t c memo united_states tax_court estate of josephine t thompson deceased carl t holst-knudsen and the bank of new york executors petitioner v commissioner of internal revenue respondent docket no filed date kirk h o’ferrall robert h goldie jonathan g blattmachr andrew e tomback edward a stelzer and jonathan w wolfe for petitioner robert a baxer and joseph j boylan for respondent memorandum findings_of_fact and opinion swift judge respondent determined a deficiency of dollar_figure in the federal estate_tax of the estate of decedent josephine t thompson and a dollar_figure accuracy-related_penalty under sec_6662 unless otherwise indicated all section references are to the internal_revenue_code in effect on date the date of decedent’s death and all rule references are to the tax_court rules_of_practice and procedure the issues for decision are the fair_market_value of big_number shares of the voting common_stock of thomas publishing co inc tpc that were owned by decedent on her death and whether the estate is liable for the accuracy-related_penalty findings_of_fact some of the facts have been stipulated and are so found on date the date of her death decedent resided in new york on date carl t holst-knudsen holst-knudsen decedent’s son and the bank of new york were appointed by the surrogate court of the state of new york county of westchester as co-executors of decedent’s estate holst-knudsen resides in new jersey and the bank of new york is headquartered in new york city tpc is a private closely_held_corporation that was formed over years ago on january as a new york corporation at the time of trial tpc’s principal_place_of_business was located in new york city the big_number shares of tpc voting common_stock that decedent owned constituted dollar_figure percent hereinafter generally rounded to percent of tpc’s total outstanding common_stock decedent’s shares constituted the largest block of tpc common_stock owned by any single stockholder on date all but big_number shares of the remaining tpc common_stock were owned by approximately other relatives of harvey mark thomas the founder of tpc holst-knudsen was designated as the sole testamentary beneficiary of decedent’s big_number shares of tpc common_stock as of date taking into account the big_number shares of tpc common_stock that he already owned and the big_number shares that he inherited from decedent it appears that holst-knudsen individually and beneficially owned big_number shares of tpc stock or approximately percent of the total outstanding tpc common_stock the last big_number shares of tpc common_stock representing dollar_figure percent of the total outstanding tpc common_stock were owned by an outside stockholder -- namely capital cities abc decedent also owned shares of tpc nonvoting preferred_stock the value of which is not in dispute inc a new york stock exchange publicly traded company as of the date of decedent’s death capital cities abc inc or its predecessor apparently had owned these shares of tpc common_stock for at least years during and subsequent years through the time of trial in holst-knudsen was president and jose e andrade was chairman of the tpc board_of directors both holst-knudsen and andrade are grandsons of harvey mark thomas tpc’s founder none of the shares of tpc common_stock has ever been publicly traded and in the years before decedent’s death and in the years after decedent’s death through the time of trial no sales of tpc common_stock occurred also as of date no buy sell agreement or stockholder agreement affecting the value of tpc common_stock was in existence over the years tpc’s primary business has been the production and sale of industrial and manufacturing business guides and directories tpc’s business directories provide in the walt disney co disney acquired capital cities abc inc for dollar_figure billion the tpc stockholder list in evidence apparently does not take into account this disney acquisition and therefore provides the former name of this outside tpc stockholder herein we refer to this stockholder as shown on tpc’s stockholder list detailed information on products and services company profiles contact information and catalog files as of date tpc published and sold throughout the united_states and abroad approximately business-to-business industrial business directories including the thomas register of american manufacturers the thomas register tpc’s 34-volume directory which is recognized throughout north america as the most comprehensive resource for finding manufacturing companies and products tpc also published and sold a variety of news magazines software comparison guides and a magazine relating to factory automation and it owned a product information exchange service and a custom publishing group by any measurement as of date tpc was regarded as a very successful and profitable company and by some as holding an effective monopoly in the united_states on business-to-business industrial and manufacturing print publications the first buying directory was published by harvey mark thomas in prior to incorporation of the business and was titled thomas’ machinery iron steel and metal trades reference book in its own publications tpc describes itself as follows thomas publishing company your product information headquarters for more than years thomas publishing company has concentrated its full energies on filling one of industry’s greatest needs the need for up-to-date product information no other publisher is as totally dedicated to this mission decision makers throughout industry need product information to operate their companies successfully regardless of job function the hunger for up-to-date product information is universal it’s given priority attention because industry’s appetite for products and services of every type is enormous it can be filled only when buying influences have comprehensive reliable up-to-date vendor information it influences profitability profoundly because dozens of new products enter the marketplace daily -- providing new functional and economic benefits to not keep up with these developments means operating without the benefit of these improvements and ultimately that means relinquishing market position to one’s competitors thomas publishing company has become the acknowledged leader in providing industry with the product information it needs today we publish twenty-four major buying guides thirty-one product news magazines two product information exchange services a magazine on factory automation and a publication to help buyers select the most cost-efficient transportation modes for their inbound freight in addition thomas business lists offers comprehensive list services for direct marketing also the thomas marketing information center helps industrial marketers research and respond to industry’s need for new products all of these services are described in the pages that follow published annually thomas register of american manufacturers is by far the most complete and helpful specifying and buying guide published today it provides instant sourcing information on nearly big_number industrial products and services along with comprehensive specifications and availability information from thousands of manufacturers in all more than big_number individual product service sources are included thomas register also contains a complete 2-volume company profiles section and a comprehensive 8-volume catalog file section headquarters and branch addresses phone numbers and asset ratings are provided on more than big_number u s firms for everyone involved in specifying and buying industrial products and services thomas register is invaluable for everyone involved in selling industrial products and services thomas register is invaluable thomas register of american manufacturers 86th ed the primary sales force for tpc directories was made up of independent salespersons located throughout the united_states and canada the salespersons were paid on a commission basis with the right to receive commission advances from tpc in the early 1990s the development and increased use of electronic and digital media provided alternatives to the form and manner in which information could be packaged and distributed for example the development of cd-rom format facilitated the transmission of large amounts of data quickly and permitted the user to sort and to access data in different ways also the development and expansion of the internet and of internet search engines allowed traditional buyers of tpc’s directories to a certain extent to locate and to purchase products on their own without reference to tpc’s print directories historically tpc’s buying directories were published only in print or paper format by the early 1990s however it was recognized by tpc’s management that the internet and other technological advances would have an impact on tpc’s business presenting to tpc special challenges risks and new competition but also providing to tpc new growth opportunities in in response to the significant advancements in technology and to increased use by business entities of electronic media tpc began publishing and offering some of its business-to-business buying directories on cd-rom in in an internal tpc management publication the thomas register was described as the undisputed leader in electronic publishing relating to business-to-business buying directories also in that same internal publication a tpc management objective relating to tpc’s continuing competitive position with electronic publishing was stated as follows finding ourselves now at such a juncture we seek an approach to securing for tpc a dominant position in the electronic interchange of information among industrial buyers and sellers comparable to that which it has enjoyed in the hard copy realm in early although tpc’s management recognized that tpc’s historical existence as a print publisher constituted a certain liability in the new electronic environment tpc’s management also recognized that tpc brought to the competitive electronic information wars ahead certain great assets which were described as the information that it traffics and the methodologies relationships and brand name recognition that support that traffic in tpc began publishing and making its directories available for free on the internet the record does not indicate exactly on which dates tpc’s various directories became available on the internet at tpc’s annual stockholder meeting holst-knudsen gave a speech in which he acknowledged that the rapid advancements in technology created uncertainty for the future of tpc but in which speech holst-knudsen also stated that the technological advancements that were occurring constituted a great opportunity for tpc a colorful excerpt from a date tpc publication comments on the positive manner by which tpc’s management as of early was addressing and dealing with the technological challenges tpc faced as the company’s flagship thomas register absorbs the brunt of competitive initiative from the various evil empires aiming to unseat us in the new digital world asked to respond with a major internet launch in and to add to that a major cd-rom program in thomas register’s production editorial circulation sales and administrative people have handled a hailstorm of change and complexity with energy and skill that few would have been bold enough to anticipate only three years ago by early thomasregister com was recognized as one of the leading business-to-business web sites in the united_states among the web sites so recognized tpc’s web site was ranked sixth for its fiscal years the number of purchasers or subscribers to tpc’s print and cd-rom directories and the number of subscribers to tpc’s internet directories are set forth below fiscal print cd-rom internet year subscribers subscribers subscribers big_number big_number n a big_number big_number n a big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number not in evidence historically tpc’s revenue was generated from the sale of subscriptions to and advertising in its print directories for the last 30-plus years the largest percentage of tpc’s revenue was generated from the sale of advertising for example for its fiscal_year advertising revenue associated with tpc’s directories accounted for percent of tpc’s total revenue by its fiscal_year advertising revenue associated with tpc’s directories accounted for more than percent of tpc’s total revenue set forth below for each of tpc’s fiscal years are the numbers for tpc’s subscription and advertising revenue and the percentage of tpc’s total sales revenue reflected by subscription revenue and by advertising revenue subscription advertising percentage of total fiscal_year revenue sales revenue revenue sales revenue 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 big_number big_number big_number big_number percentage of total not in evidence for decreases in tpc’s subscription revenue generally coincided with tpc making its directories available on cd-rom and on the internet for however increases in tpc’s advertising revenue relating to cd-rom and internet versions of its directories more than offset decreases in tpc’s subscription revenue for its fiscal years tpc’s combined subscription and advertising revenue relating to its respective print cd-rom and internet directories is set forth below combined subscription and advertising sales revenue fiscal print cd-rom internet year directories directories directories multimedia dollar_figure 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 big_number big_number big_number big_number multimedia sales revenue reflects the sale of bundled advertising in tpc’s print cd-rom and internet directories revenue numbers in this table do not match up entirely with the revenue numbers in the table above in addition to developing and implementing technology to make its directories available on cd-rom and on the internet tpc engaged in other technology projects a list and a brief description of other technology-related projects undertaken by tpc during its fiscal years are set forth below development of the nationally recognized tpc web site development of tpn register a joint_venture between tpc and general electric co through which product information similar to information contained in tpc’s directories was to be provided to companies via each company’s respective internal intranet in tpc apparently terminated this tpn register project development of thomas net a software product that enabled users to use keywords to make online digital searches of tpc’s electronic directories for industrial product information development of product news network pnn an electronic magazine containing information regarding new industrial products development in of thomas global register tgr an internet directory for tpc’s customers located outside the united_states and purchase in of plant spec a web-based software system that permitted the electronic transfer of computer assisted design cad drawings during its fiscal years tpc spent approximately dollar_figure million on the above technology-related projects as of may of tpc’s management anticipated that during tpc would undertake additional projects incur additional expenditures and realize additional income relating to technology-related projects during its fiscal years tpc’s actual expenditures associated with development and marketing of technology-related projects totaled approximately dollar_figure million set forth below are tpc’s technology-related expenditures_for its fiscal years fiscal tpc tpn year web site register thomas net pnn plant spec tgr misc total dollar_figure -- dollar_figure dollar_figure -- dollar_figure -- dollar_figure -- dollar_figure -- dollar_figure dollar_figure big_number big_number big_number big_number n a -- big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number -- big_number big_number big_number big_number big_number big_number total dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure for its fiscal years tpc’s reported financial statements reflect steady consistent and increasing revenue and show that tpc was profitable through the end of its fiscal_year as reported for each of tpc realized record apparently for federal_income_tax purposes and in the valuations made by the estate’s experts herein tpc treated all of its technology-related expenditures as current ordinary and necessary business_expenses rather than as capital expenditures respondent herein complains mildly about such current_expense treatment but stops short of asserting that the technology- related expenditures should have been capitalized and stops short of asking that tpc’s financial statements and financial projections be redone to treat such expenditures as capital in nature total revenue and as of the end of tpc’s fiscal_year tpc’s financial data reflected shareholder equity of dollar_figure as of may of tpc had reported positive net_income for every year for the prior years and the then-current in-house management financial forecast for tpc estimated net profits for in late tpc’s senior management while acknowledging significant challenges predicted that would be better than and our best year ever for each of its fiscal years tpc’s net sales revenue expenditures including tpc’s technology-related developmental expenditures operating income and total net_income as reported on tpc’s financial statements are reflected in the table below fiscal net sales operating total year revenue expenditures income net_income dollar_figure 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 big_number big_number big_number big_number big_number big_number big_number big_number also at the end of each of its fiscal years tpc owned substantial liquid short-term investments and marketable_securities as set forth below fiscal short-term marketable total liquid year investments securities investments 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 big_number big_number big_number for each of it sec_4 fiscal years subsequent to the year in which decedent died tpc’s net sales revenue expenditures including tpc’s technology-related developmental expenditures operating income or loss and total net_income or loss as reported on tpc’s financial statements are reflected in the table below fiscal net sales operating net_income year revenue expenditures income loss loss dollar_figure 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 total at the end of each of its fiscal years tpc continued to own substantial liquid short-term investments and marketable_securities as set forth below fiscal short-term marketable total liquid year investments securities investments dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number tpc had a long history of paying annual cash dividends to its stockholders in each of its fiscal years including in it sec_2 loss years of and tpc paid cash dividends on its outstanding common_stock ranging from a low of dollar_figure per share in its fiscal_year to a high of dollar_figure per share in its fiscal_year the total and the per-share cash dividends_paid by tpc in its fiscal years to its common and to its nonvoting preferred stockholders is set forth below cash dividends fiscal total per share year cash dividends common preferred dollar_figure dollar_figure dollar_figure big_number dollar_figure big_number dollar_figure big_number dollar_figure big_number dollar_figure big_number dollar_figure big_number dollar_figure big_number dollar_figure big_number dollar_figure big_number dollar_figure tpc only had big_number shares of nonvoting preferred_stock and approximately percent of tpc’s cash dividends_paid each year were paid to tpc’s common stockholders as of may of tpc’s management planned to continue paying annual cash dividends to its stockholders as of the date of decedent’s death in may of the management of tpc had no intent to liquidate or to sell tpc in the early fall of in anticipation of the filing of a federal estate_tax_return on behalf of the estate even though he lived in alaska the executors of the estate hired george e goerig goerig an alaskan lawyer to appraise and to prepare a valuation report for the estate’s 20-percent stock interest in tpc also on date the executors of the estate filed a petition with the surrogate court of the state of new york county of westchester requesting that limited estate administrative_powers be granted to goerig for the purposes of representing decedent’s estate in connection with the anticipated audit by respondent of the estate’s federal estate_tax_return and of handling the anticipated negotiations with respondent over the fair_market_value of decedent’s big_number shares of tpc stock on date the court granted to goerig such limited estate administrative_powers the acknowledged reason the estate hired goerig to value the tpc stock owned by decedent and to represent the estate as administrator was to have respondent’s audit of decedent’s federal estate_tax_return conducted not by respondent’s new york city office but by respondent’s alaska office where goerig believed and apparently represented to the estate’s representative that he would be able to obtain for the estate a more favorable valuation of the estate’s tpc stock executors for the estate had learned about goerig from an attorney for decedent’s family who had met goerig on a fishing trip tpc’s financial books_and_records were maintained on the basis of a fiscal_year ending september on approximately date the executors of the estate timely filed on behalf of the estate a federal estate_tax_return whereon the estate based on a valuation report of goerig and paul m wichorek wichorek an alaskan accountant whom goerig had hired to assist him in the valuation reported a total value of dollar_figure for the estate’s 20-percent stock interest in tpc or dollar_figure per share dollar_figure big_number shares dollar_figure per share on audit based on a valuation report dated date prepared by brian c becker a valuation expert hired by respondent respondent determined a total value of dollar_figure for the estate’s 20-percent stock interest in tpc or dollar_figure per share dollar_figure big_number dollar_figure and respondent determined an estate_tax deficiency of dollar_figure respondent also determined that the entire dollar_figure estate_tax deficiency determined was attributable to a substantial_understatement and therefore that under sec_6662 the estate was subject_to a dollar_figure gross valuation_understatement_penalty shortly before trial respondent’s expert prepared a revised valuation report in which respondent’s expert adjusted downward his valuation of the estate’s 20-percent tpc stock interest from dollar_figure to dollar_figure or from dollar_figure per share to dollar_figure per share dollar_figure big_number dollar_figure respondent’s expert’s revised valuation of the estate’s tpc stock interest was necessitated by errors in his original report in his original valuation respondent’s expert had added back to his calculation of tpc’s cashflow which was the basis for his tpc cashflow estimates for deferred income taxes of dollar_figure although the correct amount of deferred taxes that should have been added back to tpc’s cashflow was only dollar_figure also shortly before trial the estate’s experts prepared an updated or revised valuation report to make the estate’s original report more readable in which revised report the estate’s experts again opined that the date date-of-death value of the estate’s tpc common_stock was dollar_figure or dollar_figure per share opinion generally under sec_2031 the value of a decedent’s gross_estate is based on the fair_market_value of property owned by the decedent on the date of death for federal estate_tax purposes the term fair_market_value is defined as the price at which property would change hands between a willing buyer and a based on this adjustment respondent reduced the estate’s tax_deficiency to dollar_figure and the accuracy-related_penalty to dollar_figure willing seller neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts 411_us_546 sec b estate_tax regs with regard particularly to unlisted closely held stock in corporations such as tpc with regard to which no bid and asked prices or other arm’s-length sales information is available the statutory language of sec_2031 provides that the value of stock in comparable public corporations shall be taken into account sec_2031 provides -- in the case of stock and securities of a corporation the value of which cannot be determined with reference to bid and asked prices or with reference to sales prices the value thereof shall be determined by taking into consideration in addition to all other factors the value of stock_or_securities of corporations engaged in the same or a similar line_of_business which are listed on an exchange in utilizing however public companies to estimate the value of private closely held companies care must be taken to ensure that the public companies used are sufficiently comparable to the private companies being valued in this regard revrul_59_60 1959_1_cb_237 cautions as follows although the only restrictive requirement as to comparable corporations specified in the statute sec_2031 is that their lines of business be the same or similar yet it is obvious that consideration must be given to other_relevant_factors in order that the most valid comparison possible will be obtained courts recognize that a comparable company valuation may be rejected where the companies relied on are not sufficiently similar to the company being valued in 101_tc_412 significant differences between the companies used as comparables and the company being valued caused the court to reject the comparable_public_company_method in estate of klauss v commissioner tcmemo_2000_ an expert’s comparability_analysis was found to be inadequate because the expert failed to take into account differences in size product mix customer concentration and other factors between the companies used as comparables and the company being valued with regard to the other factors referred to in sec_2031 to be taken into account in the valuation of private closely held companies sec_20_2031-2 estate_tax regs explains in part as follows f where selling prices or bid and asked prices are unavailable if the provisions of paragraphs b c and d of this section are inapplicable because actual sale prices and bona_fide bid and asked prices are lacking then the fair_market_value is to be determined by taking the following factors into consideration in the case of shares of stock the company’s net_worth prospective earning power and dividend-paying capacity and other_relevant_factors some of the other_relevant_factors are the good will of the business the economic outlook in the particular industry the company’s position in the industry and its management the degree of control of the business represented by the block of stock to be valued and the values of securities of corporations engaged in the same or similar lines of business which are listed on a stock exchange however the weight to be accorded such comparisons or any other evidentiary factors considered in the determination of a value depends upon the facts of each case revrul_59_60 1959_1_cb_237 lists eight factors that are particularly relevant to the fair_market_value of stock of closely held companies as follows the nature of the business and the history of the enterprise the general economic outlook and the particular outlook for the specific industry the financial condition of the business and its book_value the earning capacity of the company the dividend-paying capacity of the company the value of any intangible assets and goodwill previous sales of the stock and the size of the interest to be valued and the market price of stocks of corporations engaged in the same or a similar line_of_business having their stocks actively_traded in a free and open market either on an exchange or over-the-counter revrul_59_60 supra acknowledges that a valuation of closely held stock is not an exact science but rather involves a question of fact in this regard revrul_59_60 states -- a sound valuation will be based upon all the relevant facts but the elements of common sense informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance c b as noted although in valuing the fair_market_value of corporate stock the future prospects of a company are relevant generally an appraisal of fair_market_value is made without regard to actual subsequent-year events ie to actual events occurring after the relevant valuation_date 977_f2d_1454 fed cir the authorities allow however that in a number of situations subsequent-year events may be considered for example actual subsequent-year events may be considered where such evidence would make more or less probable the proposition that the property had a certain fair_market_value on a given date 763_f2d_891 7th cir subsequent-year events may be considered where they are reasonably foreseeable 131_f3d_87 2d cir revg tcmemo_1994_641 or corroborate an appraisal that is based on facts known as of the valuation_date jacobson v commissioner tcmemo_1989_606 further subsequent-year events may be admissible where relevant as to whether asserted expectations or prospects as of the valuation_date were reasonable and intelligent 88_tc_38 81_tc_999 regents park partners v commissioner tcmemo_1992_ as explained in the case herein for federal estate_tax purposes both parties relied on valuation reports to estimate the date-of-death value of the estate’s 20-percent interest in tpc the estate’s experts valued decedent’s interest in tpc at approximately dollar_figure0 million respondent’s expert valued decedent’s interest at approximately dollar_figure million the large disparity between the parties’ valuations is startling where conflicting valuations are submitted a court may give different weight to the valuations and factors relied on by the parties 38_tc_357 the court is not bound to adopt either party’s valuation carte blanche and is to reach a decision based on its analysis and its consideration of the evidence 304_us_282 120_tc_358 94_tc_193 in this case the estate’s experts impress us as too inexperienced accommodating and biased in favor of the estate respondent’s expert appears to have selected his comparable companies in a casual manner based only on broad industry classification factors he made significant errors in his calculations and analysis and he made questionable and inadequately explained adjustments in his discounted cashflow valuation method the estate’s valuation as stated in their original and revised valuation reports the estate’s experts from alaska calculated a total date-of-death value of dollar_figure dollar_figure per share for the estate’s 20-percent common_stock interest in tpc in arriving at this number the estate’s experts concluded that no companies existed that were under sec_7491 where a taxpayer produces credible_evidence and otherwise satisfies the requirements of sec_7491 the burden_of_proof with respect to a factual issue relevant to ascertaining the taxpayer’s tax_liability such as the fair_market_value of property may shift from the taxpayer to respondent herein in preparation for trial the parties stipulated that the estate satisfied the requirements set forth in sec_7491 at trial we determined that for purposes of sec_7491 the evidence produced by the estate as to the valuation of the tpc stock was to be treated as credible_evidence therefore respondent has the burden_of_proof with regard to the valuation of the estate’s 20-percent stock interest in tpc comparable to tpc and they valued tpc as an entity using the capitalization of income_method in capitalizing the income of tpc however the estate’s experts significantly downplayed tpc’s long history of substantial income they misstated certain financial data and they opined that tpc’s business would be heavily and adversely impacted by the internet and by other advances in technology even though the estate’s experts demonstrated no experience with the internet- and technology-related companies under the capitalization of income valuation method a business is valued based on a projected stream of normalized or sustainable income capitalized by a risk-adjusted rate of return the basic steps involved in the capitalization of income_method are as follows a capitalization rate for the business is selected the business’s sustainable income is projected the capitalization rate is applied to the projected sustainable income for the business to calculate an operating value for the business and the amount or value of nonoperating assets owned by the business is added to the operating value of the business for example in their original report the estate’s experts stated that tpc’s growth in revenue for years subsequent to was flat contrary to the fact that tpc’s revenue reached record levels in each of the years obviously the particular capitalization rate that is selected has a significant impact on the ultimate valuation and is intended to reflect risks or volatility associated with a company’s income stream and seeks to reflect what a stockholder would require for a rate of return on an investment in the company being valued the more risky and volatile the income stream is perceived to be the higher the capitalization rate conversely the more stable the income stream is perceived to be the lower the capitalization rate in this case the estate’s experts calculated a capitalization rate of percent for tpc this capitalization rate was calculated by the estate’s experts by adding together the following risk factors and percentages percent to reflect a risk-free rate of return equal to the date yield on 20-year u s treasury securities percent to reflect an equity-risk premium to compensate an investor for the risk of investing in stocks as compared to long-term u s government securities reflecting the percentage by which the average annual return on large corporate stocks exceeds the average annual return on u s government securities as provided in the ibbotson associates’ stocks bonds bills inflation yearbook for the years percent to reflect a small stock risk to compensate an investor for the risk of investing in stock of a small_corporation as compared to a large_corporation reflecting the percentage by which the average annual return earned on small corporate stock exceeds the average annual return on large corporate stock as provided in the ibbotson associates’ stocks bonds bills inflation yearbook for the years and percent primarily to reflect risks to tpc relating to the internet and to technology and to the loss of advertising revenue that might be related thereto including perceived risks in tpc’s management structure the 5-percent capitalization rate used by the estate’s experts in the valuation of tpc stock is summarized below risk factors risk-free rate of return corporate equity risk small stock risk internet management risk capitalization rate percentage in estimating tpc’s sustainable annual net_income against which to apply the above capitalization rate the experts for the estate adjusted tpc’s historical income statements for as follows based on projections of tpc management dollar_figure million per year was subtracted from tpc’s pretax income to reflect projected additional expenditures to maintain and to further tpc’s presence on the internet and to develop additional technology-related projects and because tpc purportedly depreciated its fixed assets at a slower rate than the assets’ actual rate of economic depreciation the experts for the estate subtracted an amount to reflect the cost of additional economic depreciation to fixed assets not booked each year by tpc the adjustments made by the estate’s experts to tpc’s historic pretax income for are summarized below reported pretax income less technology expenditures less additional_depreciation adjusted pretax income dollar_figure dollar_figure 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 dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure in order to then calculate an after-tax average sustainable annual net_income for tpc using the above adjusted pretax income figures for the estate’s experts made the following calculations year adjusted pretax income dollar_figure big_number big_number big_number big_number total adj pretax income for years divided by number of years dollar_figure tpc average annual sustainable net_income le sec_35 taxes big_number big_number tpc after-tax average sustainable annual net_income dollar_figure the experts for the estate then applied their 30-percent capitalization rate for tpc to their dollar_figure after-tax average sustainable annual net_income for tpc and thereby calculated a value for tpc of dollar_figure dollar_figure dollar_figure in this and the following tables generally the numbers are rounded to the nearest thousand after calculating the above dollar_figure entity value for tpc the estate’s experts calculated a prediscounted value for the estate’s 20-percent interest in tpc as follows value of tpc multiplied by estate’s interest prediscounted value of estate’s interest dollar_figure dollar_figure the estate’s experts then discounted the above dollar_figure by applying a 40-percent minority interest discount and an additional 45-percent lack of marketability discount to arrive at a date-of-death value of dollar_figure for the big_number shares of tpc common_stock includable in decedent’s estate as summarized below prediscounted value of estate’s interest le sec_40 minority interest discount dollar_figure big_number subtotal le sec_45 lack of marketability discount dollar_figure big_number value of estate’s tpc stock interest dollar_figure the estate’s experts’ 40-percent minority interest discount was based primarily on their reading of general valuation texts the estate’s experts’ 45-percent lack of marketability discount was based largely on the following factors the stated intent of tpc’s management that it had no interest in coolidge survey shows trend toward larger minority discounts estate_planning date coolidge fixing value of minority interest in a business actual sales suggest discount as high as estate_planning spring going public the absence of sales of tpc stock for the years prior to date the inability of any stockholder of tpc to obtain control of tpc by purchasing merely the estate’s 20-percent interest and the inability of the holder of the estate’s block of tpc stock to force a liquidation of tpc the estate’s experts however provided no credible explanation for why they used 40-percent and 45-percent minority interest and lack of marketability discounts as distinguished from some other numbers -- eg percent or percent respondent’s valuation respondent’s expert estimated a date-of-death fair_market_value for tpc of dollar_figure million and a date-of-death fair_market_value for the estate’s 20-percent tpc stock interest of dollar_figure million respondent’s expert utilized two valuation methods to value tpc -- the comparable_public_company_method and the discounted cashflow method in his revised report in the process of making certain corrections to errors made in his original report respondent’s expert made significant questionable adjustments in his discounted cashflow method that are inconsistent with the methodology utilized in his original report in his original and revised reports respondent’s expert did not utilize the capitalization of income_method using the comparable_public_company_method respondent’s expert identified publicly traded companies and treated them as comparable to tpc on the basis of only two broad criteria as follows classification under the same general u s department of labor standard industrial codes as tpc namely code -- books publishing or publishing and printing and code -- miscellaneous publishing and reported positive cashflows for set forth below in schedule format is a listing of tpc and the companies selected by respondent’s expert as comparable to tpc a brief description of the primary type of content material which each company as of date published and the amount of each company’s reported revenue company publication material revenue tpc dollar_figure big_number industrial buying directories american educational products educational textbooks journals and games big_number harcourt general inc scholarly books and journals big_number educational material popular books owns the neiman marcus group inc houghton mifflin co textbooks and educational reference materials big_number intervisual books inc popup and dimensional novelty books big_number mcgraw-hill co educational books and magazines owns standard poor’s and four television stations big_number millbrook press inc children’s nonfiction books big_number nelson thomas inc religious and family value books big_number company publication material revenue dollar_figure readers digest association magazines and educational condensed and popular books recorded music collections and home videos scholastic corp children’s books and classroom and professional magazines big_number touchstone applied science associates wiley john sons reading and english testing materials big_number professional and reference works consumer books and textbooks big_number from publicly reported financial information relating to the above public companies respondent’s expert calculated four financial measurement ratios applicable to each company -- namely stock price to net_income stock price to cashflow stock market_value to book_value of tangible and intangible assets and stock price to revenue applying the ratios so calculated to the companies respondent’s expert calculated the median ratio for each measurement and he applied that respective median ratio as a multiple to tpc’s 5-year average annual net_income cashflow book_value and revenue as follows tpc 5-year average multiple based on median ratio for public companies net_income cashflow book_value revenue dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure total for tpc dollar_figure dollar_figure dollar_figure dollar_figure using the dollar_figure rounded to dollar_figure million calculated above for the cashflow ratio apparently because the cashflow ratio was the most consistent measurement ratio as between the companies respondent’s expert adjusted upward this dollar_figure million to take into account the higher valuation amounts reflected by the other measurement ratios and he calculated a total value for tpc under his comparable_public_company_method of dollar_figure million as stated in both his original report and in his revised report respondent’s expert also valued tpc using the discounted cashflow method thereunder using tpc’s reported income respondent’s expert calculated a 7-percent annual income growth rate in his original report and a 4-percent annual income growth rate in his revised report which growth rates he applied to tpc’s actual net cashflow for to estimate tpc’s net cashflow for the subsequent years as explained supra however in his original report for tpc’s net cashflow number respondent’s expert used dollar_figure this number was incorrect and was significantly overstated because respondent’s expert added back to tpc’s cashflow deferred taxes of dollar_figure instead of the correct deferred tax add-back of only dollar_figure to his estimated tpc net cashflow numbers for based on his calculation of tpc’s dollar_figure net in his revised report in calculating tpc’s net cashflow respondent’s expert used the corrected deferred tax add-back of dollar_figure this correction resulted in a revised or new number for tpc’s net cashflow of only dollar_figure cashflow respondent’s expert applied a discount rate to calculate a present_value as of date of the estimated net cashflow respondent’s expert’s discount rate for each year was based on his estimate of tpc’s cost of equity calculated under the capital_asset pricing model and involved the following elements a risk-free rate of return of percent equal to the u s government long-term bond rate as of date a market-risk premium that varied to reflect the risk of investing in a private company and the perceived risks of investing in stocks rather than in long-term government bonds and an estimate of unlevered beta for tpc of dollar_figure to reflect the volatility or level of risk associated with tpc’s stock as compared to the volatility of the stock market as a whole where the market has an overall beta of dollar_figure in his original report respondent’s expert also calculated and added to his present_value calculations of tpc’s estimated net cashflow for a dollar_figure estimate of tpc’s residual_value based on a discounted terminal value for tpc in the words of respondent’s expert this terminal value the discount rate which respondent’s expert applied to tpc’s estimated net cashflow for each year is set forth below year percentage incorporates all estimated cash flows for tpc after fiscal discounted back to the end of with his discounted terminal value for tpc added to his present_value calculation of tpc’s estimated net cashflow for respondent’s expert concluded in his original report that tpc had a date fair_market_value of dollar_figure million as follows fiscal_year subtotal plus discounted terminal value valuation of tpc present_value of estimated cashflows dollar_figure big_number big_number big_number big_number dollar_figure big_number dollar_figure in his revised report however after adjusting his add-back to tpc’s net cashflow for the corrected dollar_figure deferred taxes discussed supra which as indicated resulted in a greatly reduced calculation of tpc’s estimated net cashflow number for respondent’s expert switched his residual_value calculation for tpc after by estimating what he refers to as a dollar_figure liquidation value for tpc respondent’s expert’s revised discounted cashflow calculation using the much reduced cashflow numbers but a liquidation rather than a terminal value for tpc is summarized below fiscal_year subtotal plus liquidation value valuation of tpc present_value of estimated cashflows dollar_figure big_number big_number big_number big_number big_number dollar_figure big_number big_number dollar_figure in calculating the residual_value for tpc to be added to his net cashflow projections for respondent’s expert’s switch in his revised report from a terminal value to a liquidation value calculation appears to us to be an effort on the part of respondent’s expert to keep the valuation for tpc relatively highdollar_figure generally terminal value is used to compute an entity’s residual_value beyond the period for which an entity’s net cashflows are projected whereas liquidation value generally is used only when the entity being valued has plans to liquidate at the end of the projection period copeland et al valuation 3d ed providing that liquidation value should not be used unless liquidation is likely at the end of the forecast period here tpc’s management as of may of had no plans to liquidate tpc using the correct dollar_figure9 million in deferred tax add-back the calculation under respondent’s expert’s discounted cashflow method using a terminal value calculation for tpc’ sec_2002 residual_value would have reflected a date fair_market_value for tpc of only dollar_figure million as follows fiscal_year subtotal plu sec_2002 terminal value valuation of tpc present_value of estimated cashflows dollar_figure big_number big_number big_number big_number dollar_figure big_number dollar_figure in his revised report respondent’s expert apparently still not satisfied with his revised dollar_figure million valuation for tpc using the corrected deferred tax add-back and a liquidation value for tpc goes on to recalculate much higher projected net cashflow numbers for tpc for and he calculates three higher valuations for tpc the major aspect or component of respondent’s expert’s recalculation of tpc’s projected net cashflows for is his use of tpc’s yearend total working_capital instead of tpc’s change in net working_capital the effect of using yearend total working_capital against which his growth rate for tpc was applied was to significantly increase tpc’s estimated cashflow for by approximately dollar_figure million a year based on the various calculations under his various methods respondent’s expert ultimately concluded that the total fair_market_value for tpc as an entity as of date was dollar_figure million to the estate’s dollar_figure 20-percent share of this dollar_figure million dollar_figure x dollar_figure respondent’s expert applied a 30-percent lack of marketability discount and arrives at a date-of-death value of dollar_figure for the estate’s 20-percent stock interest in tpc respondent’s expert bases his 30-percent as opposed to a higher lack of marketability discount on the following tpc was not publicly traded historically tpc was profitable investment risks associated with tpc were moderate tpc had consistently paid cash dividends as of date tpc held more than dollar_figure million in net liquid_assets and the estate owned the single largest block of tpc stock respondent’s expert’s calculation of the dollar_figure valuation for the estate’s 57-percent stock interest in tpc may be summarized as follows value of tpc multiplied by estate’s interest in tpc dollar_figure prediscounted value of estate’s interest le sec_30 marketability discount dollar_figure big_number value of estate’s interest in tpc dollar_figure dollar_figure represents the calculation as reflected in respondent’s expert’s revised report the corrected math calculates to dollar_figure as indicated respondent’s expert does not apply a minority interest discount to the estate’s 20-percent tpc stock interest rather respondent’s expert states that his discounted cashflow method of valuation inherently reflects a minority interest in tpc and therefore that no separate or additional minority interest discount is appropriate our analysis as mentioned we find both the estate’s and respondent’s valuations to be deficient and unpersuasive in calculating the fair_market_value of tpc as an entity and in calculating the fair_market_value of the estate’s 20-percent interest therein in this case the estate the executors of the estate and the underlying company the stock of which is being valued were all headquartered and based in the new york city metropolitan area but the estate hired a lawyer and an accountant from alaska both with relatively little valuation experience to value the estate’s 20-percent interest in tpc the estate’s experts valued tpc and the estate’s interest in tpc in an aggressive manner largely by over calculating as of the date valuation_date the risks associated with the internet and technology and by applying excessive minority and lack of marketability discounts goerig is a lawyer with an audit and tax dispute resolution practice and a tax_return_preparer and he undertakes occasional valuations for small businesses and private individuals from his resume he appears to have attended limited appraisal courses other than a few courses while working for respondent many years ago goerig also was appointed to act as administrator for the estate to handle the anticipated audit by respondent of the estate’s federal estate_tax_return a role which we regard as somewhat in tension with his role as a purported independent valuation expert for the estate wichorek provides accounting and tax preparation services does business consulting and undertakes occasional valuations for small businesses generally in the context of divorce and property settlement disputes he belongs to no professional organizations or associations relating to his appraisal or valuation work although we admitted into evidence the estate’s valuation reports and treated them as credible we regard those reports and the testimony of the estate’s experts to be only marginally credible goerig and wichorek were barely qualified to value a highly successful and well-established new york city-based company with annual income in the millions of dollarsdollar_figure in our opinion in computing the sustainable net_income of tpc the estate’s experts incorrectly applied a 12-percent risk factor relating to the internet and technology we acknowledge that while the internet posed certain risks to tpc the internet also provided significant new business and financial opportunities to tpc to increase revenue and profitability as at trial the estate called additional expert witnesses in an attempt to provide corroboration for aspects of the valuation of tpc and of the estate’s interest in tpc by goerig and wichorek such witnesses however have not cured the concerns we have with goerig’s and wichorek’s valuation of tpc and of the estate’s interest therein of date tpc appeared to be well situated on the internet and tpc’s future as to its internet operations appeared good if not in the words of tpc’s president great as stated in the estate’s experts’ report as of may of tpc appears to be in a strong overall financial position when compared to the industry tpc has more liquidity no leverage and operates more profitably than the median industry based on the financial analyses of tpc the business has less financial risk than does the median company in the same industry the use by the estate’s experts of a 12-percent technology- related risk factor particularly in light of their failure to project any additional income to be produced from technology- related expenditures seems to us inappropriate and unjustified supporting our conclusion that tpc’s risks relating to the internet and technology do not support a 12-percent risk factor we note that during its fiscal_year tpc paid out cash dividends to its stockholders in excess of dollar_figure million a significant increase over total cash dividends_paid out to stockholders in prior years and inconsistent with any management perception that as of may of or in the near future tpc faced extraordinarily risky additional internet- and technology- related expenditures tpc’s cash dividends particularly in light of the lower level of stockholder dividends that had been paid in prior years are indicative of an optimistic management outlook for tpc as of may of as explained by tpc’s president although its profitability margins and net_income were declining due to increased spending on technology-related projects in and tpc experienced record revenue not until was tpc’s total revenue adversely affected in a significant way by the internet and by new technology mr holst-knudsen explained at trial as follows q by petitioner’s counsel when if at all did tpc take what you’ve termed a hit a we were taking a hit in the sense of as i said before the investments we were making that hit became more serious as we went on i would say that the year sec_2001 sec_2002 and the fiscal_year that will close this year is when we really began to take the hit on our top line on revenues we have shed approximately percent of our revenue and about to percent of our account basis disappeared over that period of time the additional dollar_figure million a year in technology-related expenditures that the estate’s experts factored into their projections of subsequent-year income and that we also allow we believe to be an adequate indication or quantification of the level of internet- and technology-related risks tpc faced as of date also we regard tpc as an extremely well managed company with top quality managers throughout the company we allow no separate risk factor for what the estate’s experts refer to as management risk respondent asserts that the estate’s dollar_figure million valuation for tpc as an entity and dollar_figure million for the estate’s percent interest therein is absurd in light of tpc’s fiscal yearend book_value in the range of dollar_figure million respondent also asserts that if we utilize the capitalization of income_method to value tpc as did the estate’s experts and as we do we should take the cash and short-term liquid_assets from tpc’s balance_sheet treat them as nonoperating assets and add them to any calculation of the capitalized income of tpc that we make from the end of its fiscal_year through the end of its fiscal_year tpc’s cash and outside short-term more than month investments reported on its yearend balance sheets increased from dollar_figure million to dollar_figure million throughout the 1990s tpc increased its short-term liquid investments and still paid significant cash dividends to its stockholders not until its fiscal_year does tpc’s yearend balance_sheet reflect any significant reduction in outside short-term investments on each of tpc’s and fiscal yearend balance sheets approximately dollar_figure million is shown as outside short-term investments with an investment term of more than months we treat these dollar_figure million in short-term liquid investments as nonoperating assets to be added to the valuation of tpc under a capitalization of income valuation method we are not persuaded that these liquid investments should be treated as operating_assets due to tpc’s commitment to advance sales commissionsdollar_figure tpc’s yearend cash on hand however is not to be treated as anything other than an operating asset and is not to be treated as an add-on in the calculation of tpc’s value under the capitalization of income_method as to the valuation of the particular 20-percent block of tpc stock includable in the estate we disagree with the large minority 45-percent and lack of marketability 40-percent discounts utilized by the estate’s experts in calculating the fair_market_value of the estate’s 20-percent tpc stock interest as noted the estate’s experts based their minority and lack of marketability discounts on general studies and not on the facts of this case the experts for the estate selected discount rates that were extreme and highly favorable for the estate without any credible substantive discussion of how the facts of this case support such particular discounts also as we have noted as of may of at least one outside public investor owned and had owned for at least years a substantial tpc stock interest the evidence before us does not suggest any problem discontent dissatisfaction or in our calculation of prior year tpc income we also add-back additional_depreciation that the estate’s experts add- back and that respondent apparently does not dispute other concern with the presence of this outside stockholder the longstanding stock interest of this actual outside investor in tpc suggests that a hypothetical outside investor would be interested in an investment in tpc in the nature of the minority 20-percent stock interest held by the estate we reject the minority and lack of marketability discounts used by the estate’s experts turning to respondent’s expert’s valuation respondent’s expert appeared to be concerned with numbers only and did not appear to make an effort to base his valuation of tpc on a real company his sterile approach is reflected both in his comparable public company analysis and in his discounted cashflow analysis in his comparable public company analysis respondent’s expert used information on companies which only in a broad sense relate to tpc valuation of a company under a comparable_public_company_method may be simple and quick but such an approach also may be easily misapplied with regard to this concern valuation textbooks caution the allure of multiples is that they are simple and easy to relate to by the same token they are also easy to misuse and manipulate especially when comparable firms are used given that no two firms are exactly similar in terms of risk and growth the definition of comparable firm is a subjective one consequently a biased analyst can choose a group of comparable firms to confirm his or her biases about a firm’s value damodaran damodaran on valuation and further since the selection of comparable firms has such a paramount role in valuation with multiples special attention must be paid to selecting a true comparable sample of firms -- firms that are in the same industry employ the same technology apply to similar clienteles are of similar size and so on benninga sarig corporate finance a valuation approach we reject respondent’s expert’ sec_11 companies as comparable to tpc see estate of clarke v commissioner tcmemo_1976_ where we rejected public companies as comparable explaining as follows the fact that two companies are both part of the same general industry does not as respondent’s expert implies make them comparable per se such a standard clearly ignores the interplay of the myriad of complex factors and features that must be accounted for in any meaningful comparison rather we think it imperative that the characteristics of the subject company and the purportedly comparable company relevant to the question of value be isolated and examined so that a significant comparison can be made those factors include the respective products market management earnings dividend paying capacity book_value and position in the industry of each company see cent trust co v united_states 305_f2d_393 ct_cl emphasis added also we reject respondent’s expert’s discounted cashflow analysis as explained significant errors were made therein and respondent’s expert’s numerous recalculations were suspect not sufficiently explained and not persuasive also we disagree with respondent’s expert that no discount should be applied to the estate’s 20-percent interest to reflect its minority status in cases cited just in the parties’ briefs the following minority discounts are observed percent--n trust co v commissioner 87_tc_349 percent-- estate of heck v commissioner tcmemo_2002_34 percent and percent--gow v commissioner tcmemo_2000_93 affd 19_fedappx_90 4th cir in cases cited in the parties’ briefs the following lack of marketability discounts are observed percent--n trust co v commissioner supra pincite percent--estate of desmond v commissioner tcmemo_1999_76 percent and percent-- barnes v commissioner tcmemo_1998_413 percent-- mandelbaum v commissioner tcmemo_1995_255 affd without published opinion 91_f3d_124 3d cir percent--estate of gallo v commissioner tcmemo_1985_363 on the evidence before us in this case we conclude that the appropriate valuation of the estate’s 20-percent stock interest in tpc as of date should be based on a capitalization of tpc’s estimated sustainable net_income for calculated as an average of tpc’s income with an additional dollar_figure million per year in expenditures relating to projected internet- and technology-related expenditures the 5-percent capitalization rate used by the estate’s experts should be reduced by percent from percent to percent to better reflect our belief that the internet as of date constituted a factor for tpc almost as positive as it was negative also dollar_figure million of nonoperating assets should be added our calculation of the appropriate 5-percent capitalization rate is as follows risk factors percentage risk-free rate of return corporate equity risk small stock risk internet management risk capitalization rate we note that in spite of the size of tpc respondent did not discretely challenge this small stock discount in discounting to reflect the estate’s minority 20-percent interest in tpc we allow a 15-percent minority interest discount and a 30-percent lack of marketability discount we scale back the minority and lack of marketability discounts from those used by the estate’s experts because as noted above we find the estate’s experts’ numbers to be arbitrary and without support we believe a minority interest discount of percent is a better reflection of the estate’s 20-percent common_stock interest in tpc although a minority interest the holder of such interest would own the single largest block of stock in tpc a major well-established well-run company with relatively few stockholders in which a longstanding outside investor is already present and apparently content with regard to the lack of marketability discount we believe a 30-percent lack of marketability discount adequately reflects difficulties the estate and a hypothetical investor might have in marketing the estate’s 20-percent tpc stock interest indeed but for the fact that respondent’s expert allowed a 30-percent discount for lack of marketability we might have been inclined to reduce this discount a discount any higher would not appear to be justified particularly in light of the presence among tpc’s stockholders of a significant outsider stockholder who already owns a relatively large minority block of tpc stock we also note the dividend-paying history of tpc and tpc’s plans as of may of to continue its practice of paying substantial cash dividends which subsequent-year dividends would allow a holder of a 20-percent interest in tpc to recover annually based on prior-year dividends_paid in excess of one quarter of a million dollars we conclude that the date-of-death value of tpc as an entity as of date is dollar_figure and that the date-of- death value of the estate’s 57-percent interest in tpc is dollar_figure or dollar_figure per share our calculation of the fair_market_value of tpc as an entity and of the estate’s 57-percent interest in tpc is set forth below capitalization rate minority discount marketability discount tpc’s sustainable net_income year pretax income dollar_figure big_number big_number big_number big_number total pretax income divided by number of years dollar_figure average pretax income less estimated taxes dollar_figure big_number sustainable net_income divided by capitalization rate dollar_figure big_number subtotal plus nonoperating assets dollar_figure big_number value of tpc dollar_figure value of estate’s 20-percent stock interest value of tpc multiplied by estate’s percent interest dollar_figure subtotal le sec_15 minority discount subtotal le sec_30 marketability discount value of estate’s tpc interest per-share value dollar_figure big_number dollar_figure big_number dollar_figure dollar_figure taking into account all of the evidence before us and the arguments of the parties we believe that our above valuation constitutes a fair and appropriate valuation of tpc and of the estate’s interest in tpc accuracy-related_penalty generally a 20-percent penalty is imposed on any portion of an underpayment_of_tax required to be shown on a return where the underpayment constitutes a substantial estate_tax_valuation understatement sec_6662 and b for purposes of sec_6662 an estate_tax_valuation understatement is treated as substantial where property required to be reported on an estate_tax_return is reported at a value percent or less than the value eventually determined by the court sec_6662 where property is reported at a value less than percent of the value eventually determined by the court the penalty imposed under sec_6662 is increased from percent to percent sec_6662 we have determined the value of the estate’s 20-percent interest in tpc to be dollar_figure because the value reported by the estate for its 20-percent interest in tpc dollar_figure million is less than percent of the value determined herein dollar_figure x dollar_figure dollar_figure unless an exception to the application of the sec_6662 penalty applies the estate would be liable for a 40-percent penalty on its understated valuation under sec_6664 an exception is provided to the imposition of a sec_6662 accuracy-related_penalty where a taxpayer establishes that there was reasonable_cause for the understatement and that the taxpayer acted in good_faith sec_6664 the regulations provide that whether an understatement_of_tax is made in good_faith and due to reasonable_cause will depend upon the facts and circumstances of each case sec_1_6664-4 income_tax regs in determining whether a taxpayer acted reasonably and in good_faith with regard to the valuation of property factors to be considered include whether the value reported on the tax_return was based on an appraisal the methodology and assumptions underlying the appraisal the appraised value the circumstances under which the appraisal was obtained and the appraiser’s relationship to the taxpayer sec_1_6664-4 income_tax regs the estate contends that it acted reasonably and in good_faith in the valuation of the estate’s 20-percent tpc stock interest in filing its federal estate_tax_return and in reporting thereon the value of the tpc stock the valuation herein of the estate’s 20-percent stock interest in tpc was particularly difficult and unique companies comparable to tpc were not found valuation of the estate’s percent tpc stock interest under the capitalization of income and under the discounted cashflow methods involved a number of difficult judgment calls we believe it noteworthy and relevant to the appropriateness of the sec_6662 penalty that even respondent’s expert made significant errors in his various calculations complicating the valuation presented to the parties and to the court herein was the difficult question as to how the internet and the risks and opportunities associated therewith should be regarded as affecting tpc the evaluation in this case of such intangible risks and opportunities was difficult and imprecise certainly the experts for the estate were aggressive in their relatively low valuation of tpc respondent’s expert was aggressive in his relatively high valuation of tpc we note that our valuation of tpc and of the estate’s 20-percent interest in tpc is closer to the estate’s valuation than to respondent’s valuation on the record before us we believe it inappropriate to impose the accuracy-related_penalty the estate is not liable for the accuracy-related_penalty accordingly decision will be entered under rule


internal_revenue_service index nos number release date cc dom it a plr-110954-99 attn date ein dear this is in reference to a form_1128 application to adopt change or retain a tax_year submitted on behalf of the above- named taxpayer requesting permission to change its accounting_period for federal_income_tax purposes from a to a taxable_year ending effective for the taxable_year beginning the taxpayer has requested that the form_1128 be considered timely filed under the authority contained in sec_301_9100-3 of the procedure and administration regulations the taxpayer's form_1128 requesting a change in accounting_period to a tax_year ending was due on or before the information furnished indicates that the application_for the change in accounting_period was filed late because of an error or misunderstanding however the form was filed within days of the due_date sec_1_442-1 of the income_tax regulations provides that in order to secure the commissioner's consent to a change in accounting_period the taxpayer must file an application on form_1128 with the commissioner on or before the 15th day of the second calendar month following the close of the short_period sec_301_9100-3 provides that requests for extensions of time for regulatory elections that do not meet the requirements of sec_301_9100-2 automatic extensions such as the instant case must be made under the rules of sec_301_9100-3 requests for relief subject_to sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that the granting of relief will not prejudice the interests of the government based on the facts and information submitted and the representations made it is held that the taxpayer has acted reasonably and in good_faith and that the granting of relief will not prejudice the interests of the government accordingly the requirements of the regulations for the granting of relief have been satisfied in this case and taxpayer’s late filed form_1128 requesting permission to change to a tax_year ending effective for the tax_year beginning is considered timely filed pursuant to appendix a of revproc_99_1 1999_1_irb_6 an additional user_fee is required in order to process the form_1128 the user_fee will be requested in a separate correspondence we will begin processing the taxpayer’s application after the user_fee is received the ruling contained in this letter is based upon facts and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party this office has not verified any of the material submitted in support of the request for a ruling verification of the factual information representations and other data may be required as part of an examination process this ruling addresses the granting of sec_301_9100-3 relief only no opinion is expressed regarding the tax treatment of the instant transaction under the provisions of any other sections of the code or regulations that may be applicable thereto or regarding the tax treatment of any conditions existing at the time of or effects resulting from the instant transaction specifically no opinion is expressed as to whether the taxpayer is permitted under the code and applicable regulations to change to the tax_year requested in the subject form_1128 in accordance with the provisions of a power_of_attorney currently on file we are sending a copy of this letter_ruling to the taxpayer's authorized representatives this ruling is directed only to the taxpayer that requested it sec_6110 of the internal_revenue_code provides that it may not be used or cited as precedent sincerely yours assistant chief_counsel income_tax and accounting s thomas a luxner by _______________________ thomas a luxner acting deputy assistant chief_counsel enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service number release date index number ---------------- ------------------------------------------------------ -------------------------------------- -------------------------------------------- - -in re ---------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------ telephone number --------------------- refer reply to cc tege eb ec plr-119232-06 date date ------------------------------- ---------------------- legend code stock taxpayer ---------------- dear -------------------- this letter is in response to a request for a ruling dated date and subsequent correspondence submitted by taxpayer’s authorized representative concerning the proposed terms of future stock_option grants under the taxpayer’s stock plan the options are not intended to qualify as incentive stock_options under sec_422 of the code the proposed terms will allow the option holder to transfer the vested portion of an option to an unrelated third party buyer in exchange for a cash payment taxpayer’s authorized representative is requesting a ruling that the ability to transfer the options will not cause the options to be taxable at grant under sec_1_83-7 --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- 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--------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ------------------------------------- sec_83 of the code provides that if in_connection_with_the_performance_of_services property is transferred to any person other than the person for whom the services are performed the excess of the fair_market_value of the property determined without regard to any restriction other than a restriction which by its terms will never lapse over the amount if any paid for the property will be included in the gross_income of the person who performed the services this inclusion will take place in the first taxable_year in which the rights of the person having the beneficial_interest are transferable or are not subject_to a substantial_risk_of_forfeiture whichever is applicable sec_1_83-7 of the regulations provides that if there is granted to an employee or beneficiary in_connection_with_the_performance_of_services an option to which sec_421 does not apply sec_83 shall apply to the grant if the option has a readily_ascertainable_fair_market_value at the time the option is granted sec_1_83-7 provides that sec_83 will not apply to the transfer of an option without a readily_ascertainable_fair_market_value sec_1_83-7 of the regulations provides that options are considered to have a readily_ascertainable_fair_market_value if they are actively_traded on an established market when an option is not actively_traded on an established market it does not have a readily_ascertainable_fair_market_value unless its fair_market_value can otherwise be measured with reasonable accuracy an option is not considered to have a readily plr-119232-06 ascertainable fair_market_value unless the taxpayer can show that all of the following conditions exist the option is transferable by the optionee the option is exercisable immediately in full by the optionee the option or the property subject_to the option is not subject_to any restriction or condition other than a lien or other condition to secure the payment of the purchase_price which has a significant effect upon the fair_market_value on the option and the fair_market_value of the option_privilege is readily ascertainable if sec_83 does not apply at the time an option is granted because the option does not have a readily_ascertainable_fair_market_value then sec_83 will not apply until the option is exercised or otherwise_disposed_of even if the fair_market_value of the option becomes readily ascertainable before then if the option is exercised sec_83 and sec_83 apply to the transfer of property pursuant to such exercise if the options are sold or otherwise_disposed_of in an arms length transaction sec_83 and sec_83 apply to the transfer of money or other_property received in the same manner as sec_83 and sec_83 would have applied to the transfer of property pursuant to an exercise of the option sec_1_83-7 under the facts described above the nonstatutory stock_options will not have a readily_ascertainable_fair_market_value on the date of grant in accordance with the foregoing we rule as follows the ability to transfer the stock_options at and after vesting will not cause the options to be taxable at grant under sec_1_83-7 because the options will not have a readily_ascertainable_fair_market_value on the date of grant no opinion is expressed or implied concerning the tax consequences of the proposed transactions under any other provision of the code or regulations or the tax treatment of any conditions existing at the time of or effects resulting from the proposed transactions that are not specifically covered by the above rulings in particular no opinion is expressed concerning the application of sec_409a of the code to the proposed transactions this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent plr-119232-06 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely william c schmidt senior counsel executive compensation employee_benefits tax exempt government entities


department of the treasury internal_revenue_service washington d c date number release date cc el gl br2 gl-611465-98 uilc memorandum for district_counsel from joseph w clark acting chief branch general litigation subject this memorandum responds to your request for advice dated date this document is not to be cited as precedent legend taxpayer x amount a date a year year year year year year year year date b date c date d date e date f date g date h gl-611465-98 issue whether an offer_in_compromise which has been terminated by the service due to a taxpayer’s default can later be reinstated by the service conclusion once an offer_in_compromise has been terminated for default by the taxpayer the service lacks the authority to reinstate the agreement background on date a the service accepted two separate offers in compromise from taxpayer x taxpayer one for the years year to year and one for the years year and year the earlier liabilities were incurred jointly with his deceased spouse the taxpayer made timely payments of amount a as agreed each offer_in_compromise contained the standard language in which the taxpayer promised to comply with all provisions of the internal_revenue_code relating to the filing of returns and payment of taxes for five years following acceptance of the offer see form_656 offer_in_compromise item d the taxpayer’s year and year income_tax returns were due to be filed august year as a result of an automatic_extension and april year respectively in october year the service_center asked that the taxpayer’s failure_to_file those returns be investigated by the field an offer_in_compromise oic specialist was assigned to the case as was the practice in these kinds of cases the oic specialist contacted the taxpayer in an attempt to secure the returns prior to declaring the compromise_agreement to be in default on date b the oic specialist sent a letter to the taxpayer requesting the unfiled returns the letter reminded the taxpayer that failing to file returns constituted default and asked that the taxpayer submit the returns by date c or contact the district immediately no response was received on date d the taxpayer was sent a letters stating that the compromise agreements had been terminated on the date d letters incorrectly stated that the compromise was being terminated for failure to return a refund for the year tax_year as was required by the compromise_agreement see form_656 offer_in_compromise item g however this error did not invalidate the termination there is no question that the taxpayer received actual notice of the reasons the compromise was in default furthermore under the terms of the compromise the service need not give notice to act on default of the agreement see id at item o see also 372_f2d_352 3d cir stating that government is not required to issue warning shot before taking action on defaulted compromise_agreement gl-611465-98 date e taxpayer’s current wife called to inquire about the status of the compromises and to promise that the returns were forthcoming the oic specialist stated that the compromises would be reinstated if the returns were filed by date f the oic specialist then called the service_center and was told that no action would be taken while they awaited receipt of the missing returns those returns were received by the oic specialist on date g on date h the oic specialist sent the taxpayer a letter indicating that the compromise agreements had been reinstated subsequently the service center’s oic unit concluded that because termination letters had been sent the compromises could not legally be reinstated that conclusion was based upon advice previously given by this office you have asked that we reconsider the question of whether a terminated offer_in_compromise can be reinstated discussion a compromise under sec_7122 of the internal_revenue_code i r c or code is recognized as a contract see 372_f2d_352 3d cir 303_f2d_1 5th cir as such the compromise_agreement is subject_to judicial interpretation using generally accepted contract principles your memorandum states that the present case requires an examination and application of the law of rescission of contracts we do not agree that rescission is the issue rescission is defined broadly as canceling nullifying or avoiding a contract see eg black’s law dictionary 6th ed however there is some disagreement as to the scope of that term in contract law some authorities use the term to describe only cases of mutual agreement to discharge the parties’ obligations under the contract see 5a corbin on contracts sec_1236 supp woodruff v mcclellan p 2d wash while others also apply the term to situations where the contract authorizes unilateral cancellation upon the occurrence of specific events see 17a am jur 2d contracts et seq on one point however all authorities appear to be in agreement a rescission only takes place when a contract is undone from the beginning placing both parties in the same position they would occupy had they never entered into the contract see id at 17a c j s contracts sec_385 in nebco associates v united_states cl_ct the claims_court discussed the confusion regarding the use of the term rescission that court distinguished between rescission by agreement and rescission which sometimes refers to a power of avoidance arising from fraud or mutual mistake id use of the term rescission to refer to a unilateral power to cancel a contract finds its roots in the concept that fraud or mistake supports a finding of implied consent by the other party see dooley v stillson a r i gl-611465-98 27_fedclaims_805 aff’d 16_f3d_1197 fed cir brannock v fletcher s e 2d n c an offer_in_compromise can only be rescinded if there was a mutual mistake as to a material fact or there was a misrepresentation by one of the parties to the agreement sec_301_7122-1t d irm action taken by the service in response to a failure to meet the compliance provisions of item d of form_656 is not a rescission the parties are not returned to their former positions as they would be in a rescission the service in response to the taxpayer’s breach of the agreement applies the funds remitted in compromise to the underlying tax_liabilities and takes action to collect the balance administratively or through filing a suit service procedures term this action a termination of the agreement see irm upon breach of a contract the non-breaching party may cease performance and sue for damages or seek other remedies allowed by law see 973_f2d_1548 fed cir in the offer_in_compromise context the agreement clearly spells out that the service may without notice to the taxpayer take action to collect either the unpaid compromise amount or the full amount of the underlying liability see form_656 item o although no notice to the taxpayer is required before commencing action notice is generally given in the form of a termination letter this practice has the benefit of showing with certainty that the service regards the agreement as terminated and establishes the date on which the termination takes effect we conclude that the service terminated the offers in compromise on date d as evidenced by the letters of that date sent to the taxpayer you cite the proposition that a rescinded contract can be reinstated by mutual agreement of the parties the difference between rescission and termination of a contract in response to default illustrates why reinstatement is not such a simple matter in this case as stated above the parties to a rescinded contract are restored to their former positions they are then free to reinstate the contract through an exchange of the same promises that formed consideration for the original contract such an act is indistinguishable from forming a new contract in the context of termination of a defaulted contract however one party or another may have partially or fully performed under the contract as such the promise they receive from the other party in reviving the contract may be considered gratuitous-not supported by any consideration flowing in return a contract must be supported by consideration to be valid and legally enforceable c j s contracts sec_71 see 945_f2d_1568 fed cir in this case the service would revive the compromise_agreement in return for current and future compliance with applicable provisions of the internal_revenue_code acts the taxpayer was already legally obligated to perform a promise to gl-611465-98 perform on a pre-existing legal_obligation cannot be consideration for a contract see 17a am jur 2d contracts sec_144 for offers in compromise consideration is found in the potential for mutual concessions which exists after doubt as to liability or collectibility has been established see op att gen xiii-47-7138 date such concessions form the bases for compromise and these bases have been incorporated into the regulations delineating the authority of the service to compromise tax_liabilities see sec_301_7122-1t b see also sec_301_7122-1t b providing additional authority where compromise would promote effective tax_administration thus even if contract law would allow the compromise to be reinstated we question whether the service has the authority to reinstate a compromise absent a finding that one of the bases in the regulation is present based on the foregoing we stand by our prior advice that a terminated offer_in_compromise cannot be reinstated the reinstatement essentially forms a new agreement between the taxpayer and the service as such it must be executed in accordance with accepted principles of contract law furthermore because the service’s authority to compromise is circumscribed by the code and treasury regulations a new agreement requires a finding that there is an authorized basis for compromise hazards other considerations gl-611465-98 if you have any questions please contact the general litigation attorney assigned to this matter at cc assistant regional_counsel gl