t c no united_states tax_court michael t caracci and cindy w caracci et al petitioners v commissioner of internal revenue respondent docket nos filed date 14711-99x 17336-99xx 17339-99x ' cases of the following petitioners are consolidated herewith vincent e and denise a caracci docket no christina c and david c mcquillen docket no sta-home home health agency inc of grenada mississippi docket no 14711-99x sta-home health agency of carthage inc docket no sta-home health agency of greenwood inc docket no michael caracci docket no sta-home home health agency inc of forest mississippi docket no 17336-99x victor caracci docket no christina c mcquillen docket no sta-home home health agency inc docket no 17339-99x joyce p caracci docket no vincent e caracci docket no and sta-home health agency of jackson inc docket no -- - members of the c family wholly own three home health care organizations pl p2 and p3 exempt from federal income taxes under sec_501 i r c in the c family created three s_corporations si sec_2 and sec_3 and collectively received all of the resulting stock pl p2 and p3 then transferred all of their assets to sl sec_2 and sec_3 respectively in exchange for each transferee’s assumption of the transferor’s liabilities r determined that the fair_market_value of the transferred assets substantially exceeded the consideration received in exchange accordingly r determined sec_1 sec_2 sec_3 and members of the c family were liable for excise_taxes under sec_4958 i r c and members of the c family who received stock in sl sec_2 or sec_3 but did not have an ownership_interest in pl p2 and p3 were liable for income taxes on the value of the stock received r also revoked the tax exemptions of pl p2 and p3 held the transferred assets’ value at the time of transfer decided held further the value of the transferred assets exceeded the value of the consideration received thus sl sec_2 sec_3 and members of the c family are disgqualified persons subject_to excise_taxes under sec_4958 i r c as beneficiaries of excess_benefit transactions held further although pl p2 and p3 engaged in excess_benefit transactions a revocation of their tax-exempt statu sec_1s inappropriate given the intermediate_sanctions under sec_4958 i r c held further the three members of the c family are not liable for the income taxes determined by r david d aughtry and vivian d hoard for petitioners robin w denick and mark a ericson for respondent laro judge these cases are before the court consolidated petitioners seek review of respondent’s determinations for of income_tax deficiencies excise_tax deficiencies under sec_4958 accuracy-related_penalties under sec_6662 and revocations of exempt status under sec_501 c respondent determined the following income_tax deficiencies and accuracy-related_penalties accuracy-related_penalty petitioner deficiency sec_6662 a michael t and cindy w caracci dollar_figure dollar_figure vincent e and denise a caracci big_number dollar_figure christina c and david c mcquillen big_number dollar_figure respondent determined the following excise_tax deficiencies deficiency sec_4958 sec_4958 sec_4958 petitioner a a b sta-home health agency dollar_figure -0- dollar_figure of carthage inc sta-home health agency big_number -o- big_number of greenwood inc sta-home health agency big_number -o- big_number of jackson inc joyce p caracci big_number dollar_figure big_number michael caracci big_number big_number big_number victor caracci big_number --q- big_number vincent e caracci big_number --q- big_number christina c mcquillen big_number big_number big_number respondent determined that the three sta-home tax-exempt entities failed to qualify for tax-exempt status under sec_501 unless otherwise indicated section references are to the internal_revenue_code in effect for the year in issue and rule references are to the tax_court rules_of_practice and procedure the three sta-home tax-exempt entities are sta-home home health agency inc sta-home home health agency inc of forest mississippi and sta-home home health agency inc of grenada mississippi the three entities against which respondent determined excise_tax deficiencies are the sta-home for-profit entities q4e- following respondent’s concession that none of petitioners are liable for sec_4952 excise_taxes or sec_6662 a accuracy-related_penalties we are left to decide whether joyce caracci michael caracci victor caracci vincent caracci christina mcquillen and the sta-home for-profit entities are liable for excise_taxes under sec_4958 because of the transfers of assets from the sta-home tax-exempt entities to the sta-home for-profit entities in exchange for the transferees’ assumption of the transferors’ liabilities the asset transfer whether michael caracci vincent caracci and christina mcquillen as shareholders of the sta-home for-profit entities but not of the sta-home tax-exempt entities are liable for income taxes in connection with the asset transfer and whether the asset transfer resulted in a revocation of the sta-home tax-exempt entities’ tax-exempt status on account of a violation of sec_501 ie the transfer resulted in the sta-home tax-exempt entities’ being operated for a substantial nonexempt purpose constituted prohibited inurement and impermissibly benefited private interests ’ the parties also dispute who bears the burden_of_proof as to the central issue in this case namely the value of the transferred assets we do not decide that dispute our findings of value are based on our examination of the evidence in the well-developed record which in relevant part includes stipulated facts expert reports other exhibits and witness testimony - - findings_of_fact some facts have been stipulated we incorporate herein by this reference the parties’ stipulation of facts and the exhibits submitted therewith we find the stipulated facts accordingly the couples michael and cindy caracci victor and joyce caracci vincent and denise caracci and christina and david mcquillen are husband and wife each of whom resided in mississippi when the petitions were filed christina mcquillen is the sister of michael and vincent caracci and the three of them are the children of victor and joyce caracci the father mother and three children are referred to collectively as the caracci family the principal_place_of_business of the various sta--home entities also was in mississippi at that time from to joyce caracci served as a consulting nurse for the state of mississippi board_of health surveying health care facilities for participation in the medicare medicaid programs on date joyce caracci victor caracci anda third individual not relevant herein started sta-home home health agency inc approximately year later joyce caracci victor caracci anda third individual not relevant herein formed the other two sta-home tax-exempt entities each of the sta-home tax-exempt entities was formed as a nonstock corporation under mississippi law with victor and joyce caracci as the owners -- - during all relevant times in the early years of their business victor and joyce caracci borrowed money collateralized by their residence to fund the sta-home tax-exempt entities’ operations and they the individuals guaranteed the extension of credit to the entities throughout the years the managers of the three separate entities generally operated the entities as one integrated unit because the parties also generally treat the three separate entities as one integrated unit so do we during the subject year joyce caracci michael caracci and christina mcquillen were the sta-home tax-exempt entities’ only directors and officers those entities employed or retained the following caracci family members or spouses in the corresponding position individual position victor caracci consultant joyce caracci chief operating officer administrator michael caracci chief_executive_officer christina mcquillen director of personnel vincent caracci general counsel denise caracci nurse from date to date david mcquillen maintenance man the sta-home tax-exempt entities participated in the medicare program medicare was established in title xviii of the social_security act publaw_89_97 79_stat_291 and is the principal health care insurance for individuals who are either disabled or aged or older it is administered by the healthcare financing administration hcfa a division of the u s department of health and human services with whom private insurance_companies in different regions of the country have contracted to serve as fiscal intermediaries in medicare reimbursed home health care providers at an amount that equaled the lesser_of the actual reasonable cost or customary charges up to the maximum cost cap ie the aggregate per-visit costs limitation under the law applicable to medicare during medicare paid home health care agencies for the necessary services they provided to covered beneficiaries on a retrospective cost system under which medicare sent a periodic interim payment pip every weeks to home health care agencies to cover claims activity the sta-home tax-exempt entities used the pip payments to fund their payroll which was paid biweekly home health care agencies also submitted quarterly reports and filed annual cost reports with the fiscal intermediary if pip payments differed from the payments allowable as ascertained from the cost report the fiscal intermediary made the appropriate adjustment by reimbursing the home health care agency for an underpayment or requiring the agency to remit an overpayment the aetna insurance co which was the fiscal intermediary for the sta-home tax-exempt entities --- - disallowed the sta-home tax-exempt entities’ claimed costs on various items such as advertisements pencils cell phones pagers desks and nurse recruiting the average amount of disallowed costs annually was percent under mississippi law a certificate of need con is required to operate a licensed home health agency since mississippi has had a moratorium on issuing new home health care licenses in the only method of establishing a new home health care agency business in mississippi was to purchase the license of an existing licensed home health care agency although several bills have been introduced in the mississippi legislature to lift the moratorium none has ever been enacted michael vincent the chief_executive_officer of the sta-home corporations had personally contacted members of the mississippi legislature to urge them not to lift the moratorium he also had urged others to ask the mississippi legislators not to lift the moratorium from to the home health care business in mississippi increased percent as compared to doubling nationally but no new home health care agencies had entered that state in the sta-home tax-exempt entities ranked first or second in market share in of the counties in their service area sta-home was a recognized name in home health care in --- - mississippi and it had a generally good reputation among mississippi’s elderly population in the sta-home tax- exempt entities were the first freestanding agencies in mississippi to become accredited by the joint commission on accreditation of healthcare organizations jcaho jcaho accreditation required achieving or exceeding certain regulatory standards including conditions as to the quality of patient care during the sta-home tax-exempt entities provided big_number home health care visits and over percent of the entities’ services were to medicare beneficiaries the sta-home tax-exempt entities also had several manuals that they had developed in-house regarding policies and procedures including personnel nursing home health aid physical therapy and social work manuals it was generally recognized that under the medicare reimbursement system in place in there was no ability for home health agencies to realize profits beyond costs and that the reimbursement system provided little incentive for providing services efficiently this situation prevailed because medicare reimbursed a home health agency only for allowable costs at its discretion therefore any denied claim for reimbursement produced a cash outflow to the business the sta-home tax-exempt -- - entities generated gradually increasing revenue but also commensurate losses in the years preceding date the sta-home tax-exempt entities’ accounting firm prepared unaudited combined financial statements the results from operations reported by the combined sta-home tax-exempt entities on their returns for fiscal years ended date through were year revenue expenses net_income loss dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number according to those combined financial statements the total assets and liabilities of the sta-home tax-exempt entities for those years were year assets liabilities deficit dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number to ease their financial statuses the sta-home entities required their employees---including the caracci family members themselves---to forgo payment for the first weeks of employment after that initial period the employees were entitled to collect - a paycheck for weeks’ work the weeks’ initial earnings were withheld until the employees left the companies the sta-home tax-exempt entities had a policy of giving its employees discretionary bonuses for the pay_period ended date the entities paid bonuses totaling dollar_figure to all personnel with the exception of new hires on date the entities also approved for the directors bonuses of percent for the pay_period ended date the entities approved additional bonuses totaling dollar_figure on date the entities approved further bonuses totaling dollar_figure this bonus created a dollar_figure liability that was assumed by the sta-home for-profit entities incident to the asset transfer mississippi historically reports the lowest per capita income of any state with corresponding high unemployment and low education levels an official mississippi state health plan prepared in indicated that poorly educated low-income and ill-housed people often had greater health care needs than other members of society the socioeconomic characteristics of the sta-home tax-exempt entities’ service territory produced a higher use of home health care services in comparison to other areas of the country in medicare paid an average of dollar_figure per mississippi patient ranking the state highest in federal payments per recipient among all states during and percent of all visits made by home health agencies operating in mississippi were paid for by medicare during and the prospect arose of medicare’s shifting from a pip cost reimbursement system to a prospective payment system pps several groups discussed the proposal in theory but no one knew exactly what form pps might take the sta-home tax-exempt entities through vincent caracci an attorney whose job included keeping abreast of current events learned of these proposed changes petitioners came to understand that the sta-home tax-exempt entities would not under a pps receive a check every weeks but would have to file a claim for every service rendered and wait for the claim to be processed and paid petitioners became concerned about the lack of cashflow under a pps they also believed that a pps would reduce the sta-home tax-exempt entities’ income late in date the caracci family consulted an attorney named thomas kirkland kirkland about converting the sta-home tax-exempt entities into for-profit corporations kirkland’s firm represented many home health care agencies and he had recommended that all of those agencies make such a conversion kirkland’s recommendation was based in part on his discussions with bankers who were reluctant to lend money to nonprofit home health care agencies by petitioners’ regular accountant danny hart hart also recommended that the sta-home tax-exempt entities convert to nontax-exempt status kirkland retained a tax attorney named james pettis pettis to help kirkland convert the sta-home tax-exempt entities into for-profit entities subsegquently pettis learned that kirkland’s firm had not obtained an appraisal for any of its previous conversions pettis informed kirkland that pettis strongly disagreed with that approach by letter dated date kirkland’s firm retained hart’s accounting firm to appraise the sta-home tax-exempt entities’ net assets as of a proposed transaction date of date the appraisal was slow in coming pettis the tax adviser insisted on seeing the appraisal before proceeding with any transaction that would effect a conversion after reading the appraisal pettis was concerned that it failed to deal with issues concerning intangible assets he believed that the mere fact that an entity had lost money or had a negative cashflow did not mean that the entity was worthless he also was concerned that the appraisal failed to address revrul_59_60 1959_1_cb_237 where the commissioner has set forth standards on valuation for federal_income_tax purposes upon pettis’s request he received a second appraisal because some of his concerns as to intangible assets remained after reading the second appraisal he sought and received assurance that the sta-home tax-exempt entities’ liabilities far exceeded the value of their assets and that the value of the intangibles would not give the entities a positive fair_market_value on date the sta-home tax-exempt entities’ boards of directors authorized the conversion of those entities into s_corporations the s status was chosen so that the shareholders could deduct the new entities’ future losses on date in anticipation of a transfer of the sta-home tax-exempt entities’ assets kirkland’s firm with petitioners’ approval formed the sta-home for-profit entities under mississippi law fach of those corporations subsequently elected to be taxed as an s_corporation for federal_income_tax purposes since their formation the only shareholders of each of the sta-home for- profit entities have been joyce caracci percent victor caracci percent michael caracci percent christina mcquillen percent and vincent caracci percent the only directors and officers have been members of the caracci family on date hart’s accounting firm tendered an appraisal stating that the value of the sta-home tax-exempt entities’ assets was less than their liabilities kirkland had assumed that this would be the case on date -- - kirkland executed and filed on behalf of each of the sta--home tax-exempt entities notices of intent to change ownership with the state of mississippi department of health brffective date sta-home home health agency inc transferred all of its tangible and intangible assets to sta-home health agency of jackson inc sta-home home health agency inc of forest mississippi transferred all of its tangible and intangible assets to sta-home health agency of carthage inc and sta-home home health agency inc of grenada mississippi transferred all of its assets to sta-home health agency of greenwood inc the consideration paid_by each transferee was the assumption of the related transferor’s liabilities since the transfers the transferors have not engaged in any activities charitable or otherwise nor have they been dissolved under mississippi law on date robert crowell hart’s accounting partner sent a letter to kirkland setting forth several reasons that sta-home should convert to a profit corporation from a nonprofit these included the need to raise capital and or enter into profit-making ventures in view of the past losses and accumulated deficit the ability to participate in major changes taking place in the health care industry including mergers and acquisitions the provision of ownership interests for succession -- - plans to keep key management in place and the ability to deal with changes in the reimbursement system within the near future four days later the documents were executed that constitute the contract under which all of the transferors’ assets were transferred to the transferees other than state and federal filing_requirements and the slight changes in the names of the entities the sta-home operations remained the same after the transfer as they were before the sta-home for-profit entities continued to use a fiscal_year ending on september for financial_accounting and medicare reporting purposes although not for tax purposes as part of the transfers the sta-home for-profit entities accepted assignment of the sta-home tax-exempt entities’ medicare provider agreements and continued to use the provider numbers of the sta- home tax-exempt entities the sta-home for-profit entities continued to receive pip payments and lump-sum settlements from the medicare program including guarterly payments based on guarterly pip reports the sta-home for-profit entities received a net preacquisition payment relating to settlement of the sta- home tax-exempt entities’ fiscal_year substantially the same employees continued to do the same work and the same assets were used in the same three locations the caracci family members continued to be employed by the sta-home for-profit entities in the same positions in which they were employed by the sta-home tax-exempt entities and each member’s compensation and employment benefits remained subject_to review by hcfa through the cost reporting process the and combined salaries paid to joyce caracci michael caracci vincent caracci and christina mcquillen by the sta-home entities were as follows individual joyce caracci dollar_figure dollar_figure michael caracci big_number big_number vincent caracci big_number big_number christina mcquillen big_number big_number the mid-1990's showed significant growth in the home health care industry natl expenditures_for home nursing care grew from dollar_figure billion in to dollar_figure billion in there was also substantial activity in home health care agency acquisitions there were such acquisitions in in in and in during the primary buyers of home health agencies were hospitals nursing homes and other home health agencies they were able to take advantage of a mechanism known as cost- shifting this attribute enabled a buyer such as a hospital which generally received reimbursement under the pps to shift some of its costs to a cost reimbursement system for payment by victor caracci was paid on a consulting basis that varied significantly from year to year -- - the medicare program cost shifting was possible because the purchased home health care agencies had room under their cost cap because they had sought less than the maximum reimbursement allowed by medicare and medicare reimbursed home health care providers for costs such as overhead that were not directly related to home visits hospitals and nursing homes could benefit by acquiring a home health care agency and shifting some of their overhead costs to that agency to the extent that there was room under its cost cap during and a number of home health agencies in mississippi were sold the state board_of health identified such acquisitions seven were by hospitals two were by home health care agencies one was by an individual from a bankruptcy trustee and one was a corporate_reorganization all of the acquisitions by hospitals involved home health agencies in or near mississippi although on occasion the corporate headquarters of the acquiring corporations were located outside mississippi in the deaconess hospital corp of cincinnati ohio acquired the stock of southern mississippi home health inc a mississippi corporation home health agencies remained under a cost reimbursement system until date when legislation passed by congress in providing a pps for home health agencies took - - full effect hcfa encountered problems implementing the system and it was not finally implemented until date opinion i introduction respondent has determined that petitioners’ participation in the asset transfer made them liable for deficiencies totaling dollar_figure respondent’s determination rests on his expert’s determination that the fair_market_value of the transferred assets exceeded the assumed_liabilities by approximately dollar_figure million petitioners argue that the assumed_liabilities exceeded the fair_market_value of the transferred assets petitioners rely on their expert who concluded similarly it is with this backdrop that we proceed to decide the assets’ value at the time of the transfer we bear in mind the wide difference in values ascertained by the experts il fair_market_value a overview a determination of fair_market_value is factual and a trier of fact must weigh all relevant evidence of value and draw of course were the respondent to prevail in full he would be entitled to only dollar_figure of approximately dollar_figure the lion’s share of the dollar_figure is attributable to excise_taxes under sec_4958 and and b totaling dollar_figure dollar_figure dollar_figure dollar_figure for all or part of which respondent has determined that eight petitioners are jointly and severally liable - - appropriate inferences 323_us_119 304_us_282 79_tc_714 affd 731_f2d_1417 9th cir mandelbaum v commissioner tcmemo_1995_255 affd without published opinion 91_f3d_124 3d cir fair_market_value is the price that a willing buyer would pay a willing seller both persons having reasonable knowledge of all relevant facts and neither person being under any compulsion to buy or to sell 411_us_546 644_f2d_1282 9th cir affg 71_tc_235 92_tc_312 see generally revrul_59_60 1959_1_cb_237 the willing buyer and the willing seller are hypothetical persons rather than specific individuals or entities and the characteristics of these hypothetical persons are not necessarily the same as the personal characteristics of the actual seller or a particular buyer 680_f2d_1248 9th cir 658_f2d_999 5th cir 101_tc_412 mandelbaum v commissioner supra fair_market_value reflects the highest_and_best_use of the relevant property on the valuation_date and takes into account --- - special uses that are realistically available because of the property’s adaptability to a particular business 267_us_341 87_tc_892 87_tc_389 estate of proios v commissioner tcmemo_1994_442 fair_market_value is not affected by whether the owner has actually put the property to its highest_and_best_use the reasonable and objective possible uses for the property control the valuation thereof 259_f2d_41 2d cir stanley works v commissioner supra pincite the hypothetical willing buyer and seller are presumed to be dedicated to achieving the maximum economic advantage estate of true v commissioner tcmemo_2001_167 and the hypothetical sale should not be construed in a vacuum isolated from the actual facts estate of andrews v commissioner t c here the parties dispute whether any value should be given to the sta-home tax-exempt entities’ cost-shifting attribute cost-shifting could attract prospective purchasers such as hospitals that desired to acquire a home health care agency and use its cost-shifting capacity at our request the parties have discussed whether attributing value to this mechanism is consistent with the requirement that fair_market_value be -- - determined using a hypothetical buyer we conclude that it is a hypothetical buyer may be one of a class of buyers who is positioned to use the purchased assets more profitably than other entities accordingly we have held that fair_market_value takes into account special uses that are realistically available because of a property’s adaptability to a particular business stanley works v commissioner supra pincite acknowledging the existence of such businesses in the universe of hypothetical buyers also is consistent with the standard that assets are not valued in a vacuum but instead are valued at their highest_and_best_use the cases petitioners cite do not require a different conclusion the cases of 243_f3d_1145 9th cir revg and remanding estate of kaufman v commissioner tcmemo_1999_119 estate of andrews v commissioner supra and estate of magnin v commissioner tcmemo_2001_31 stand for the proposition which we accept that the attributes of a hypothetical willing buyer cannot be limited to those of a particular buyer that proposition is inapplicable where as here we do not confine the hypothetical buyer to a specific and identifiable buyer but include the entire class of buyers for whom the sta-home tax-exempt entities’ cost-shifting attributes could be especially adaptable stanley works v commissioner supra - - nor are petitioners assisted by citing 110_tc_530 there we rejected the commissioner’s attempt to narrow the field of hypothetical willing buyers the commissioner had done so by advancing the unwarranted assumption that a hypothetical buyer would cause the acquired_corporation to escape its potential tax_liabilities by having it elect s_corporation status and by not permitting it to sell any of its assets for years thereafter unlike the assumption there the assumption here that the cost-shifting attribute is a valuable asset is fully warranted in fact as explained below both experts have ascribed value to the sta--home tax-exempt entities’ cost-shifting mechanism in addition petitioners’ expert alfred d hahn hahn has elsewhere written that transaction prices reflect the value to a buyer to shift overhead costs hahn et al home health agency valuation opportunity amid chaos intrinsic value spring b role of the expert as typically occurs in a case of valuation each party relies primarily upon an expert’s testimony and report to support the respective positions on valuation a trial judge bears a special gatekeeping obligation to ensure that any and all expert testimony is relevant and reliable 526_us_137 509_us_579 -- - the court has broad discretion to evaluate the cogency of an expert’s analysis 115_tc_43 sometimes an expert will help us decide a case e g 108_tc_524 106_tc_274 see also m i c ltd v commissioner tcmemo_1997_96 estate of proios v commissioner supra other times he or she will not e g estate of scanlan v commissioner tcmemo_1996_331 affd without published opinion 116_f3d_1476 5th cir mandelbaum v commissioner t c memo aided by our common sense we weigh the helpfulness and persuasiveness of an expert’s testimony in light of his or her qualifications and with due regard to all other credible_evidence in the record neonatology associates p a v commissioner supra pincite we may embrace or reject an expert’s opinion in toto or we may pick and choose the portions of the opinion to adopt helvering v natl grocery co u s pincite 538_f2d_927 2d cir affg tcmemo_1974_285 97_tc_496 see also pabst brewing co v commissioner tcmemo_1996_506 we are not bound by an expert’s opinion and will reject an expert’s opinion to the extent that it is contrary to the judgment we form on the basis of our understanding of the record as a whole 813_f2d_837 7th cir affg 85_tc_56 silverman v commissioner supra pincite it s of iowa inc v commissioner supra pincite 84_tc_722 here the experts began by observing that the methodology traditionally used in business appraisals includes an income approach a cost approach and a market approach in an income approach value depends upon the present_value of future economic benefits to be derived from ownership an enterprise’s price- per-share value is then estimated by discounting the net cashflows available for distribution back to their present_value at market-based rates of return the cost approach uses estimates of current costs to replace the enterprise’s fixed assets and certain intangible assets the market approach establishes the value of a privately held corporation through analyses of sales or transfers of guideline companies the information derived from this analysis is then used to form an opinion of market_value for a subject company c expert testimony for petitioners to support their contention that the value of the sta-home tax-exempt entities’ assets was less than the liabilities assumed petitioners rely upon the report and testimony of hahn hahn a director in pricewatershousecoopers northeast region corporation valuation consulting group has written extensively - - on the valuation of home health care agencies and has frequently appeared as an expert witness hahn started by noting that because of the predominance of medicare in the payor mix of most home health agencies a conventional cashflow or earnings approach to valuation would produce a very different result from other more appropriate approaches this is so because home health agencies with a preponderance of medicare-eligible patients earn little if any profit ’ hahn instead relied principally upon an adjusted balance_sheet methodology a form of the cost approach that methodology restates a company’s accounting balance_sheet to its fair_market_value egquivalent hahn explained that this approach involves the identification and valuation of tangible and intangible assets and liabilities whether or not they appear on the subject company’s accounting balance_sheet hahn started with the unaudited balance sheets prepared by petitioners’ accounting firm in he concluded that several of the sta-home tax-exempt entities’ asset accounts required revaluation he noted that there were several unrecorded ’ the evidence includes an article written by hahn wherein he reports that his firm’s database reflects that more than percent of home health agency acquisitions involved agencies that recorded losses hahn payment reform will shift home health agency valuation parameters healthcare financial management date -- p7 - material assets and liabilities in addition to the assets and liabilities on the balance sheets in terms of the assets he indicated that economic intangible assets should be adjusted to fair_market_value he also included some liabilities that were not recorded on the unaudited balance_sheet such as a balance due to medicare from the jackson and grenada facilities for the fiscal_year he further made allowance for pending events which he opined suggested the possibility of future claims against the companies such as a reserve for future downward reimbursement adjustments by medicare hahn observed that the passage of time had obscured the then-current value of the companies because the analysis was prepared years after the actual transaction accordingly hahn prepared both a base case and a best case scenario to develop a range of fair market values he concluded that the fair_market_value of the sta-home tax-exempt entities’ total tangible and intangible assets was between dollar_figure million and dollar_figure million he noted that the entities’ total recorded and contingent liabilities were between dollar_figure million and dollar_figure million his result indicates that the combined liabilities of the sta-home tax-exempt entities exceeded the value of their assets by dollar_figure million to dollar_figure million the following tables set forth hahn’s base case and best case adjusted balance sheets the first figure column lists the unaudited balance sheets for the fiscal_year ended september the next column made by hahn pwc valuation adjustments shows changes the last column shows hahn’s estimate of the fair_market_value of each category after making his changes valuation of sta-home agency inc - combined adjusted balance_sheet approach valuation performed as of best case scenario cash accounts_receivable allowance for contractual adjustments allowance for bad_debts est third-party payor settlements--medicare allowance for unsuccessful claims accounts receivable--employees accounts receivable--other prepaid expenses total current_assets property plant equipment accumulated depreciation total pp e deposits long-term accounts receivable--other total other assets workforce-in-place cost-shifting capacity total intangible assets total assets current portion of long-term debt accounts_payable accounts payable---other accrued payroll accrued payroll_taxes other accrued expenses due to medicare total current liabilities notes payable long-term portion total liabilities liabilities in excess of assets valuation of sta-home agency dollar_figure compiled pwc fair_market_value fye valuation fye adjustments big_number --- dollar_figure big_number dollar_figure big_number big_number big_number big_number --- big_number big_number big_number big_number big_number -7 big_number big_number big_number -7 big_number big_number -7 big_number big_number --- big_number big_number -7 big_number big_number --- big_number big_number --- big_number big_number -7 big_number big_number --- big_number big_number big_number big_number big_number -7 big_number --- big_number big_number -7 big_number big_number --- -- big_number big_number big_number big_number -7 big_number big_number --- big_number big_number -7 big_number big_number --- big_number big_number --- big_number big_number -7 big_number big_number big_number big_number -7 big_number big_number -7 big_number big_number -7 big_number big_number -7 big_number - combined appendix c inc adjusted balance_sheet approach valuation performed as of base case scenario fair_market_value fye pwc valuation compiled fye adjustments cash dollar_figure --- dollar_figure accounts_receivable big_number dollar_figure big_number allowance for contractual adjustments big_number big_number big_number allowance for bad_debts big_number big_number est third-party payor settlements---medicare big_number big_number big_number allowance for unsuccessful claims big_number big_number accounts receivable--employees big_number -- big_number accounts receivable---other big_number -- big_number prepaid expenses big_number --- big_number total current_assets big_number -- big_number property plant equipment big_number -- big_number accumulated depreciation big_number --- big_number total pp e big_number --- big_number deposits big_number -- big_number long-term accounts receivable--other big_number big_number big_number total other assets big_number -- big_number workforce-in-place -- big_number big_number total intangible assets -- -- big_number total assets big_number -- big_number current portion of long-term debt big_number -7 big_number accounts_payable big_number -7 big_number accounts payable--other big_number -7 big_number accrued payroll big_number -- big_number accrued payroll_taxes big_number -- big_number other accrued expenses big_number -- big_number due to medicare -- big_number big_number total current liabilities big_number -- big_number notes payable long-term portion big_number -7 big_number unaudited cost reports -- big_number big_number total liabilities big_number big_number big_number liabilities in excess of assets big_number big_number big_number to corroborate his findings of net asset value hahn used a market-transaction approach this approach involved valuing the sta-home tax-exempt entities on the basis of market values of comparable companies that had been sold to hahn the comparable approach was only a secondary indication of value because sales of other individual home health care agencies appeared to be too idiosyncratic to provide a principled basis for valuation in any event hahn noted that approximately applications to change ownership had been filed by home health care agencies in -- - mississippi during the 1l-year period ended in little information was available as to these ownership changes and hahn found only two guideline transfers hahn further noted that the sta-home tax-exempt entities were focused almost entirely upon traditional home health care and depended almost entirely upon medicare payments publicly traded companies by contrast usually utilized traditional home health care agencies as part of a broader mix of health care business hahn concluded therefore that a comparison to publicly traded companies would not be appropriate to value the sta-home tax-exempt entities and he instead utilized readily available information on comparable sales derived from privately held transactions engaged in by those publicly traded companies from these privately held transactions hahn excluded sales of privately held home health agencies that provided sophisticated infusion or respiratory therapy because those could attract reimbursement at a higher rate than those available to the more traditional home health care agencies such as sta- home principally upon the basis of his adjusted balance_sheet and comparable market computations hahn reached an ultimate conclusion that the sta-home tax-exempt entities’ liabilities exceeded their total tangible and intangible assets by dollar_figure to dollar_figure --- - finally hahn turned his attention to making adjustments to the sta-home for-profit entities’ stock for control premiums and lack of marketability he hypothecated that no additional premium for control of the sta-home tax-exempt entities was appropriate because the sale of percent of the sta-home tax- exempt entities was contemplated therefore all of the value of the companies would be included in the transaction price he also concluded that any adjustment to reflect the fact that mississippi presented an unattractive market for the sale of the sta-home tax-exempt entities had been incorporated into his adjusted balance_sheet valuation with respect to the value of the stock held by the individual shareholders hahn noted that no one individual could control the sta-home tax-exempt entities while he believed that this usually would require that a minority discount be reflected in the value of the shares held by the noncontrolling shareholders he concluded that a minority discount was not appropriate here because the shares represented equity interests in a loss_corporation he noted however that at the time of the asset transfer the appropriate control premium and market_discount in the home health care industry were approximately percent and percent respectively d expert testimony for respondent - - charles a wilhoite wilhoite presented expert testimony on behalf of respondent wilhoite a certified_public_accountant is a principal of willamette management associates and codirector of that firm’s office in portland oregon he has performed a number of assignments involving the analysis and appraisal of professional practices with a heavy concentration in the health care field he has been involved with assignments requiring the valuation of intangible assets including cons customer relationships goodwill and workforces petitioners argue that wilhoite’s testimony should be stricken because they claim his qualifications as an expert and his methodology are insufficient to meet the standards set forth in 509_us_579 these contentions are nonsensical and border on the frivolous gross v commissioner tcmemo_1999_254 affd 272_f3d_333 6th cir we have no reason to question our recognition of wilhoite as an expert on the fair market valuation of health industry and related businesses ie the business of the sta-home tax-exempt entities nor are we unsatisfied as to the reliability of his methodology including ascertaining the fair market values of invested capital for comparable entities btr dunlop holding inc v commissioner tcmemo_1999_377 turning to wilhoite’s testimony wilhoite like hahn considered the three principal means of valuing a company’s - - assets ie the income cost and market approaches wilhoite rejected the cost approach as a means of valuing the sta---home tax-exempt entities he noted that the value of the sta-home tax-exempt entities’ intangible assets was especially important because the entities were service-based business with a relatively low investment in tangible assets he noted that the sta-home tax-exempt entities’ intangible assets included operating licenses medicare certifications patient lists referral relationships a trained and assembled workforce proprietary policies and procedures and trade_name and a going_concern_value he noted that the cons had been subject toa moratorium for the years prior to the valuation_date he noted that health issues prevented him from learning details about the sta-home tax-exempt entities’ intangible assets from the sta-home tax-exempt entities’ management and that much of that information was simply not available he explained that several of the home health care agencies acquired in recent transactions had incurred losses immediately before their sale he observed however that the purchasers of those agencies still had paid considerable amounts to acquire them to wilhoite this factor indicated that the intangible assets even of companies that showed losses were worth considerable sums to potential acquirers moreover it indicated to wilhoite that an examination of similar acquisitions would - -- result in an indication of a value which included the value of intangible assets wilhoite decided that a better valuation would come from employing the market approach e examining transfers of ownership of comparable home health care agencies his market approach utilized two types of transfers one involved the valuation of comparable publicly traded home health care agencies the other valued the consideration paid for merged or acquired companies in addition to the two-pronged market approach wilhoite also utilized an income_method wherein he calculated the value of the sta-home tax-exempt entities’ cost-- savings attribute to a potential buyer as a basis for his valuations under both the market and income approaches wilhoite ascertained the market_value of invested capital mvic for the sta-home tax-exempt entities the mvic represents the market_value of a company’s capital structure---all of its ownership equity and all of its interest-- bearing debt the mvic method is commonly used in the valuation of closely held companies its use operates to minimize differences in capital structure between a closely held company and publicly traded companies which are used as comparables see pratt et al valuing small_business and professional practices 3d ed -- - wilhoite turned first to the market approach examining the value of publicly traded companies that operated home health care agencies for each of these he ascertained a revenue pricing multiple ie a percentage that when multiplied by the annual revenues of a home health care agency would reflect the mvic of that agency the mvic of the comparable companies reflected a median revenue multiple of because sta-home tax-exempt entities were nonprofit companies however their returns on invested capital were considerably lower wilhoite selected a multiple of noting that this multiple represented a discount of percent from the median guideline company multiple he then multiplied times the sta-home tax-exempt entities’ revenues of dollar_figure to arrive at an mvic for the sta-home tax-exempt entities of dollar_figure wilhoite next turned his attention to the guideline merged and acquired company method he examined figures available from publications such as the home health care m a report published by irving levin associates inc he pointed out that two of the comparable merged or acquired companies were very close in revenues to the sta-home tax-exempt entities of those two the mvic of patient-care inc represented a revenue multiple of -40 and the mvic of magellan health services inc reflected a revenue multiple of with respect to a comparable company that operated at a loss namely nurse-care inc wilhoite noted - - that when acquired it had reported revenues of dollar_figure million but overall losses of percent nurse-care inc sold for an mvic revenue multiple of taking these factors into consideration wilhoite selected a revenue multiple of dollar_figure times the last year’s revenue this amount was approximately percent higher than that of nurse-care inc but percent lower than the guideline for the median merged or acquired companies having applied the dollar_figure multiple to the sta-home tax- exempt entities’ last 12-month revenue of dollar_figure wilhoite arrived at an mvic of dollar_figure wilhoite then turned to the income approach he ascertained that the sta-home tax-exempt entities could generate meaningful income for a purchaser that was positioned to use the cost- shifting strategy an officer of sta-home tax-exempt entities had indicated to wilhoite that the entities had historically received reimbursed costs in an amount that wa sec_5 percent below the limit they were allowed wilhoite ascertained that the annual value of such a saving in was dollar_figure to ascertain the present_value of a stream of such payments wilhoite ascertained an appropriate multiplier by examining the weighted average cost of capital for sta-home tax-exempt entities less the anticipated increases generated by long-term growth wilhoite arrived at a capitalization rate of percent this capitalization rate yielded a value for the sta- -- - home tax-exempt entities on the basis of use of the cost gap of dollar_figure to conclude his study wilhoite assigned a weighted percentage to each of the three values he had derived under the two market approaches and the single income approach he gave the most weight to the income approach somewhat less weight to the publicly traded comparable approach and the least weight to the merged or acquired comparable approach his weighted average was dollar_figure for the mvic wilhoite then took into account the fact that although they were ongoing businesses the sta- home tax-exempt entities had nevertheless generated a net working_capital deficit ie the current liabilities exceeded the current_assets by more than dollar_figure million while sufficient current_assets would usually be present in an ordinary operating business to pay for current liabilities this was not the case for the sta-home tax-exempt entities a purchaser would quickly have to come up with additional moneys to pay the bills wilhoite viewed the necessity for such a working_capital infusion as a factor that would lower the value of the calculated mvic thus from the dollar_figure value for the mvic he subtracted the dollar_figure deficit that a buyer of the sta-home tax-exempt entities would have to provide following an acquisition of the companies to the resulting figure for the now-discounted mvic wilhoite added the companies’ current liabilities he did so -- - because accounting rules require the asset side and the liability side of a company’s balance_sheet to be equal his calculated mvic which comprised long-term liabilities and owners’ equity did not include current liabilities wilhoite reasoned that by adding the known current liabilities to the mvic he would complete the liability side of the balance_sheet the asset sheet would thus be an amount that equaled the liabilities so computed he compared the inclusion of current liabilities as a means of ascertaining value by showing that petitioners had done essentially the same operation their position was that the companies’ value was egual to the total liabilities both long- term and short-term debt the difference between wilhoite’s view and that of petitioners is that wilhoite concluded on the basis of his mvic analysis that the companies had some value which was expressed on the liabilities side as owners’ equity petitioners however maintained that there was no owners’ equity and hence they did not include it in the balance_sheet his explanation stated basic accounting requires that the total asset value of an entity ie the left-hand side of the balance_sheet is equal to the sum of the total liabilities and equity or net asset value of an entity ie the right-hand side of the balance_sheet the sta-home for-profit entities and the caraccis reported acquired all of the assets of the tax-exempt agencies by assuming all of the liabilities of the tax-exempt agencies because the caraccis assumed no equity value existed and because basic accounting requires that the -- -- left-hand side of the balance_sheet equal the right-- hand side our independently determined estimate of the fair_market_value of sta-home’s invested capital e interest-bearing debt and equity reduced by the estimated working_capital infusion combined with reported current liabilities provides the total right-hand side of the balance_sheet the result is as follows indicated mvic dollar_figure less working_capital infusion big_number plus current liabilities big_number indicated asset value big_number e our valuation of the sta-home tax-exempt entities the traditional determinants of fair_market_value persist even when valuing a nonprofit tax-exempt company there are differences however in the amount of weight usually given to the earnings_and_profits of regular business organizations and those of tax-exempt entities earnings_and_profits are obviously less meaningful in the case of nonprofit_organizations here medicare funded percent of the sta-home tax-exempt entities’ operations as applicable herein the medicare program was not designed to produce corporate profits nor to contribute to the capital growth of health care organizations it was designed to reimburse providers of home health care services for their costs including administrative salaries and overhead the system nevertheless permitted the operators of such agencies to generate executive-level salaries and benefits for themselves it also permitted them to accumulate substantial assets in their businesses without paying income taxes on any of their earnings -- - petitioners urge that common sense requires a decision in their favor they argue that they incurred losses not gains on the transactions leading to formation of the sta-home for-profit entities they point to balance sheets which show that the liabilities they assumed exceeded the value of the assets they acquired we disagree with petitioners’ so-called common sense rationale to the contrary we think it obvious that a company’s negative book_value does not require a finding that the company had a fair_market_value of less than zero nor does the fact that a company operates at a loss mean that its intangible assets have no value those assets are still capable of generating revenue thus proving they have value even petitioners’ tax adviser pettis testified to that effect moreover the sta-home tax-exempt entities’ assets generated revenues of approximately dollar_figure million in the year they were transferred to the sta-home for-profit entities the sta-home tax-exempt entities reported a modest income from operations but after deducting interest and depreciation mostly for their fleet of automobiles they reported a loss of dollar_figure although in they also reported an increase for the third consecutive year in the negative net asset value to a new total of dollar_figure the evidence shows that their fourth employee bonus in that year amounted to some dollar_figure had they not - al --- declared that bonus they would have reported nontaxable income of approximately dollar_figure or in other words more than enough to eliminate the accumulated deficit in net asset value the sta-home tax-exempt entities’ expert also reported that their total payroll for was dollar_figure or about percent of operating_expenses and that this amount of employee compensation was generous a common range of compensation_for other home health care agencies was between and percent had petitioners not declared the last bonus their compensation expense would have been dollar_figure or percent of operating_expenses this amount would have exceeded the industry average and still enabled the companies to eliminate their accumulated deficit and show a modest profit thus even though the sta-home tax-exempt entities reported a history of losses they at least had the potential to generate income and thus demonstrate a substantial fair_market_value we believe that the best evidence of the value of the sta- home tax-exempt entities arises from the use of the comparable value method employed by both experts we also are persuaded that the fair_market_value is best determined by relying upon the rationale of wilhoite his use of the mvic approach to compare the privately held sta-home tax-exempt entities to similar publicly traded businesses is especially appropriate here that approach harmonizes the differences between debt and equity usage - -- by publicly traded companies and privately held entities it also considers the total investment which as discussed infra is especially important for the sta-home tax-exempt entities we do not agree however that wilhoite ascertained an accurate price-to-revenue multiple for ascertaining the sta-home tax-exempt entities’ mvic his multiplier was approximately half that applicable to the median of the publicly traded comparables his discount reflects petitioners’ demonstration that many of these publicly traded companies functioned in areas where combinations of businesses including managed care operations produced more favorable prospects than were generally available in mississippi wilhoite’s discount does not however sufficiently take into account the absence from the sta--home services of some of the more sophisticated and remunerative home health care techniques such as infusion and respiratory therapies these techniques were utilized by many of the comparison companies we therefore believe that the price-to- revenue multiple for publicly traded companies should be no higher than the dollar_figure that he applied to the merged and acquired comparable companies we also fail to find wilhoite’s valuation particularly meaningful solely on the basis of the capitalization of sta-home tax-exempt entities’ intangible known as the cost gap wilhoite has correctly noted that the cost gap has substantial -- - potential value to a hospital purchaser and in fact hahn has written extensively about the value of this cost-shifting attribute we feel however that wilhoite has included too many imponderables in his calculation for example we do not believe that the entire value of the sta-home tax-exempt entities is appropriately bound up in the marketability of a single intangible asset---the cost gap nor do we believe that it is justified to conclude that the cost gap would produce economic benefits indefinitely especially in view of the official scrutiny it had received before and during finally we observe that wilhoite has assumed that the cost gap would equal percent of the allowable cost ceiling ie be percent less than the ceiling this percentage appears to have been accurate for earlier years but the most recent cost gap was only dollar_figure percent below the cost ceiling the way for a potential buyer to increase the cost-gap percentage would be to reduce costs further we do not think however that a buyer of the sta-home tax-exempt entities would necessarily decrease expenses to move the cost gap asset from its most recent 86-percent level back to historic 5-percent level and then continue this cost gap indefinitely on balance we believe that the most weight is properly given to wilhoite’s estimate of the mvic for the sta- home tax-exempt entities using a price-to-revenue multiple of this results in an mvic of dollar_figure million - petitioners have raised a number of issues concerning the sta-home tax-exempt entities’ mvic and we believe that one of their points has merit their principal contention arises from their concession that the sta-home tax-exempt entities’ capital structure was different they explained that the entities’ practice of requiring employees to forgo paychecks for the first weeks created a pool of approximately dollar_figure million although they identified this amount as a current_liability in the form of accrued payroll and accrued payroll_taxes this permanent pool actually functioned as a source of permanent capital to prove their point they show that their reported current liabilities for were percent of invested capital an amount several times greater than that of comparable companies in effect they argue their employees had made a collective long-term_loan to the company we agree in operation much of the dollar_figure million which had been held back from the employees’ payroll and payroll_taxes functioned as a source of long-term financing not all of the withheld payroll however is properly considered long-term financing petitioners’ accountant hart testified that the sta-home tax-exempt entities originally hada two-week payroll which was extended to weeks and then to weeks as a source of working_capital hahn’s report states that medicare pays home health care agencies no less frequently than every weeks based on estimated costs to aid their cashflow -- situation the sta-home entities paid their employees weeks in arrears thus an employee was required to wait weeks before getting his or her first paycheck for weeks’ work in the meantime however medicare reimbursed the companies for the amount of accrued wages every weeks the entities thus received weeks’ worth of wages per employee before being required to pay out weeks’ worth the deferral of actual payment meant in effect that each employee made a loan of weeks’ wages to the company and the loan would not be repaid until the employee left his or her employment when one employee left another was presumably hired and the new employee would be required to forgo weeks’ salary thus keeping the total amount of deferrals relatively stable by this practice had generated a float of approximately dollar_figure million that the entities possessed and were not required to repay until some unspecified time in the future it appears that weeks’ worth of payroll and payroll_taxes is properly characterized as short-- term liabilities we conclude that the amounts of payroll that were withheld for longer than weeks were not in this case properly characterized as current liabilities for purposes of this valuation they should be considered part of the invested capital accordingly of the dollar_figure withheld two-thirds or weeks’ worth should be excluded from the current liabilities that wilhoite added to the mvic wilhoite based his calculation - of mvic upon an informed estimate of the value of invested capital ie long-term debt plus owner’s equity that would produce the known revenues for his calculations showed that invested capital of dollar_figure million would produce the reported dollar_figure in revenue that the sta-home tax-exempt entities generated some part of this mvic is readily discernible it includes dollar_figure of long-term debt additionally as we have explained it also includes the dollar_figure million of deferred wages that functioned as long-term debt for the companies as earlier observed however a buyer would have to include as part of the purchase_price not only the value of the invested capital the mvic but also the current liabilities that the purchased company would have to pay wilhoite accordingly added current liabilities of dollar_figure from the sta-home tax-exempt entities’ balance sheets to his calculated mvic of dollar_figure million that amount of current liabilities however includes dollar_figure million of withheld wages that operate as long-term debt and thus form part of the mvic to avoid duplicating this dollar_figure million figure in arriving at a fair_market_value for the companies we believe that it should be excluded from current liabilities removing dollar_figure million from current liabilities however also restores the dollar_figure working_capital shortfall resulting from the failure of current_assets to match current liabilities accordingly there is no longer a need to reduce the asset value by the amount a7 - of the capital infusion finally we also believe that current liabilities should be increased by dollar_figure as suggested by hahn to reflect a reserve for disallowed claims on its medicare cost reports this increases the current liabilities to dollar_figure before deducting the amount of withheld payroll that is to be considered part of the mvic when we take these modifications into account we arrive at a fair_market_value of dollar_figure indicated mvic dollar_figure plus current liabilities big_number less withheld payroll big_number indicated asset value big_number we are unimpressed and unpersuaded by hahn’s conclusions as to the fair_market_value of the sta-home tax-exempt entities and we have decided not to accept them his reasoning that the sta- home tax-exempt entities had a fair_market_value of less than zero 1s unconvincing and in fact appears to be more an advocacy of petitioners’ litigating position than a candid fair market appraisal we think a willing buyer would be puzzled and confused by his conclusions neither hahn’s adjusted balance_sheet approach nor his backup market approach justify the finding of a negative net_worth first in one substantial respect even hahn’s best case adjusted balance_sheet is seriously deficient hahn’s report states most buyers concentrate on the intangible assets of a home health agency his conclusions however fail to account -- - for much of the substantial value of the sta-home tax-exempt entities’ intangible assets hahn ascertained a value for two intangible assets he first developed a value for the sta-home tax-exempt entities’ workforce in place of dollar_figure million to dollar_figure million he used the dollar_figure million value in both the base case and best case scenarios he fails to justify using the lower value in the best case scenario petitioners have assembled a workforce of approximately big_number a very substantial proportion of them are highly trained professionals including registered nurses and other trained medical personnel the sta-home tax- exempt entities employed percent of the full-time and percent of the part-time home health care staff in the state of mississippi if hahn has developed an approximate value of dollar_figure million we see no reason not to employ this estimate in the best case scenario indeed we suspect that the value of the workforce is higher but on this record we cannot reasonably estimate how much with respect to another intangible asset hahn’s best case scenario ascribed a value of dollar_figure to the cost gap attribute that the sta-home tax-exempt entities presented for a qualifying buyer his valuation is based on the assumption that the value of this attribute would end after year this value is too low the cost gaps were available under the then-current reimbursement program they would cease to exist under a pps although there --- - had been discussions of a pps for several years congress had passed no such legislation at the time of the transfer and there is no evidence that the prospect of such legislation had a negative effect upon the value of home health care agencies in fact one of hahn’s articles published in the spring of demonstrates a furious pace of home health transfers from through the article contains a chart showing that the number of home health agency transfers did not begin to decrease until the second guarter of a best case scenario would we think indicate at least a 2-year value for the cost gap asset by using a 2-year figure in hahn’s computations we arrive at a value of more than dollar_figure million for the cost-shifting attribute hahn’s valuation of the intangible assets also fails to address the value of the cons held by the sta-home tax-exempt entities these certificates effectively closed the home health care market to competition during a period of high growth for the industry michael caracci acknowledged his efforts to lobby the mississippi legislature in the interests of keeping the con moratorium in place thus preserving the monopoly of the sta-home tax-exempt entities and others who had received cons before the moratorium his efforts indicate that the cons possessed by the sta-home tax-exempt entities would be worth considerable amounts to a willing buyer but hahn did not ascribe any value to them -- - we conclude that the absence of a candid valuation for the sta-home tax-exempt entities’ intangible assets explains the considerable gap between the adjusted balance_sheet value ascertained by hahn and the dollar_figure value we have decided today we also reject hahn’s assertion that his alternate market approach to valuation guideline supports his adjusted balance_sheet approach initially we find that his selection of guideline companies is at least adequate most of them value traditional visiting nurse companies such as petitioners and thus hahn avoids the problem of including home health care agencies that offer more technical home health care services he has also included both publicly traded and privately held companies in his survey and he has included both companies that have positive_income and companies that reported losses his guideline companies also include those with a positive net_worth and companies that indicate a negative equity_capital hahn’s best case scenario indicates that the value of the intangible assets represents dollar_figure percent of the total assets in one of his recent articles he presents a chart showing the goodwill value of seven publicly traded home health care companies the lowest of these indicates a goodwill value to total asset ratio of percent and the others indicate values pincite percent percent percent percent and two others pincite percent hahn et al home health agency valuation opportunity amid chaos intrinsic value spring -- - we are unable however to accept hahn’s conclusions of fair_market_value on the basis of his market approach hahn has derived two implied valuation multiples the first is a ranking based upon the ratio of selected comparable companies’ sale prices to their most current revenues the second is a ranking of the companies’ sale prices to their total book assets ’ the median sale prices were dollar_figure times annual revenues and times total book assets here however in his best case scenario he has ascertained that the sta-home tax-exempt entities would sell at a price only dollar_figure times annual revenues and further that they would sell at a price only times their total book assets hahn’s best case scenario ranks the sta-home tax-exempt entities next to last in both categories in contrast none of the comparable companies ranks as low in both categories clausen health services for example sold at a multiple of dollar_figure times revenues a ratio close to that ascribed to the sta-home tax-exempt entities clausen’s sale price however also represented a price-to-asset ratio of ranking seventh among the comparables if the sta-home tax-exempt entities sold at this multiple the indicated fair_market_value would be it is important to keep in mind that hahn’s valuation multiples generated a figure that represented the total asset value of a company while wilhoite’s multiples generated the value of its invested capital or mvic thus application of the same valuation multiple say will generally yield different fair market values depending upon which method is used - - dollar_figure ' another example shows that house call inc sold at a price dollar_figure times its total assets a ratio close to the dollar_figure that hahn has ascribed to the sta-home tax-exempt entities house call inc ’s sale price however also indicates that it sold at a multiple of dollar_figure times revenues ranking second of the comparables if the sta-home tax-exempt entities were sold at this ratio the indicated sales_price would be approximately dollar_figure million moreover in an article published in the spring of hahn indicated that for the prior years a standard market benchmark for valuing traditional visiting nursing agencies such as the sta-home tax-exempt entities was a price- to-revenue multiple of hahn spieler valuation of home health care companies intrinsic value spring we fail to understand why the sta-home tax-exempt entities had a much lower multiple of we recognize that the sta-home tax-exempt entities operated at a loss for the prior year but so did of the comparable companies we further recognize that the sta-home tax-exempt entities’ equity_capital was a negative_amount but so was that of of the comparable companies these characteristics reflect the accepted conclusion that exempt entities operating under the medicare reimbursement system stood the book_value used for the sta-home tax-exempt entities’ total asset value excludes any value for intangible assets it is unclear whether clausen’s book_value for total assets includes intangibles -- - little chance of turning a profit in fact hahn’s article states that analysis of recent vna ie traditional visiting nursing agency transactions indicates that companies with operating losses have transacted at multiples of revenue similar to agencies with operating profits id pincite accordingly we conclude that the sale price we have decided more accurately reflects the fair_market_value of the sta-home tax-exempt entities than does that of hahn we note that our valuation of dollar_figure indicates that the sta-home tax-exempt entities would sell at a price-to-revenue multiple of lower than the dollar_figure median applicable to hahn’s comparable home health care agencies our finding also indicates that the ratio of price to book_value would be which again is less than the dollar_figure median for the same comparable companies in reaching this value we have also considered but rejected petitioners’ arguments that conditions in mississippi require a finding that the assets of the sta-home tax-exempt entities were worth less than the liabilities assumed petitioners argue strenuously that the sta-home tax-exempt entities’ operation in mississippi a relatively poor and rural_state dramatically reduces their fair_market_value petitioners do not mention however that the federal per-patient medicare payment was higher for mississippi than for any other state we -- think that this factor substantially offsets the demographic challenges of operating home health care agencies in mississippi petitioners also maintain that there was no market in mississippi for acquisition of the sta-home tax-exempt entities the record in this case however indicates that there were many such sales including the purchase of mississippi home health care agencies by out-of-state hospitals we are not convinced that reasonable exploration by a willing seller would have failed to turn up a willing buyer whether in mississippi or elsewhere f excess value having found the fair_market_value of the sta-home tax- exempt entities we turn to decide the value in excess of the assumed_liabilities we are satisfied that the sta-home for- profit entities intended to and did assume all of the liabilities of the predecessor businesses the evidence includes an audited balance_sheet prepared for purposes of this case which indicates that the total liabilities as of date were dollar_figure to this amount we think there is properly added dollar_figure as ascertained by hahn representing a reserve_account for cost claims disallowed by medicare total liabilities assumed were therefore dollar_figure subtracting the total liabilities from the fair_market_value we have decided results in an excess of dollar_figure fair_market_value dollar_figure assumed_liabilities big_number excess big_number tiil excise_taxes under sec_4958 sec_4958 the provisions of which are set forth in the appendix to this report was added to the internal_revenue_code by the taxpayer bill of right sec_2 publaw_104_168 110_stat_1452 sec_4958 is patterned after sec_4941 which applies to acts of self-dealing between private_foundations and disqualified persons sec_4958 applies to public_charities and social welfare organizations which are exempt from federal income taxes ’ sec_4958 was enacted to impose penalty excise_taxes as intermediate_sanctions in cases where organizations exempt from tax under sec_503 engage in excess_benefit transactions h rept pincite 1996_3_cb_49 an excess ‘t no regulations apply to the transactions at issue the treasury_department published proposed_regulations under sec_4958 on date sec_53_4958-1 through proposed excise_tax regs fed reg date which were revised and replaced by temporary regulations effective date sec_53_4958-1t through 4958-8t temporary excise_tax regs fed reg date on date the treasury_department removed the temporary regulations and published final regulations effective date sec_53_4958-0 through excise_tax regs t d 2002_7_irb_500 sec_4958 is generally effective for transactions occurring after date at trial the parties directed considerable attention to the effective date of the transfers at issue on brief however petitioners did not argue that the transfers were effective on or before date and we deem that argument to have been abandoned -- - benefit transaction is one in which a tax-exempt_organization provides an economic benefit to one or more of the organization’s insiders called disgqualified persons if the fair_market_value of the benefit exceeds the value of what the organization receives in return sec_4958 a h rept supra pincite c b pincite disqualified persons include not only those who are able to exercise substantial influence over the tax-exempt_organization but also their family members and entities in which those individuals have percent of the voting power disqualified persons are subject_to the excise penalties whether the excess_benefit transactions are accomplished directly or indirectly sec_4958 before the enactment of sec_4958 if an organization within its purview did not comply with the rules regarding tax exemption the commissioner’s only recourse was to revoke the organization’s exemption the treasury_department realized that such a response might be inappropriate when the exempt_organization did not conform to all the applicable rules but was nevertheless capable of functioning for a charitable purpose see u s department of the treasury’s proposals to improve compliance by tax-exempt organizations hearing before the subcommittee on oversight of the house comm on ways and means 103d cong 2d sess at the urging of the treasury - - department congress enacted sec_4958 see h rept supra pincite c b pincite a disqualified_person who receives an excess_benefit from an excess_benefit_transaction is liable for an initial excise_tax equal to percent of the excess_benefit sec_4958 if the initial tax is imposed and the transaction is not corrected within the taxable_period then the disqualified_person is liable for an additional tax of percent of the excess_benefit sec_4958 here the fair_market_value of the sta-home tax-exempt entities’ transferred assets far exceeded the consideration paid_by the sta-home for-profit entities thus the asset transfers were excess_benefit transactions which directly benefited the transferees ie the sta-home for-profit entities and indirectly benefited the sta-home for-profit entities’ shareholders e the caracci family members petitioners do not seriously dispute that they are disqualified persons with respect to the sta-home tax-exempt entities joyce p caracci michael caracci and christina c mcquillen as directors and officers of each of the three sta-home tax-exempt entities are disqualified persons because they were in positions to exercise substantial influence over the entities’ affairs sec_4958 f a victor caracci and vincent caracci are disqualified persons because of their familial relationships to -- - joyce p caracci michael caracci and christina c mcquillen sec_4958 b sta-home health agency of carthage inc sta-home health agency of greenwood inc and sta-home health agency of jackson inc are disqualified persons because they are entities that are 35-percent controlled by disqualified persons in fact members of the caracci family own percent of the sta-home for-profit entities’ voting_stock sec_4958 f c accordingly petitioners are subject_to excess_benefit taxes under sec_4958 because we have decided the value of the sta-home tax-exempt entities’ assets on the basis of a revenue multiple it is appropriate to ascribe the excess_benefit to each of the sta-home for-profit entities in proportion to the amounts the revenues of their respective predecessors bore to the total revenue this produces the following results entity percentage benefit sta-home health agency dollar_figure of carthage inc sta-home health agency big_number of greenwood inc sta-home health agency big_number of jackson inc because each of the three entities acquired or assumed its predecessor’s assets and liabilities as opposed to acquiring its predecessor’s stock we see no basis to apply a minority discount to the value of the excess_benefits each has received nor for that reason is an application of a minority discount appropriate --- - as to the excise_taxes imposed upon the individual shareholders of the sta-home for-profit entities we conclude that each of the disqualified_person petitioners is jointly and severally liable for the initial and additional taxes under sec_4958 and b as to the excess_benefits the effect of our holding is that the individual petitioners are jointly and severally liable for the total excess_benefit of dollar_figure from the three sta-home entities while the sta-home for profit entities are liable for taxes as specified in the above table in so concluding we decline at this time petitioners’ invitation to abate the initial and additional excise_taxes pursuant to sec_4961 second-tier tax abatement and sec_4962 first-tier tax abatement because the excess_benefit transactions have never been corrected for purposes of sec_4958 petitioners’ invitation is at best premature petitioners have not as of yet met the prereguisite for the requested abatement ie a timely correction in this regard however we note that sec_4961 and sec_4963 generally allow for the abatement of a sec_4958 excise_tax if the excess_benefit_transaction giving rise thereto is corrected within days after our decision sustaining the tax becomes final cf morrissey v commissioner tcmemo_1998_443 because the issue of whether petitioners -- - will or would qualify for an abatement is not yet ripe for decision we express no opinion on this issue iv revocation of tax-exempt status sec_501 reguires among other things that an organization be operated exclusively for one or more specified exempt purposes an organization is not operated exclusively for one or more exempt purposes unless it serves a public rather than a private interest and its net_earnings do not inure to the benefit of any shareholder or individual sec_1 c -1 income_tax regs the presence of a single substantial nonexempt purpose can destroy the exemption regardless of the number or importance of exempt purposes 326_us_279 am campaign acad v commissioner 92_tc_1053 when an organization operates for the benefit of private interests such as designated individuals the creator or his family or persons directly or indirectly controlled by such private interests the organization by definition does not operate exclusively for exempt purposes prohibited benefits may include an advantage profit fruit privilege gain or interest am campaign acad v commissioner supra pincite- we have held that when a sec_501 tax-exempt_entity sells its assets for less than fair_market_value to a for- profit corporation whose shareholders are directors of the tax- -- - exempt entity the sale constitutes inurement and revocation may be appropriate anclote psychiatric ctr inc v commissioner tcmemo_1998_273 with the enactment of sec_4958 however the issue whether the tax-exempt status of the sta-home tax-exempt entities should be revoked must now be considered in the context of the intermediate sanction provisions as noted above the intermediate sanction regime was enacted in order to provide a less drastic deterrent to the misuse of a charity than revocation of that charity’s exempt status the legislative_history explains that the intermediate_sanctions for ‘excess benefit transactions’ may be imposed by the irs in lieu of or in addition to revocation of an organization’s tax-exempt status h rept supra pincite c b pincite a footnote to this statement explains in general the intermediate_sanctions are the sole sanction imposed in those cases in which the excess_benefit does not rise to a level where it calls into question whether on the whole the organization functions as a charitable or other tax-exempt_organization id n c b pincite although the imposition of sec_4958 excise_taxes as a result of an excess_benefit_transaction does not preclude revocation of the organization’s tax-exempt status the legislative_history indicates that both a revocation and the imposition of intermediate_sanctions will be an unusual case -- - we do not believe that this is such an unusual case the dormant state of the sta-home tax-exempt entities precludes calling into question whether on the whole they are functioning tax-exempt entities moreover we perceive three reasons why it is not appropriate to remove their tax-exempt status at this time first the excess_benefit represented the fair_market_value of the sta-home tax-exempt entities’ assets less the liabilities assumed by the sta-home for-profit entities given that we have already sustained the imposition of intermediate_sanctions as to this excess value we do not believe it appropriate under the facts herein to conclude that the single transaction as to each entity underlying the excess value also requires our revocation of each entity’s tax-exempt status second the sta-home tax-exempt entities have not since the transfers been operated contrary to their tax-exempt purpose third we find some credence in petitioners’ suggestion that maintenance of the tax exemption may enable them to utilize the correction provisions made available in sec_4961 through while the issue is not ripe for us to decide at this time we note that a permissible correction may require that the sta-home for-profit entities transfer the assets back to the sta-home tax-exempt entities if we were to remove the sta-home tax-exempt entities’ tax-exempt status at this stage however -- - those entities would no longer be tax-exempt entities available to receive the assets the legislative_history quoted above indicates that the term ‘correction’ means undoing the excess_benefit to the extent possible and taking any additional measures necessary to place the organization in a financial position not worse than that in which it would be if the disqualified_person were dealing under the highest fiduciary standards h rept supra pincite c b pincite petitioners suggest that preserving the tax- exempt status of the now-dormant tax-exempt sta-home entities may leave petitioners with a means of correction by placing the entities back into a financial position not worse than it would be if the disqualified persons had observed the proper standards while as noted above we do not address the issue of timely corrections we believe that leaving the exemptions intact is consistent with both the legislative_history underlying sec_4958 and the provisions for abatement in sec_4961 through v income taxes michael caracci vincent caracci and christina mcquillen collectively the caracci children had no ownership_interest in the sta-home tax-exempt entities the caracci children also did not contribute any property to the sta-home for-profit entities in exchange for the stock that they received in those entities - -- upon their formation respondent determined that the caracci children realized gross_income by virtue of the fact that the sta-home for-profit entities in connection with their organization received the assets of the sta-home tax-exempt entities respondent argues in brief that the assets of the sta- home tax-exempt entities were constructively transferred to the caracci children who in turn contributed those assets to the sta-home for-profit entities respondent argues in brief that the constructive transfer is an accession to wealth that is includable in the caracci children’s gross_income under sec_61 we disagree with respondent that the asset transfer resulted in gross_income to the caracci children although sec_61 provides broadly that gross_income includes all income from whatever source derived sec_102 generally exempts from that provision the value of any property received by gift when property is transferred for less than adequate_and_full_consideration in money or money’s worth the amount by which the value of the property exceeds the value of the consideration is deemed a gift sec_2512 324_us_303 georgia ketterman trust v commissioner 86_tc_91 estate of higgins v commissioner tcmemo_1991_47 in the corporate setting such a transfer may be a gift by the donor to the individual shareholders of the corporation to the -- - extent of their proportionate interests in the corporation 682_f2d_1220 5th cir 393_f2d_972 45_tc_96 88_tc_590 estate of trenchard v commissioner tcmemo_1995_121 sec_25 h gift_tax regs when the shareholders of a recipient corporation are members of the donor’s family that fact is strongly indicative of a gift see kincaid v united_states supra tilton v commissioner supra estate of hitchon v commissioner supra estate of trenchard v commissioner supra estate of higgins v commissioner supra here victor and joyce caracci set up transactions pursuant to which their three children each received stock in the sta--home for-profit entities that in connection therewith had a total net asset value of more than dollar_figure million the caracci children the natural heirs of victor and joyce caracci paid nothing for that stock nor did they contribute property for it the transfers were effectively gifts to the caracci children the fact that the children were also employees of the new corporations does not transform their receipt of percent of the corporate stock into compensation subject_to income_tax we are aware that sec_102 provides that the transfer of property to an employee is generally deemed to be compensation -- - rather than a gift we believe however that a transfer of property to an employee who is a member of the employer’s family is more properly considered a gift when the transfer is not made in recognition of the employee’s work but is made in connection with the family relationship the transfer of most of the assets involved in this case is clearly attributable to the familial relationship between the caracci parents and their children it contrasts strongly to situations cited by respondent involving compensation such as strandguist v commissioner tcmemo_1970_84 president of car sales company taxable on value of new cars he received in excess of value of used cars he turned in nor is this a situation involving disguised rentals paid to a lessor-shareholder as in 334_f2d_351 8th cir affg t cc nor is it in substance a distribution with respect to the stock of a controlling shareholder for his personal benefit as in kenner v commissioner tcmemo_1974_ doctor who owned tax-exempt hospital corporation taxed on relatively small amounts it transferred to corporation that operated his ranch in arizona here during the year in issue none of the home health care assets was distributed to any of the children and none of the children sold the stock or otherwise benefited personally from the transfer of the home health care assets to the for-profit entities -- - on the evidence before us we conclude that the transfers of the home health care assets to the for-profit entities constituted gifts to the caracci children and not the realization of taxable_income by them they are not subject_to income taxes on those transfers in view of the foregoing decisions will be entered for petitioners in docket nos 14711-99x 17336-99x and 17339-99x and will be entered under rule in the remaining dockets -- - appendix sec_4958 taxes on excess_benefit transactions a initial taxes -- on the disqualified_person ----there is hereby imposed on each excess_benefit_transaction a tax equal to percent of the excess_benefit the tax imposed by this paragraph shall be paid_by any disqualified_person referred to in subsection f with respect to such transaction on the management --in any case in which a tax 1s imposed by paragraph there is hereby imposed on the participation of any organization_manager in the excess_benefit_transaction knowing that it is such a transaction a tax equal to percent of the excess_benefit unless such participation is not willful and is due to reasonable_cause the tax imposed by this paragraph shall be paid_by any organization_manager who participated in the excess_benefit_transaction b additional tax on the disqualified_person --in any case in which an initial tax is imposed by subsection a on an excess_benefit_transaction and the excess_benefit involved in such transaction is not corrected within the taxable_period there is hereby imposed a tax equal to percent of the excess_benefit involved the tax imposed by this subsection shall be paid_by any disqualified_person referred to in subsection f with respect to such transaction c excess_benefit_transaction excess_benefit --for purposes of this section-- excess_benefit_transaction --- a in general --the term excess_benefit_transaction means any transaction in which an economic benefit is provided by an applicable_tax-exempt_organization directly or indirectly to or for -- - the use of any disqualified_person if the value of the economic benefit provided exceeds the value of the consideration including the performance of services received for providing such benefit for purposes of the preceding sentence an economic benefit shall not be treated as consideration for the performance of services unless such organization clearly indicated its intent to so treat such benefit b excess_benefit --the term excess_benefit means the excess referred to in subparagraph a authority to include certain other private_inurement --to the extent provided in regulations prescribed by the secretary the term excess_benefit_transaction includes any transaction in which the amount of any economic benefit provided to or for_the_use_of a disqualified_person is determined in whole or in part by the revenues of or more activities of the organization but only if such transaction results in inurement not permitted under paragraph or of sec_501 as the case may be in the case of any such transaction the excess_benefit shall be the amount of the inurement not so permitted d special rules ----for purposes of this section-- joint_and_several_liability ---if more than person is liable for any_tax imposed by subsection a or subsection b all such persons shall be jointly and severally liable for such tax limit for management --with respect to any excess_benefit_transaction the maximum amount of the tax imposed by subsection a shall not exceed dollar_figure -- jo - e applicable_tax-exempt_organization ---for purposes of this subchapter the term applicable tax- exempt_organization means--- any organization which without regard to any excess_benefit would be described in paragraph or of sec_501 and exempt from tax under sec_501 and any organization which was described in paragraph at any time during the year period ending on the date of the transaction such term shall not include a private_foundation as defined in sec_509 f other definitions --for purposes of this section-- disqualified_person ---the term disqualified_person means with respect to any transaction-- a any person who was at any time during the 5-year period ending on the date of such transaction in a position to exercise substantial influence over the affairs of the organization b a member_of_the_family of an individual described in subparagraph a and c a 35-percent_controlled_entity organization_manager ----the term organization_manager means with respect to any applicable_tax-exempt_organization any officer director or trustee of such organization or any individual having powers or responsibilities similar to those of officers directors or trustees of the organization - 7jl1- 35-percent_controlled_entity -- a in general --the term percent controlled_entity means--- a corporation in which persons described in subparagraph a or b of paragraph own more than percent of the total combined voting power a partnership in which such persons own more than percent of the profits interest and a_trust or estate in which such persons own more than percent of the beneficial_interest b constructive_ownership rules --rules similar to the rules of paragraphs and of sec_4946 shall apply for purposes of this paragraph family members ---the members of an individual’s family shall be determined under sec_4946 except that such members also shall include the brothers and sisters whether by the whole or half blood of the individual and their spouses taxable_period --the term taxable_period means with respect to any excess_benefit_transaction the period beginning with the date on which the transaction occurs and ending on the earliest of-- a the date of mailing a notice_of_deficiency under sec_6212 with respect to the tax imposed by subsection a or - j2 - b the date on which the tax imposed by subsection a is assessed correction --the terms correction and correct mean with respect to any excess_benefit_transaction undoing the excess_benefit to the extent possible and taking any additional measures necessary to place the organization in a financial position not worse than that in which it would be if the disqualified_person were dealing under the highest fiduciary standards