t c memo united_states tax_court estate of james waldo hendrickson deceased mark hart hendrickson executor petitioner v commissioner of internal revenue respondent docket no filed date brett j miller and megan j kight for petitioner russell d pinkerton for respondent memorandum findings_of_fact and opinion beghe judge respondent determined a deficiency in petitioner's federal estate_tax of dollar_figure and an accuracy- related penalty of dollar_figure for negligence under sec_6662 b - unless otherwise noted all section references are to the internal_revenue_code in effect at decedent's death and all rule references are to the tax_court rules_of_practice and procedure after concessions including respondent's concession of the penalty the sole issue for decision is whether for purposes of computing the gross_estate of james waldo hendrickson decedent the fair_market_value of big_number common shares of peoples trust and savings bank of boonville indiana peoples was dollar_figure dollar_figure per share as petitioner contends dollar_figure dollar_figure per share as respondent contends or some other amount we hold that the fair_market_value was dollar_figure dollar_figure per share findings_of_fact decedent died testate on date the valuation_date survived by his two sons mark hart hendrickson mark and vinson eric hendrickson decedent and mildred a hendrickson the mother of decedent's sons had been divorced in after more than years of marriage when the petition was filed indiana was the residence and principal_place_of_business of mark and peoples respectively the co-personal representatives of decedent's_estate ’ under indiana law the term personal representative includes executor ind code ann sec michie supp in accordance with decedent's will we use the term co-personal representative exclusively in this case a peoples trust and savings bank of boonville indiana peoples is an independent bank chartered by the state of indiana it was originally chartered in and has been in continuous operation ever since peoples has only one office located in boonville indiana which has a population of approximately big_number boonville is the county seat of warrick county indiana and is located near the southwest corner of the state approximately miles east of evansville indiana the primary customer base of peoples is warrick county which does not include evansville warrick county is bordered on the west by vanderburgh county and on the east by spencer county decedent's branch of the hendrickson family has played the leading role in the management of peoples for more than years james w hendrickson j w decedent's father began working at peoples in while maintaining a law practice and eventually became its president at his death in j w owned very few shares of stock in peoples decedent who inherited fewer than shares of peoples stock from j w thereupon took over as president and served as president for years until when mark took over as president like his father decedent was a practicing lawyer and maintained a solo probate practice during the years he was employed by peoples in while decedent was away on vacation members of his extended family attempted to gain control of peoples in order to thwart the attempted hostile takeover decedent borrowed money - from old national bank in evansville old national to finance his acquisition of sufficient shares of peoples stock to maintain control although decedent acquired small blocks of peoples stock over the years he made his major purchases in response to the takeover attempt mark began his employment with peoples as a teller in date following his graduation from college and was employed by peoples until his admission to law school in following graduation from law school in mark returned part-time to peoples assisting in the trust department where he did legal work and handled collection matters in the mid-1980's he became a part-time trust officer a position he maintained until he became president in after decedent's health started to deteriorate after mark became president decedent assumed the honorary title of chief_executive_officer ceo which was not provided for in the bylaws mark's relationship with decedent became increasingly tense and difficult because of their differences of opinion on how peoples should be managed while decedent had managed peoples very conservatively mark wanted to adopt a more progressive approach that was favored by younger employees of peoples at the time of his death decedent was cko and a director of peoples and the owner of big_number shares of peoples common_stock the estate shares representing dollar_figure percent of the shares outstanding --- - b balance_sheet and capitalization as of date the reporting date peoples had reported total assets of dollar_figure million total liabilities of dollar_figure million and stockholder's equity of dollar_figure million on the valuation_date the capital structure of peoples included no debt other than deposits and other short-term liabilities assets as of the reporting date peoples' assets consisted primarily of net loans of dollar_figure million and marketable_securities of dollar_figure million marketable_securities thus represented approximately percent of peoples' assets while net loans represented approximately percent the bulk of peoples' investment portfolio consisted of year treasury bonds that had been purchased in the high interest rate environment of the late 1980's and early 1990's as of date a substantial number of those bonds were scheduled to mature in to months subjecting peoples to interest rate risk in the lower interest rate environment prevailing at that time stock a control on the valuation_date there were big_number shares of peoples common_stock outstanding the two largest shareholders were decedent big_number shares and mildred hendrickson shares -- - mark had shares the remaining shares were held by shareholders each of whom held at least shares on the valuation_date the estate shares were dollar_figure percent of peoples' outstanding shares and no other shareholder held an interest of similar size although the estate shares were numerically a minority interest they were a controlling_interest in substance the estate shares had effective_control of peoples regardless of who owned them there would be few circumstances in which the estate shares would not determine the outcome of any particular vote because unless every other shareholder voted against the estate shares the estate shares would always win thus over time the holder of the estate shares would in all likelihood be able to determine all or substantially_all the members of peoples' board_of directors the board because every shareholder owned at least shares any existing shareholder who acquired the estate shares would automatically acquire actual control because he or she would acquire a majority interest big_number big_number big_number the articles of incorporation of peoples do not provide for cumulative voting for directors although the indiana general corporate law permits the certificate of incorporation to provide for cumulative voting for directors ind code ann sec b michie the indiana corporate law applicable to financial institutions does not appear to permit cumulative voting see ind code ann sec michie b stock transactions there was no regular market for peoples common_stock and transfers were infrequent on the valuation_date peoples did not have an employee_stock_ownership_plan nor any history of repurchasing shares within the months before and after the valuation_date there was only one arm's-length sale of peoples stock in that transaction which occurred after the decedent's death in julia raibley assistant secretary of peoples purchased shares at dollar_figure per share from the stone estate in date after being named to the board victor bowden purchased shares from the toole estate in order to comply with the requirement in peoples' bylaws that members of the board own at least shares of peoples stock mr bowden purchased the shares for dollar_figure per share using funds he borrowed from decedent also in date the toole estate sold peoples shares to mark for dollar_figure per share ’ in date decedent transferred by gift shares of peoples stock to mark reducing his interest in peoples from big_number shares dollar_figure percent to big_number shares dollar_figure percent the only reason given by decedent to mark for the gift was to round off mark's holdings from shares to shares mark the fair_market_value per share for peoples stock reported on the form_706 united_states estate and generation- skipping transfer_tax return of the ella wright estate in or was also dollar_figure --- - and decedent had not previously discussed a control-breaking transfer such as this one some years earlier when mark had suggested estate_planning to decedent decedent had not expressed any interest although there was no active market for peoples shares after mark became president he occasionally received informal purchase inguiries from representatives of other banks in the area peoples did not receive any purchase inguiries from business brokers or investment banking firms there was not much of a market for peoples stock and shares could not always be sold for example sometime prior to mark's becoming president of peoples in date mark and decedent received telephone solicitation from a representative of hilliard-lyons a louisville investment banking firm about purchasing shares from charlotte marsh mark and decedent both declined the same shares were still available for purchase in and again in or when mark was personally solicited by the son of mrs marsh cc dividend payments the board did not declare any dividends between and during this time period mrs hendrickson and her attorney made a demand for dividend payments at an annual shareholders’ meeting mrs hendrickson had received her approximately percent interest in peoples from decedent as part of her divorce property settlement the board apparently took no action on her - demand as no dividends were paid until when the board declared a dollar_figure million dividend in the board declared a dividend of around dollar_figure to dollar_figure million d excess capital as a result of not having paid dividends peoples on the valuation_date was overcapitalized as measured by the ratio of book equity to total assets on the reporting date and the valuation_date peoples had an equity-to-asset ratio of approximately percent at that time the average equity-to- asset ratio for midwestern banks and thrifts with assets less than dollar_figure million was between and percent on the valuation_date and the reporting date a 9-percent equity-to-assets ratio would have been a reasonable level of capitalization for peoples on the reporting date peoples had equity of dollar_figure of which dollar_figure was excess capital c governance and management as of the valuation_date peoples was still incorporated in the state of indiana and was subject_to applicable indiana corporate and banking law shareholder approval the articles of incorporation and bylaws of peoples contain no provisions concerning shareholder voting requirements for mergers acquisitions sales of assets or liquidation accordingly under indiana corporate law a plan of merger or - sale of substantially_all the assets would have required the approval of no more than a majority of the shares entitled to vote see ind code ann sec e e michie see also ind code ann sec michie supp board_of directors on the valuation_date the board_of directors comprised eight individuals the majority of whom were also employed by peoples the bylaws of peoples then in effect provided that two- thirds of the board would constitute a quorum and prohibited the transaction of any business without a quorum the bylaws also required all directors to own at least shares of stock in peoples thus all the directors were shareholders in addition to decedent and mark the board included the following individuals name position alan bender executive v p senior loan officer alan bennett decedent's friend victor bowden decedent's godson florence davis v p trust officer john farrell v p loan and security officer richard johnson outside director most of the board members had been selected by the decedent because of their longstanding personal relationships with him rather than on account of any relevant expertise victor bowden the provision for a vote of two-thirds of the outstanding shares to approve a sale of assets by an indiana financial_institution applies only to such institutions organized after date see ind code ann michie for example was a young man whom decedent had supported much like a foster_child john farrell was a friend from military service in world war ii and alan bender used to drive a laundry truck and had the decedent on his route none of the members of the board had any formal training in banking and only half the members of the board had attended college despite the close relationships of the other board members to decedent however they were not a rubber stamp for decedent and mark the other directors were strong-willed independent thinkers who contributed to the board's deliberations moreover those directors who were also officers could use their positions as employees to subvert any board decision with which they were in disagreement but while the board was not a rubber stamp many of the directors thought similarly to decedent and were resistant to change financial management and reporting a outside accountant peoples' longstanding regular accountant and auditor was ronnie robinson a sole practitioner in evansville mr robinson had no other financial institutions as clients mark completed graduate banking training at the university of wisconsin in after the valuation_date tony aylsworth chief operating officer of peoples since date but not a member of the board also completed graduate banking training at the university of colorado boulder b budgeting peoples did not prepare budgets until after being forced to do so by the fdic the budgets were prepared one gquarter at a time by julia raibley cc rarnings in the years peoples enjoyed an unusually high yield curve because of the spread between the rates of interest received on securities and loans over interest_paid on savings accounts and certificates of deposit by the time of decedent's death peoples had begun performing interest rate sensitivity analyses however its methods of doing so were criticized as unreliable by the fdic examiners peoples did not follow the practice of forecasting its earnings d operation sec_1 employees on the valuation_date peoples had approximately employees most of whom were in their mid-50's or older peoples had no retirement_plan but it also had no mandatory_retirement_age as a result peoples had employees in their 70's and 80's in general peoples had a good relationship with its employees resulting in very little turnover and a median term of employment of years however there was some friction between tellers and bookkeepers on the one hand and loan officers on the other resulting in little mingling between the two groups facilities the operations of peoples were housed in a two-story building built in peoples had no branches peoples' facilities and equipment were in average condition and considered adequate for its operations when mark became president peoples was for the most part operating with 1960's technology most operations in the bank were done manually and there were no information systems to keep track of customers' credit payments or deposits peoples did not have any atm machines peoples had desktop pc's for use by loan officers and customer service representatives but only to print out loan applications signature cards and other operational documents under mark's direction however peoples had entered into a contract with old national to provide electronic data processing edp applications for deposits loans and accounting although many of the directors were hesitant about learning the new technology they reluctantly cooperated during and peoples converted its system of accounting for its loan portfolio from a manual system to a computerized system and began having its loans serviced by old national however on the valuation_date the complete conversion of peoples to the old national edp applications had not been completed - security at peoples was antiquated despite a number of bank robberies in the area peoples had little protection from armed robbery or burglary security at the bank consisted of glass doors that could be locked and two 1960's vintage still image security cameras peoples did not employ security guards or arm its employees and did not have a central alarm system in the event of a robbery peoples did have a system in place to activate a silent alarm that would notify the sheriff if bait money should be removed from a teller bay however at the time of decedent's death the physical cash was not carefully managed and tellers frequently kept as much as dollar_figure in their cash drawers franklin loan and savings association on the valuation_date the franklin loan and savings association franklin was affiliated with peoples franklin did not have its own facilities or employees and used those of peoples franklin paid peoples for employee time used along with an annual rent of dollar_figure depository accounts a checking accounts on the valuation_date peoples offered free checking accounts that really were free there were no monthly charges ’ ’ peoples charged a fee on dormant accounts as provided by state law -- - minimum balances or charges for transactions in fact until shortly before decedent's death peoples provided checking account customers with free printed blank checks even after peoples decided to charge for checks it charged customers only for actual printing costs with no markup as a result of peoples' generous checking account policy there were approximately big_number checking accounts open at peoples on the valuation_date however approximately big_number of those accounts had an average daily balance of less than dollar_figure and total checking account deposits amounted only to approximately dollar_figure million asa result most checking accounts were unprofitable for peoples inasmuch as the costs of servicing the accounts exceeded earnings on the deposits b savings accounts on the valuation_date peoples had dollar_figure to dollar_figure million in deposits in savings accounts cc certificates of deposit the overwhelming majority of peoples' deposits were attributable to certificates of deposit those deposits included hot money large deposits that come from a wide geographic area in search of the best interest rate hot money is a volatile source of deposits because it is likely to be withdrawn anytime a better interest rate is being offered by another depository_institution peoples was not interested in pursuing or retaining hot money because as discussed infra it did not have - sufficient loan demand to pay the yields demanded by hot money depositors lending activities a loan products as of the reporting date peoples' loan portfolio was heavily concentrated in real_estate over percent of peoples' loan portfolio was in real_estate loans of which dollar_figure percent were loans on to family residential real_estate most real_estate loans made by peoples were for existing properties rather than new_construction peoples' concentration of loans in to family residential real_estate placed it in the 98th percentile in comparison to its peer institutions peoples offered few choices in the way of loan products to real_estate borrowers it did not offer adjustable rate mortgages arm's or home equity loans’ and did not participate in any fha or va mortgage programs fixed-rate mortgages were offered only with a or 20-year term a 30-year term often favored by first-time home buyers because of the lower monthly payments was not available also discouraging to first-time home buyers peoples' loan-to-value ltv and loan limit peoples did not have sufficient information_technology to comply with regulations concerning the disclosures required to be made to consumers with respect to adjustable rate mortgage borrowers peoples now offers home equity loans restrictions required significantly greater downpayments than competing lenders while its competitors were lending on an percent ltv or as high a sec_90 to percent with private mortgage_insurance pmi peoples required an ltv ratio of percent although peoples raised its ltv requirement to percent in discussed infra it did not offer any programs using pmi to lower the borrower's downpayment finally peoples' dollar_figure lending limit required proportionately larger downpayments on more expensive homes than competitors with a maximum mortgage loan of dollar_figure any house with a purchase_price of more than dollar_figure would require a downpayment greater than percent peoples generally avoided making other types of consumer loans such as credit cards automobile leasing and automobile financing although it technically offered automobile financing peoples set rates above market because it was not interested in making automobile loans due to concerns over whether it had sufficient personnel to track automobile documentation insurance titles etc and deal with collections such automobile loans as were made were mainly to peoples' employees as of the reporting date only dollar_figure percent of the peoples loan portfolio was in commercial and industrial loans placing peoples in the 4th percentile very low in comparison to its peers peoples generally did not make commercial loans had only one revolving line of credit open and did not offer letters of credit after mark became president and before decedent's - - death peoples tried to start a small_business administration sba loan program but was unsuccessful in submitting loan applications to the sba because of inadequate documentation in sum although peoples' charter permitted it to offer a broad range of lending products to consumer and commercial borrowers peoples in practice generally failed to serve all but a select class of home buyers who were not discouraged by peoples' ltv loan limit 20-year maximum term and lack of arm's b loan-to-asset ratio the effects of peoples' narrowly defined market and conservative lending practices are readily apparent during the 4-year period ending on the valuation_date peoples' net loans as a percentage of assets averaged percent peoples' peers in comparison averaged to percent after mark became president of peoples he tried to raise peoples' loan-to-asset ratio significantly and set a goal of to percent for a rate that had not been achieved as of the date of trial aside from adopting a more aggressive stance in the market peoples could also have achieved an increased loan-to-asset ratio by reducing its assets by declaring a substantial dividend on date joe melhiser was hired as an assistant vice president from another bank in an effort to increase lending as part of the effort to increase lending peoples raised its ltv to percent in although the increased ltv triggered concerns at peoples over increased risks of default or delinquency peoples did not raise its interest rates cc loan underwriting and documentation loan decisions were made by a four-person loan committee on the basis of a loan application peoples' underwriting procedures were criticized by the fdic for a number of shortcomings until early for example peoples did not require credit reports or title insurance for residential mortgage loans and did not check whether flood insurance was required on the property being financed ’ contrary to standard industry practice peoples made loans without verifying the market_value of the underlying collateral through independent appraisal instead peoples used less reliable in-house appraisals that did not conform to the format used by independent appraisers in some cases peoples even recycled old appraisals of a property rather than obtaining a new appraisal that would reflect current market values unlike most mortgage lenders peoples did not sell any mortgage loans in the secondary mortgage market peoples had unsuccessfully tried to sell mortgage loans in the past to fannie_mae and freddie_mac but did not have underwriting practices and documentation sufficient to comply with the standards of the there was a high likelihood of flooding in some areas served by peoples the ohio river is the southern boundary of warrick county - - secondary market in any event peoples needed to retain ownership of the mortgage loans it made because its supply of funds exceeded the demand for its mortgage loans---selling the mortgages would have further compromised peoples' net interest margin and earnings d loan monitoring peoples monitored loans using paper ledger cards that were stored in pockets that tracked the day of the month on which each loan was due so that if the loan was past due the card would remain in what would become a past due pocket instead of being put in a current pocket meetings concerning delinquent loans were held by peoples' loan committee peoples also had watch lists of problem loans as required by the fdic examiners but they were not used by peoples to monitor loans fee income income from fees can make a significant contribution to the income of a bank banks may earn income or fees from points and origination fees on loans atm fees trust fees credit card fees servicing agreements and insurance sales peoples generally charged no points or fees however and had only minimal fee income from its activities peoples did not service loans made by other depository institutions be requlation and monitoring classification regulation and insurance the banking industry includes both commercial banks and thrifts while there is some overlap commercial banks generally provide a wider range of banking services than thrifts whose principal mission is financing home ownership there are also some differences in ownership commercial banks are always owned as stock companies while thrifts may be stock-owned or mutually owned commercial banks and stock-owned thrifts are frequently owned by a bank_holding_company owning one or more institutions although most thrifts are mutually owned stock companies account for more than two-thirds of the assets of thrifts both banks and thrifts can be federally or state chartered and are generally insured by either the bank insurance fund bif or savings association insurance fund saif of the federal deposit insurance corporation fdic bif insures all federally- chartered commercial banks most state-chartered commercial banks and some state-chartered thrifts saif insures all federally-chartered and some state-chartered thrifts since date saif- and bif-insured institutions have paid the same level of deposit insurance premium dollar_figure percent of deposits on the valuation_date peoples was chartered by the state of indiana with the powers of a commercial bank and was bif-insured as a result peoples was subject_to regulation at the federal -- - level by the fdic and at the state level by the department of financial institutions of the state of indiana idfi the fdic and the idfi share regulatory responsibilities and exchange documents reports and examinations and correspondence concerning the institutions that they both supervise and regulate although peoples was chartered with the powers of a commercial bank it displayed the characteristics of a thrift its loan portfolio was heavily concentrated in residential real_estate loans that were held until maturity peoples did not sell or service loans the asset structure of peoples was heavily weighted toward investment securities and the loan-to-deposit ratio was below percent despite the powers granted under its charter peoples was not equipped to operate as a commercial bank without significant expenditures to update its systems and procedures to process commercial lending and deposit products accordingly for purposes of valuing the estate shares peoples should be treated as a thrift rather than a commercial bank safety and soundness both fdic and idfi conduct regular compliance and safety and soundness examinations of peoples using a composite ratings system based on six areas of concern capital adequacy asset quality management competency earnings level and trend level of liquidity and interest rate sensitivity fdic conducted examinations of peoples as of the - - close of business date and date idfi conducted an examination as of date in all three cases peoples received a uniform composite rating of one the highest possible rating institutions earning a uniform composite rating of one are basically sound in every respect and are considered to be resistant to external economic and financial disturbances and more capable of withstanding the vagaries of business conditions than institutions with lower ratings nevertheless in their reports with respect to the examinations both fdic and idfi expressed concern over peoples' liability sensitive position and cautioned that earnings could be negatively impacted during a period of rising interest rates the fdic also expressed concern over shortcomings in various policies and procedures of peoples including financial reporting underwriting and budgeting although apparently not of sufficient magnitude to affect peoples' top rating community reinvestment act the community reinvestment act cra title vii of the housing and community development act of publaw_95_123 sec 91_stat_1147 currently codified pincite u s c sec was enacted by congress to encourage depository institutions to help meet the credit needs of the communities in which they operate including low- and moderate-income neighborhoods consistent with safe and sound banking operations cra requires that each insured depository institution’s record in -- - helping meet the credit needs of its entire community be evaluated periodically that record is taken into account in considering an institution’s application_for deposit facilities including mergers and acquisitions cra examinations are conducted by the federal agencies that are responsible for supervising depository institutions such as fdic and the office of thrift supervision ots inasmuch as peoples was insured by fdic it was subject_to fdic examination with respect to its cra compliance peoples' designated cra area included all of warrick county peoples reduced the size of its cra area in date at the suggestion of an fdic examiner because of its compliance difficulties if evansville had been included in peoples' designated cra area peoples would have had significantly greater difficulty complying because it would have had to prove it was fairly serving evansville's low- and moderate-income neighborhoods peoples received cra performance ratings of needs to improve on two occasions in its cra performance report as of the close of business on date first cra report fdic cited three principal cra compliance issues lack of adequate effort by peoples to determine the credit needs of the community lack of adequate effort by peoples to publicize the types of loans it offered and generally conservative lending practices in a memorandum of understanding dated date first mou and signed by all directors of - - peoples peoples agreed to address the cra compliance issues raised by the fdic in the first cra report in a cra performance report as of the close of business date second cra report fdic identified additional cra compliance problems including lack of formal training by peoples of its employees on cra compliance failure by peoples to monitor its own performance in complying with the cra failure by peoples to review its lending patterns for evidence of discriminatory lending practices loan-to-deposit ratio low volume of farm and business_credit extended and lobby hours significantly below that of the competition in response to the second cra report the directors of peoples signed another memorandum of understanding on date second mou within a month after signing the second mou in an attempt to improve its cra compliance peoples created a new position--- compliance officer--and hired thomas krochta a local attorney to do the job nevertheless on date as mr krochta was settling into his new position simona l frank chicago regional director of fdic's division of supervision wrote to the board expressing concern over peoples' continued noncompliance and requesting immediate corrective action ms frank said that she planned to recommend to the national_office of the division of supervision that peoples continue to be designated a problem bank under the cra as a result of the - - problem bank designation peoples was subjected to a very high level of scrutiny in future examinations by the fdic examinations were conducted more frequently greater correspondence between peoples and the fdic was required and peoples could have been prohibited from any merger acquisition divestiture or expansion activity designation as a problem bank also excluded peoples from bidding on the assets of failed financial institutions continued failure to comply with the cra could have resulted in a cease-and-desist order by the fdic with the ultimate sanction of forced closure peoples' cra compliance costs were significant for a bank its size in addition to the additional demands on management imposed by the cra requirements peoples was forced to hire two full-time attorneys to oversee its cra compliance in date shortly after hiring mr krochta peoples hired tony aylsworth another local attorney as an assistant vice president and assistant compliance officer mr aylsworth's first assignment at peoples was scrubbing the loan files scrubbing as used in this context refers to the process of reviewing loan files to see if they contain adequate documentation and correcting any documentation problems discovered such as missing documents or signatures inadequate loan documentation was a contributing factor in peoples' cra compliance difficulties because peoples was unable to show why and where it was denying certain loans until decedent's death - on date he worked closely with mr aylsworth on the scrubbing project on date the fdic notified peoples that it had demonstrated compliance with only about half of the terms and conditions of the second mou not until early did peoples finally achieve compliance with the second mou in date mr aylsworth ceded his position as assistant compliance officer and became a_trust officer a position he held until date when he became chief operating officer third-party monitoring peoples was highly regarded by regulators and the banking community for its safety and soundness and was recognized by the following bank rating services rating service rating veribank inc blue ribbon bank bauer financial reports five star bank sheshunoff information listed in highest rated services banks in america f market condition sec_1 banking industry in the banking industry was still recovering from the recession of the early 1990's and--in the case of thrifts----from the savings and loan crisis the first quarter of was the first time since when the savings and loan industry bailout was introduced that no savings banks had failed prospects for - - the industry were encouraging as a result of low interest and inflation rates that led to increased consumer borrowing and spending increased production and expansion and lower unemployment competition peoples’ main competitors in boonville were old national warrick federal credit_union the credit_union and boonville federal savings bank old national and the credit_union both had competitive positions superior to that of peoples among its boonville competitors peoples was considered to be something of a dinosaur peoples had been losing customers since the credit_union opened in comparison to its competitors peoples' only advantage was in the low costs and fees it offered on home mortgages along with a competitive interest rate peoples also faced competition from large commercial banks in evansville that had presences in other parts of southern indiana old national cnb bancshares and national city bancshares however all three evansville banks were trying to grow through acquisition so while they may have posed a competitive threat they were also a potential acquirer of peoples old national's boonville branch for example had resulted from old national's acquisition of a local bank local bconomy on the valuation_date the local economy served by peoples was growing slowly in boonville the largest employer was the school corporation in warrick county the two largest employers alcoa and peabody coal were both significantly downsizing alcoa which previously employed big_number to big_number local workers was reducing its local workforce by one-third while peabody coal was reducing its local workforce by two- thirds to fewer than employees another coal mining concern amax had ceased local mining operations entirely the area served by peoples also contained a whirlpool manufacturing plant and some farming activity despite the negative developments in the warrick county economy many residents of warrick county worked in evansville which was experiencing modest growth on date the u s district_court for the southern district of indiana entered a consent judgment in an action filed by the u s environmental protection agency epa against the state of indiana and the city of boonville epa had initiated the action because boonville's sewage treatment facilities were overloaded resulting in the discharge of insufficiently treated wastewater in violation of the clean water act and other federal laws the consent judgement required boonville to ‘t water quality act of publaw_100_4 101_stat_7 currently codified a sec_33 u s c sec_1251 -- - prohibit all new sewer connections sewer tap ban until it could demonstrate compliance with all remedial provisions of the consent judgment epa could grant waivers from the sewer tap only under very limited circumstances waivers from this sewer ban for new sources may be granted only if epa determines that the proposed connection will eliminate an existing health hazard and the resulting public health benefit outweighs the adverse impact of any reduction in wastewater effluent guality the sewer tap ban made it very difficult to obtain commercial or residential building permits in boonville and was considered a high priority issue by the boonville board_of public works but it did not bar new_construction elsewhere in warrick county on the valuation_date newburgh a suburb of evansville was one area in warrick county where new home construction was active primarily single-family homes priced between dollar_figure to dollar_figure however because of its conservative lending practices described supra pp peoples could not serve the needs of younger cash-poor borrowers who could otherwise afford to purchase a dollar_figure to dollar_figure house although peoples was located only miles from evansville peoples generally chose not to engage in lending activities in evansville or its surrounding county vanderburgh county ‘2 tony aylsworth an officer of peoples since date served on the boonville three-person board_of public works from date until date - - peoples avoided making loans in vanderburgh county because its conservative-minded loan officers were unfamiliar with the area and its values and because adding evansville to peoples' designated cra area would have increased peoples' cra compliance requirements g estate_tax_return decedent's co-personal representatives executed and timely filed a united_states estate and generation-skipping_transfer_tax return form_706 on date the form_706 had been prepared by jeffrey b baker a certified_public_accountant and certified financial planner decedent's big_number shares of peoples common_stock were included on schedule b of the form_706 of the big_number shares the form_706 reported big_number shares at a value of dollar_figure dollar_figure per share and shares at a value of dollar_figure dollar_figure per share the dollar_figure-per-share value reported on the form_706 was based on a valuation of the estate shares by harding shymanski company p c hsc an evansville indiana public accounting firm hsc valued the peoples' total equity on a minority basis using the weighted average value under three different valuation methods the three methods and their weightings were capitalized earnings percent price earnings multiple ‘3 petitioner requested and received a timely extension of time for filing the form_706 - - percent and price book multiple percent after computing the weighted average value of total equity ona minority basis hsc applied a 30-percent marketability discount and divided the result by big_number the total number of shares of peoples common_stock outstanding to determine the fair_market_value of the estate shares on a per share basis petitioner did not use hsc as an expert witness in this case on date respondent timely mailed petitioner a notice_of_deficiency with respect to its estate_tax liability the notice_of_deficiency determined a value of dollar_figure big_number for the estate shares based upon an appraisal prepared by david f fuller of business valuation services inc who acted as respondent's expert witness in this case h lack of marketability on the valuation_date peoples had few opportunities for growth peoples' earnings were subject_to significant interest rate risk peoples had no employee stock_option plan or history of repurchasing shares and there was no readily available public or private market for peoples stock each of these conditions contributed to a lack of marketability of peoples stock the redetermined value of the estate shares in the notice_of_deficiency and the amount asserted at trial by respondent are essentially the same they differ only because respondent's expert rounded certain figures in his report see discussion infra of respondent's expert - - ultimate finding of fact on the valuation_date the fair_market_value of the estate shares was dollar_figure dollar_figure per share opinion the issue for decision is the fair_market_value on the valuation_date date of big_number shares of peoples common_stock included in decedent's gross_estate valuation is a question of fact and the trier of fact must weigh all relevant evidence to draw the appropriate inferences see 323_us_119 304_us_282 250_f2d_242 5th cir affg in part and remanding in part on another ground tcmemo_1956_178 94_tc_193 84_tc_285 fair_market_value is defined for federal estate and gift_tax purposes as the price that a willing buyer would pay a willing seller both having reasonable knowledge of all the relevant facts and neither being under compulsion to buy or to sell see 411_us_546 citing sec_20_2031-1 estate_tax regs see also 93_tc_529 92_tc_312 the willing buyer and the willing seller are hypothetical persons rather than specific individuals or entities and the peculiar characteristics of - - these hypothetical persons are not necessarily the same as the individual characteristics of an actual seller or an actual buyer see estate of curry v united_states f 2d 7th cir 658_f2d_999 5th cir estate of newhouse v commissioner supra pincite see also 823_f2d_483 11th cir affg tcmemo_1985_595 the hypothetical willing buyer and willing seller are presumed to be dedicated to achieving the maximum economic advantage see estate of curry v united_states supra pincite estate of newhouse v commissioner supra pincite this advantage must be achieved in the context of market and economic conditions at the valuation_date see estate of newhouse v commissioner supra pincite for federal estate_tax purposes the fair_market_value of the subject property is generally determined as of the date of death of the decedent ordinarily no consideration is given to any unforeseeable future event that may have affected the value of the subject property on some later date see sec l b estate_tax regs see also 763_f2d_891 7th cir estate of newhouse v commissioner supra pincite 88_tc_38 special rules apply to the valuation of the stock of a closely_held_corporation while listed market prices are the - - benchmark in the case of publicly traded stock recent arm’ s-- length transactions generally are the best evidence of fair_market_value in the case of unlisted stock see 79_tc_938 73_tc_266 estate of branson v commissioner tcmemo_1999_231 where the value of unlisted stock cannot be determined from actual sale prices value is best determined by taking into consideration the value of listed stock in comparable corporations engaged in the same or a similar line_of_business as well as all other factors bearing on value including analysis of fundamentals see sec_2031 b estate of newhouse v commissioner supra pincite estate of hall v commissioner supra pincite the factors that we must consider are those that an informed buyer and an informed seller would take into account see 325_f2d_934 8th cir affg tcmemo_1961_347 revrul_59_60 1959_1_cb_237 has been widely accepted as setting forth the appropriate criteria to consider in determining fair_market_value estate of newhouse v commissioner supra pincite it lists the following factors to be considered which are virtually identical to those listed in sec_20_2031-2 estate_tax regs a the nature of the business and the history of the enterprise from its inception b the economic outlook in general and the condition and outlook of the specific industry in particular - - c the book_value of the stock and the financial condition of the business d the earning capacity of the company e the dividend-paying capacity f whether or not the enterprise has goodwill or other intangible value g sales of the stock and the size of the block of stock to be valued h 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 rev_rul c b pincite as is customary in valuation cases the parties rely primarily on expert opinion evidence to support their contrary valuation positions we evaluate the opinions of experts in light of the demonstrated qualifications of each expert and all other evidence in the record see anderson v commissioner supra 86_tc_547 we have broad discretion to evaluate 'the overall cogency of each expert's analysis ' 838_f2d_330 9th cir quoting 783_f2d_906 9th cir affg in part and revg in part t c memo affg in part and revg in part on another ground tcmemo_1986_318 expert testimony sometimes aids the court in determining values sometimes it does not particularly when the expert is merely an advocate for the position argued by one of the parties see eg estate of halas v commissioner t c - - 92_tc_101 we are not bound by the formulas and opinions proffered by an expert witness and will accept or reject expert testimony in the exercise of sound judgment see helvering v national grocery co u s pincite anderson v commissioner f 2d pincite estate of newhouse v commissioner t c pincite estate of hall v commissioner t c pincite where necessary we may reach a determination of value based on our own examination of the evidence in the record see 945_f2d_92 5th cir citing 538_f2d_927 2d cir affg t c memo ames v commissioner tcmemo_1990_87 affd without published opinion 937_f2d_616 10th cir where experts offer divergent estimates of fair_market_value we decide what weight to give these estimates by examining the factors they used in arriving at their conclusions see 38_tc_357 we have broad discretion in selecting valuation methods see 640_f2d_249 9th cir affg on this issue and revg in part tcmemo_1978_191 and in determining the weight to be given the facts in reaching our conclusion because finding market_value is after all something for judgment experience and reason 202_f2d_105 2d cir affg a memorandum opinion of this court moreover while we may accept the opinion of an expert in its entirety buffalo tool die -- - manufacturing co v commissioner t c we may be selective in the use of any part of such opinion or reject the opinion in its entirety parker v commissioner supra pincite finally because valuation necessarily results in an approximation the figure at which we arrive need not be directly attributable to specific testimony if it is within the range of values that may properly be arrived at from consideration of all the evidence see silverman v commissioner supra pincite 302_f2d_790 2d cir respondent's expert respondent relies on the expert report of david n fuller a principal in the dallas texas office of business valuation services inc bvs mr fuller has worked in business valuation since he graduated from southern methodist university in with an m b a in finance he was a manager in the valuation group at deloitte touche from until when he became associated with bvs mr fuller is an accredited senior appraiser and chartered financial analyst mr fuller valued the estate shares at dollar_figure dollar_figure per share using the weighted average value of the estate shares under an income approach and a market approach reduced by a marketability discount of percent a discounted cash-flow the income approach employed by mr fuller was the discounted cash-flow method dcf a dcf analysis attempts to measure value by forecasting a firm's ability to generate cash and discounting the flows to present_value using the firm’s cost of capital there are three components to the dcf analysis the cash-flow projections over the forecasted period the terminal value and the appropriate discount rate using dcf a firm's value is calculated as the discounted_present_value of the forecasted cash-flow from operations plus the discounted_present_value of the terminal value see brealey myers principles of corporate finance g4 4th ed before performing his dcf analysis mr fuller reduced the operating_assets shown on peoples' balance_sheet in order to project peoples' free cash-flow from operations fcf mr fuller made these adjustments because he considered peoples to be overcapitalized as measured by its ratio of book equity to assets with total equity of dollar_figure and total assets of dollar_figure on the reporting date peoples had a book equity-to- assets ratio of percent ’ in comparison according to mr 's the pro forma balance_sheet prepared by mr fuller as of date showed total eguity of dollar_figure and total assets of dollar_figure resulting in a similar book egquity- to-assets ratio -- - le was only fuller the average of peoples' peer group percent mr fuller considered a 9-percent book egquity-to-assets ratio to be a reasonable level of capitalization for peoples ’ and accordingly he reduced the balances of peoples' total assets and total equity accounts by dollar_figure--the amount necessary to lower peoples' book equity-to-asset ratio to percent resulting in adjusted total equity and total assets of dollar_figure and dollar_figure respectively mr fuller then treated the dollar_figure in assets removed in his adjustments as ‘ the depository institutions comprising peoples' peer group are determined by the federal financial institutions examination council ffiec an entity established by congress in to promote consistent examination and supervision of financial institutions members in the ffiec include the comptroller of the currency the chair of the fdic and a member of the federal reserve board_of governors peer group data is used by the ffiec in uniform bank performance reports which are issued by the ffiec for every insured bank on a quarterly basis the ffiec assigns each bank or holding_company to a particular peer group based upon asset size and number of branches or banks mercer valuing financial_institution sec_61 sec_143 peoples' peer group consisted of commercial banks and thrifts operating in indiana illinois ohio and kentucky with average total assets of approximately dollar_figure million ‘7 we note that the 9-percent figure used by mr fuller was very close to the average equity-to-assets ratios for the guideline companies selected by petitioner's expert james be magee of alex sheshunoff co investment banking discussed infra mr magee used two groups of guideline company data one that was based on controlling_interest transactions and one that was based on minority interest transactions the average equity-to-asset ratios for the two groups were dollar_figure percent and dollar_figure percent respectively - al --- nonoperating assets whose income would not be included in peoples fcf mr fuller forecasted peoples' fcf for years forward the valuation horizon and computed a terminal value using the gordon dividend growth model gordon model the gordon model is a model for estimating the terminal value of a going concern which assumes that fcf will continue indefinitely and grow at a constant rate for purposes of computing the terminal value under the gordon model mr fuller assumed that peoples fcf would continue indefinitely growing at a rate of percent annually in forecasting fcf for the valuation horizon and the terminal value mr fuller took into account the earnings impact of removing dollar_figure from operating_assets mr fuller assumed that such a reduction would reduce peoples' net_interest_income rather than loan income because peoples could readily dispose_of marketable_securities while its loans had proven to be unmarketable accordingly mr fuller forecasted peoples' net_interest_income at approximately dollar_figure million less than peoples' reported net_interest_income for the calendar_year 1992--a sufficient amount to reflect the loss of an approximately percent return on the nonoperating assets mr fuller estimated peoples' cost of capital using a weighted average cost of capital wacc formula and calculated peoples' cost of equity using the standard capital_asset pricing model capm formula the cost of equity was calculated using a - 7-percent risk-free rate a risk premium of percent anda beta of about approximately equal to the overall market average of mr fuller calculated beta using the average unlevered beta’ for the publicly traded midwestern banks tracked by the value line investment survey 4th ed date the vl list the vl list included the leading full-service commercial banks in the midwest such as banc one corp first chicago corp national city corp and norwest corp the vl list did not contain any small single-location banks such as peoples all the banks on the vl list were substantially larger the market capitalizations of the banks on the vl list ranged from approximately dollar_figure million to dollar_figure billion with mean and median capitalizations of approximately dollar_figure billion and dollar_figure billion respectively after calculating unlevered betas for each of the companies mr fuller calculated an average unlevered beta of and an average relevered beta of despite the fact that peoples was unleveraged mr fuller chose a beta of the same as the average relevered beta ‘8 an unlevered beta measures the business risk of a company by removing the effect of financial leverage this permits the betas of comparison companies to be considered so that business risk can be isolated and evaluated apart from the risks associated with financial leverage copeland et al valuation measuring and managing the values of companie sec_331 2d ed - using the 3-percent discount rate he calculated under capm mr fuller calculated discounted present values of dollar_figure and dollar_figure for peoples' fcf for the valuation horizon and its terminal value respectively for a value from operations of dollar_figure he then added back the book_value of the nonoperating assets net of a 10-percent minority discount to arrive at a total equity value of dollar_figure dollar_figure per share there are significant shortcomings in mr fuller’s application of capm in this case that highlight our doubts over the appropriateness of its application to the valuation of small closely held companies as we said recently capm is a financial model intended to explain the behavior of publicly_traded_securities and we do not believe that capm and wacc are the proper analytical tools to value a small closely_held_corporation with little possibility of going public furman v commissioner tcmemo_1998_157 75_tcm_2206 t c m ria par big_number pincite unlike the market contemplated by capm the market for peoples stock to the extent one even exists is not efficient liquid or free of significant transaction costs moreover in relation to other closely held corporations the liguidity of a financial_institution is even further reduced by the fact that acquisitions and dispositions of - its stock are subject_to regulatory approval ’ finally capm assumes that investors hold or have the ability to hold diversified portfolios that eliminate on a portfolio basis the effects of unsystematic risk---the elements of risk that are specific to the asset held consequently because capm assumes that an investor holding a diversified portfolio will encounter only systematic risk the only type of risk for which an investor can be compensated is systematic or market risk which represents the sensitivity of the future returns from a given asset to the movements of the market as a whole see id citing brealey myers principles of corporate finance 4th ed pratt et al valuing a busine sec_166 3d ed in calculating peoples' discount rate mr fuller followed the principles of capm and did not make any provision for peoples' unsystematic risk based on the assumption that such risk was diversifiable yet respondent and mr fuller have overlooked the difficulties in diversifying an investment ina block of stock they argued is worth approximately dollar_figure million construction of a diversified portfolio that will eliminate most unsystematic risk requires from to securities of similar value see brealey myers supra pincite thus proper diversification of an investment in the peoples shares owned by an acquisition of greater than a 9-percent interest requires federal regulatory approval - - petitioner as valued by respondent would require a total capital_investment of at least dollar_figure million we do not think the hypothetical buyer should be limited only to a person or entity that has the means to invest dollar_figure million in peoples anda portfolio of nine other_securities as illustrated by mr fuller's valuation the selection of beta is another problem inherent in the application of capm to the valuation of closely held companies see furman v commissioner supra beta a measure of systematic risk is a function of the relationship between the return on an individual security and the return on the market as a whole see pratt et al supra pincite the betas of public companies are frequently published or can be calculated using historical pricing data on the company's stock thus a beta cannot be calculated for the stock in a closely held corporation---it can only be estimated based on the betas of comparable publicly traded companies however because the betas for small corporations tend to be larger than the betas for larger corporations it may be difficult to find suitable comparables when valuing a small closely_held_corporation see ibbotson associates stocks bonds bills inflation yearbook ibbotson pincite copeland et al valuation measuring managing the value of companies 2d ed in this case mr fuller used - - as the beta which equaled the relevered average beta of the banks on the vl bank list as discussed supra there are substantial differences in size and operations between peoples and the banks on the vl bank list we do not believe that their betas are representative of the greater business risks faced by peoples for example in comparison to the large banks on the vl list peoples had limited opportunities for growth less ability to diversify risk because of limited product offerings and dependence on the economic conditions of a few counties lacked the ability to create the economies of scale available to large banks had greater interest rate risk because it could not sell mortgages on the secondary market had less control_over credit risk due to inadequate underwriting standards anda lack of information_technology support and could not afford to employ the personnel and technology used by large banks to protect and pursue earnings through the management of interest rate risk mr fuller did not otherwise adequately support his selection of a beta of a figure he admits is approximately wal egual to the overall market average of based on the s p that statement if anything suggests that mr fuller's beta is mr fuller did not explain why he used the relevered beta rather than the unlevered beta when peoples was not leveraged the s p stock index includes of the largest stocks by market_value in the united_states a7 - unreasonably low using a beta greater than would increase the discount rate used in the fuller analysis thereby decreasing the value otherwise computed we do not believe that an investment in peoples a small single-location bank whose earnings were susceptible to impending interest rate mismatches and sluggish local economic conditions presents the same systematic risk as an investment in an index fund holding shares in of the largest corporations in the united_states in calculating the discount rate mr fuller used an equity risk premium of percent based on the average share of common_stock of publicly traded companies and cited ibbotson we think that mr fuller meant ibbotson's long-horizon equity risk premium which represents the total returns of large company stocks less the long-term risk-free rate which is widely used in calculating a cost of capital under capm although mr fuller cited ibbotson as his source for equity risk premium in his initial report he ignored a crucial aspect of the ibbotson approach to constructing a cost of capital----the small stock premium in his rebuttal report mr fuller unsuccessfully tried to persuade us that the small stock premium is not supported by financial theory characterizing the risk associated with a firm's size as unsystematic risk for which the market does not compensate the relationship between firm size and return is well known size is not an unsystematic risk factor and cannot be eliminated through diversification on -- - average small companies have higher returns than large ones ibbotson pincite citing banz the relationship between returns and market_value of common_stock j fin econ we have already alluded to the likelihood that small stocks will have higher betas than larger stocks because of greater risk see ibbotson pincite however it has been found that the greater risk of small stocks is not fully reflected by capm in that actual returns may exceed those expected based on beta see id consequently when calculating a cost of capital under capm on a small stock it is appropriate to add a small stock premium to the equity risk premium to reflect the greater risk associated with an investment in a small stock in comparison to the large stocks from which the equity-risk premium is calculated based on peoples' size a microcapitalization equity size premium of percent should have been added see ibbotson pincite consequently even if we accepted mr fuller's beta of which we do not peoples' cost of capital should have been at least percent b guideline company method the market approach used by mr fuller was the guideline company method guideline method under the guideline method there are actually three different premiums the mid- capitalization equity size premium capitalization between dollar_figure and dollar_figure million the low-capitalization equity size premium dollar_figure million to dollar_figure million and the microcapitalization equity size premium capitalization below dollar_figure million --- - value measures are developed using the stock prices of similar companies guideline companies that are publicly traded the value measures are then compared to the subject company’s fundamental data to reach an estimate of value for the subject company or its shares because value under the guideline method is developed from the market data of similar companies the selection of appropriate comparable companies is of paramount importance mr fuller’s principal criterion for selecting guideline companies was geography rather than size financial or operating characteristics all seven of the guideline companies selected operated primarily in indiana illinois and ohio as in the dcf analysis mr fuller adjusted the values of peoples' equity and assets to adjust the book egquity-to-assets ratio to percent and made an adjustment to earnings mr fuller then calculated the median price-to-earnings multiple price-to-assets ratio percent and price-to-book equity ratios of the guideline companies percent after calculating a value from operations using the ratios mr fuller added back the excess egquity value reduced by a 10-percent minority discount to find the total value of peoples' equity applying the ratios to the adjusted equity assets and earnings the price-to-earnings multiple used by mr fuller was based on the most recent four quarters' earnings for each corporation -- - figures of peoples mr fuller determined the following total equity values ratio total value price-to-earnings dollar_figure price-to-book equity big_number price-to-assets big_number mr fuller then used the mean of the values determined using the price-to-book equity and price-to-assets ratios to determine a total equity value of dollar_figure he did not include the value determined using the price-to-earnings ratio as he thought the unusually high earnings reported for the period may result in the value of peoples being overstated finally mr fuller applied a 10-percent marketability discount mr fuller supported his finding of a 10-percent marketability discount in his discussion of both marketability and control premium factors he concluded that little or no marketability discount was appropriate because the estate shares carried significant elements of control and might command a control premium mr fuller failed to focus on the fact that two conceptually distinct adjustments were involved one a discount for lack of marketability and the other a premium for the benefits of control see 79_tc_938 although there may be some overlap because control or lack of it is a factor that may affect marketability even controlling shares in a nonpublic corporation - - can suffer from lack of marketability because of the absence of a ready private_placement market and the costs of floating a public offering see id pincite we agree with mr fuller's use of the guideline method and his adjustments to reflect excess capital however we do not think that his selection of guideline companies was appropriate in light of peoples' thriftlike operations and earnings base five of the seven guideline companies selected by mr fuller were bank holding_companies engaged in a broad range of personal and commercial banking services only two of the guideline companies chosen were thrifts and like most of the other guideline companies they were multibranch institutions that had significantly greater assets than peoples though not by the same order of magnitude as the banks on the vl bank list on its date balance_sheet peoples reported total assets of dollar_figure million in comparison the mean and median total asset values of the guideline companies were dollar_figure million and dollar_figure million respectively for the comparable period ’ petitioner's expert petitioner relies on the expert report of james e magee a director and senior associate of alex sheshunoff co investment banking asc headquartered in austin texas asc is nationally mr fuller provided asset values for six of the guideline companies as of date and for the seventh as of date - - known for its valuation and mergers and acquisitions expertise in the financial services industry and has been recognized as an expert by federal banking regulators including fdic federal reserve bank frb office of the comptroller of the currency o c and ots asc has completed over merger and acquisition transactions and over big_number stock valuations involving regional and community banks and thrifts mr magee has over years of experience in the banking industry in the first half of his career mr magee worked in management positions at two new york banks including one money center bank where he wass a vice president and as a regulator employed by the board_of governors of the federal reserve system division of supervision and regulation the latter half of mr magee's career has been spent as an appraiser and consultant serving the banking industry exclusively mr magee holds an m b a in finance from adelphi university in new york using the guideline method mr magee valued the estate shares at dollar_figure dollar_figure per share while employing the same general approach as mr fuller there are a number of differences in mr magee's report that account for their substantial differences of opinion regarding the fair_market_value of the estate shares mr magee's methodology for selecting guideline companies was significantly more exacting than mr fuller's as discussed supra mr fuller's guideline companies included five banks and two thrifts most of which were significantly larger than peoples in contrast mr magee's selection criteria were -- - limited to thrifts comparable in size to peoples the emphasis on thrifts rather than banks is in accordance with our finding that peoples while legally chartered as a bank more closely resembled a thrift in its operations as discussed supra the guideline company data used by mr fuller was based on publicly traded minority interests mr magee in contrast used two groups of guideline companies one based on mergers and acquisitions of private companies the other based on publicly traded minority interests like that used by mr fuller mr magee looked at both minority and control transactions because he conceded that the estate shares had effective_control to examine thrift pricing on a control basis mr magee selected six thrifts the control group meeting the following criteria thrifts that sold in the midwest return on average assets greater than percent total assets less than dollar_figure million and transactions that were pending or completed between january and date in order to examine thrift pricing on a minority basis mr magee selected thrifts the minority group meeting the following criteria thrift organizations in the united_states total assets less than dollar_figure million not subject_to announced or rumored acquisition and publicly_traded_securities as evidenced by listing on a major exchange or trading market comparison of the experts' reports in performing their analyses under the guideline method messrs fuller and magee both focused on the same three ratios -- -- price-to-earnings price-to-book equity and price- to-assets however they disagreed to some extent on the weight to be accorded each of the three ratios as discussed supra mr fuller used an equal weighting of the values derived using the price-to-book and price-to-assets ratios while rejecting the use of the price-to-earnings ratio over concerns that it would overstate value mr magee used an equal weighting of the values found using the price-to-earnings multiple and the price-to-book ratio mr magee did not use the price-to-assets ratio in reaching his valuation conclusion and described it as a check point for the other two ratios rather than as the principal determinant of the value of a controlling_interest however mr magee noted the price-to-assets ratio does provide additional stability to the analysis by removing the effects of variability in earnings and book equity we agree with mr fuller that the use of the price-to- earnings ratio may overstate the value of the estate shares due to the fact that a large portion of peoples earnings was attributable to investments in high yielding treasury securities we also think the weighted average of the price-to-book and price-to-asset ratios will be more likely to cancel out any anomaly in the data for either ratio accordingly in valuing the estate shares under the guideline method we look to the price-to-book and price-to-asset ratios the mean median high and low values for the guideline companies examined by messrs fuller and magee are as follows -- - guideline method ratios price earnings price book price assets multiple ratio ratio fuller mean dollar_figure median dollar_figure dollar_figure dollar_figure high dollar_figure dollar_figure dollar_figure low dollar_figure dollar_figure dollar_figure magee control mean dollar_figure dollar_figure dollar_figure median dollar_figure dollar_figure dollar_figure high dollar_figure dollar_figure dollar_figure low dollar_figure dollar_figure dollar_figure minority mean dollar_figure dollar_figure n a median dollar_figure dollar_figure dollar_figure high dollar_figure dollar_figure dollar_figure low dollar_figure dollar_figure dollar_figure based on the data of their respective guideline companies messrs fuller and magee chose the following ratios to value the estate shares guideline method ratios used in valuing the estate shares price earnings price book price assets fuller magee not used calculated but not used in actual valuation differences in perception are common in questions of valuation the differing ratios chosen by messrs fuller and magee to value the estate shares reveal an extreme divergence of views all three ratios used by mr fuller exceed the respective -- - mean and median of the guideline companies both the price-to- earnings multiple used but ultimately ruled out and the price- to-book equity ratio are near the highest values in the guideline company data in contrast the price-to-earnings multiple and price-to-book ratios selected by mr magee are comparable to the mean values from the minority group data while there is little difference in mr fuller's guideline company data and mr magee's control group data we think that mr magee's criteria for the selection of comparable companies produced a group of companies that more closely resembled the size and operating characteristics of peoples than mr fuller's guideline companies accordingly in determining the value of the estate shares under the guideline method we rely on the data supplied by mr magee mr magee did not however address peoples' overcapitalization and unlike mr fuller did not make any normalizing adjustments in contrast as discussed supra mr fuller removed excess equity valued equity from operations and then added back the excess equity adjustments to equity were necessary to value peoples properly and we think mr fuller used a sensible approach in so doing accordingly in valuing the estate shares we use adjusted equity and assets of dollar_figure and dollar_figure respectively for purposes of the guideline method and dollar_figure in excess equity before discounts - we also differ with mr magee on his use of ratios that more closely resemble the minority group data than the control group data inasmuch as the estate shares had effective_control we think that they should be valued as a controlling rather than minority interest accordingly we value the estate shares using the control group data we disagree with mr fuller's optimistic assessment of peoples' standing among comparable institutions or the less-- than-comparable institutions he used had we not removed the excess equity in performing the guideline method then perhaps peoples would be more attractive than its financials would otherwise suggest due solely to the value of excess equity which could be paid out as an extraordinary_dividend however when using the guideline method to value peoples' equity from operations and adding back the excess capital we think that the attractiveness of peoples and of the estate shares takes a dramatic nosedive as an institution peoples was financially sound but offered an investor little hope of meaningful growth in revenues or earnings a number of negative factors have been discussed supra such as a limited market limited product offerings aggressive competitors and outdated technology peoples was also hindered by its employees who on average were at least in their midfifties and tended to resist change in sum we think that peoples showed little potential to be much more than what it - -- was on the valuation_date we therefore think it appropriate to value peoples as an enterprise at the low end of the control group accordingly for purposes of valuing the estate shares we use a price-to-book ratio of percent and price-to-assets ratio of percent based on adjusted shareholder equity of dollar_figure dollar_figure per share and adjusted assets of dollar_figure dollar_figure per share we find a value of equity used in operations of dollar_figure dollar_figure per share using the price-to-book ratio and dollar_figure dollar_figure per share using the price-to- assets ratio averaging the two ratios we find a value of equity from operations of dollar_figure dollar_figure per share we agree with mr fuller's application of a 10-percent minority discount to the excess equity and accordingly add dollar_figure dollar_figure per share of excess equity from nonoperating assets to the value of equity from operations producing a fair_market_value of total equity of dollar_figure dollar_figure per share accordingly we hold that the fair_market_value of big_number shares of peoples stock before consideration of marketability concerns is dollar_figure mr magee distinguished the estate shares from the shares of publicly traded companies due to their lack of marketability in support of his application of a 30-percent marketability discount mr magee cited several empirical studies that on dollar_figure x big_number dollar_figure --- - average support the application of marketability discounts in the range of to percent mr magee analyzed several factors with respect to the marketability of the estate shares such as earnings quality dividend payment history size of the block of stock prices of comparable investment substitutes management's stock_redemption policies capitalization of the firm and economic factors in his analysis he noted certain factors in support of a discount including peoples' interest rate risk the sewer tap ban and the modest economic growth in peoples' market area mr fuller also emphasized the lack of liguidity in peoples stock which was not subject_to any repurchase or employee stock_option plan and was not easily sold as evidenced by the fact that a block of shares had been offered and available for sale for more than years without eliciting any expressions of interest while we recognize that elements of control may enhance marketability we do not think that the estate shares were rendered marketable by virtue of their effective_control no matter who was in control peoples was still a small community bank with limited growth opportunities capitalized with common_stock that was not publicly traded and not easily sold privately a buyer of the estate shares would either have to sell the block privately cause peoples to make a public offering or seek an acquiror any of those three options could take a number of months and require significant transaction - - costs for the services of accountants lawyers and investment bankers accordingly although we recognize the estate shares' effective_control in valuing peoples equity from operations we do not think that a 97-percent interest ina small closely held bank is a readily marketable interest accordingly we apply a 30-percent marketability discount to the fair_market_value of the estate shares and hold that on the valuation_date the estate shares had a fair_market_value of dollar_figure dollar_figure per share to give effect to the concessions of the parties and our determination of the fair_market_value of the estate shares decision will be entered under rule


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc psi b03 plr-100312-03 date date legend x a d1 state dear this letter responds to a letter dated date and subsequent correspondence written on behalf of x by x’s authorized representative requesting a ruling under sec_1362 of the internal_revenue_code facts the information submitted provides that x was incorporated under state law on d1 a x’s sole shareholder intended for x to be treated as an s_corporation from d1 the minutes of the organizational meeting for x and the form ss-4 application_for employer_identification_number filed by x indicate that it was intended that x would elect to be an s_corporation x retained a tax advisor to aid with its s election however the tax advisor retained by x failed to file a form_2553 election by a small_business_corporation plr-100312-03 taxable_year beginning d1 x filed a form_1120s u s income_tax return for an s_corporation for its law and analysis sec_1362 provides that except as provided in sec_1362 a small_business_corporation may elect to be an s_corporation sec_1362 provides that such election shall be effective for the current taxable_year if it is made during the preceding_taxable_year or before the 15th day of the third month of the current taxable_year sec_1362 provides that an election made after the 15th day of the third month of the current taxable_year shall be treated as having been made for the following taxable_year sec_1362 provides that if an election under sec_1362 is made for any taxable_year determined without regard to sec_1362 after the date prescribed by sec_1362 for making such election for such taxable_year or no such election is made for any taxable_year and the secretary determines that there was reasonable_cause for the failure to timely make such election then the secretary may treat such an election as timely made for such taxable_year and sec_1362 shall not apply conclusion based on the facts submitted and representations made we conclude that x has established reasonable_cause for failing to make a timely s election thus we conclude that x is eligible for relief under sec_1362 accordingly if x makes an election to be an s_corporation by filing with the appropriate service_center a completed form_2553 containing an effective date of d1 within days of the date of this letter then such election shall be treated as timely made for x’s taxable_year beginning d1 a copy of this letter should be attached to the form_2553 filed with the service_center except as specifically set forth above we express or imply no opinion concerning the federal tax consequences of this case under any other provision of the internal_revenue_code specifically we express or imply no opinion on whether x is eligible to be an s_corporation plr-100312-03 this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office we are sending a copy of this letter to x’s authorized representative sincerely yours s james a quinn senior counsel branch office of the associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes