
-46-

[*46]

Assets of PHC $52,159,430

Less: Liabilities - 45,389

Less: BICG discount - 7,817,106

NAV of PHC 44,296,935

23.44% Interest in NAV 10,383,202

Less: LOC discount 

(7.75% of $10,383,202) - 804,698

 9,578,504

Less: LOM discount 

(32.1% of $9,578,504) - 3,074,700

Value of decedent’s

 interest in PHC 6,503,804

V. Accuracy-related penalty

Generally, a 20% penalty is imposed on “any portion of an underpayment of

tax required to be shown on a return” where the underpayment is attributable to a

substantial estate tax valuation understatement. Sec. 6662(a), (b)(5). An estate

tax valuation understatement is treated as “substantial” where the value of any

property required to be reported on an estate tax return is reported at 65% or less

29

The estate tax return at issue here was filed on September 20, 2006.

29

Section 6662(g)(1) was amended for returns filed after August 17, 2006, to

provide that a valuation understatement is substantial if the value of any property

(continued...)
-47-

[*47] of the correct value. Sec. 6662(g)(1). The Commissioner bears the burden

of production with respect to the penalty determined under section 6662. See sec.

7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

The estate reported the value of the decedent’s interest in PHC to be

$3,149,767 on the estate tax return. Given that we have determined the proper

value of the decedent’s interest in PHC was $6,503,804, the amount reported on

the estate tax return was less than 65% of the proper value, and a “substantial”

valuation understatement therefore exists for purposes of section 6662(g)(1). 

Therefore, the Commissioner has met his burden under section 7491(c).

However, the 20% penalty under section 6662(a), (b)(5), and (g) will not

apply to any portion of an underpayment “if it is shown that there was a reasonable

cause for such portion and that the taxpayer acted in good faith with respect to

such portion.” See sec. 6664(c)(1) (emphasis added). The regulations provide

that whether an underpayment of tax is made in good faith and due to reasonable

cause will depend upon the facts and circumstances of each case. 26 C.F.R. sec.

1.6664-4(b)(i), Income Tax Regs. Reasonable cause may involve reliance on a

(...continued) 29

required to be reported on an estate tax return is reported at 65% or less of the

correct value. Before August 17, 2006, that figure was 50%. See Pension

Protection Act of 2006, Pub. L. No. 109-280, sec. 1219(a)(1)(B), 120 Stat. at

1083.
-48-

[*48] professional tax advisor, but such reliance does not necessarily demonstrate

reasonable cause and good faith, and “[r]easonable cause and good faith ordinarily

is not indicated by the mere fact that there is an appraisal of the value of property.” 

Id.

In determining whether a taxpayer acted reasonably and in good faith with

regard to the valuation of property, factors to be considered include: (1) the

methodology and assumptions underlying the appraisal; (2) the appraised value;

(3) the circumstances under which the appraisal was obtained; and (4) the

appraiser’s relationship to the taxpayer or to the activity in which the property is

used. Id. To establish good faith, taxpayers cannot rely blindly on advice from

advisers or on an appraisal. Bergquist v. Commissioner, 131 T.C. 8, 23 (2008)

(citing Kellahan v. Commissioner, T.C. Memo. 1999-210; and Estate of Goldman

v. Commissioner, T.C. Memo. 1996-29).

Mr. Lyle, who was deceased at the time of trial, was the co-executor of the

estate, was a C.P.A., and was primarily responsible for obtaining the valuation. 

Ms. Zerbey, the other co-executor, who attended business school and had some

modest experience in financial matters, allowed Mr. Lyle to be the principal

contact with the accountant (Mr. Winnington at the Belfint firm) who was retained

to value the decedent’s interest in PHC. Ms. Zerbey testified that Mr. Lyle kept
-49-

[*49] her informed, and she knew that Mr. Winnington was selected to value the

decedent’s interest in PHC and that two prior valuations were being used as

guidelines. According to Mr. Winnington, Mr. Lyle provided him with sufficient

information to value the decedent’s interest in PHC.

Mr. Winnington is a C.P.A. who is knowledgeable about PHC. 

Mr. Winnington testified that his fee was not contingent on the value he reached

and that Mr. Lyle did not influence the value ultimately reported on the estate tax

return. Although Mr. Winnington has some appraisal experience (i.e., having

written 10-20 valuation reports and having testified in court), he does not have any

appraiser certifications. The estate did not proffer him as an expert witness and

did not demonstrate that he is qualified as an expert in valuation.

On the record before us, we cannot say that the estate acted with reasonable

cause and in good faith in using an unsigned draft report prepared by its

accountant as its basis for reporting the value of the decedent’s interest in PHC on

the estate tax return. Mr. Winnington is not a certified appraiser. The estate never

demonstrated or discussed how Mr. Winnington arrived at the value reported on

the estate return except to say that two prior estate transactions involving PHC

stock used the capitalization-of-dividends method for valuation. Furthermore, the

estate did not explain--much less excuse--whatever defects in Mr. Winnington’s
-50-

[*50] valuation resulted in that initial $3.1 million value’s being abandoned in

favor of the higher $5 million value for which the estate contended at trial. 

Consequently, the value reported on the estate tax return is essentially

unexplained.

The estate observes that four substantially different values were reached by

four professionals--Mr. Winnington ($3.1 million), the estate’s expert ($5 million),

the Commissioner’s expert ($7.3 million), and the IRS auditor ($9.2 million)--and

the estate argues that this fact demonstrates the difficulty of valuing the decedent’s

interest in PHC. While we do not disagree with the estate’s assertion that the

decedent’s interest in PHC may be difficult to value, we believe that this further

supports the importance of hiring a qualified appraiser. In order to be able to

invoke “reasonable cause” in a case of this difficulty and magnitude, the estate

needed to have the decedent’s interest in PHC appraised by a certified appraiser. 

It did not. Instead, the estate relied on the valuation by Mr. Winnington but did

not show that he was really qualified to value the decedent’s interest in the

company. The $3.1 million value reported on the estate tax return was less than

65% of even the $5 million value defended by the estate’s own expert; and if the

Court had adopted the $5 million value, the return would still reflect a substantial

valuation understatement that would warrant the accuracy-related penalty; that is,
-51-

[*51] even by the estate’s lights, the value on the estate tax return needed

explaining, but no explanation was given.

Given that the Commissioner has met his burden to show that the accuracyrelated penalty applies, the burden shifted to the estate to show why it should be

excused from the penalty. The estate failed to make such a showing. As a result,

we find that the estate has not demonstrated that it acted with reasonable cause and

in good faith in reporting the value of the decedent’s interest in PHC on the estate

tax return. As a result, the Commissioner’s imposition of an accuracy-related

penalty under section 6662(a), (b)(5), and (g) will be sustained.

Decision will be entered under 

Rule 155.