third party communication none date of communication not applicable cca_2014012915472096 id uilc number release date from sent wednesday date pm to cc bcc subject re --case - counsel timeframe greetings ---------- - the issue raised is whether the dividend_equivalent units are considered part of the restricted_stock units rsus or are considered a separate plan rsus are not stock and thus are not entitled to dividends in and of themselves also under the taxpayer’s agreement with the employee the employee can never receive stock only cash from the rsus the employment agreement provides that the dividend_equivalent payments are intended to be a benefit in addition to the rsus and the dividend_equivalent payments are subject_to different payment terms than the rsus the dividend_equivalent payments are made at the same time as dividends are paid and are not deferred unlike the rsus thus the dividend_equivalent payments should be considered as a separate benefit apart from the rsus for federal_insurance_contributions_act fica purposes the dividend_equivalent benefits are properly viewed as not a nonqualified_deferred_compensation_plan but subject_to federal_insurance_contributions_act fica_taxes as and when paid sec_31_3121_v_2_-1 related to the definition of nonqualified_deferred_compensation_plan for fica purposes provides that a plan provides for deferral of compensation with respect to an employee only if under the terms of the plan and the relevant facts and circumstances the employee has a legally binding right during a calendar_year to compensation that has not been actually or constructively received and that pursuant to the terms of the plan is payable to or on behalf of the employee in a later year the regulations also state that an employee does not have a legally binding right to compensation if that compensation may be unilaterally reduced or eliminated by the employer after the services creating the right to the compensation have been performed the taxpayer is not required to pay any amount of dividend_equivalent payments if there are no dividends_paid and dividends_paid are at the discretion of the taxpayer a privately held company thus the dividend_equivalent benefit is not a nonqualified_deferred_compensation_plan for fica tax purposes and the dividend_equivalent payments are simply fica wages on the date paid example in sec_31_3121_v_2_-1 of the regulations which was cited by the taxpayer is not inconsistent with this conclusion this example refers to an account_balance_plan that is increased in value each year by the total return on employer n’s publicly traded common_stock that example does not apply to the dividend_equivalent payments paid_by the employer in this case the employer is a private company and the dividend_equivalent plan is separate from the restricted_stock units the dividend_equivalent unit payments are made as the dividends are paid rather than as part of the deferral of the restricted_stock units the dividend_equivalent payments are in contrast to an account_balance_plan where the total dollar amount deferred in the account is increased annually by the total return on a specific publicly-traded common_stock that example is not germane to the current fact situation i hope this is helpful please let me know if i can be of further assistance ---------


t c summary opinion united_states tax_court fedor ratnikov petitioner v commissioner of internal revenue respondent docket no 3770-07s filed date fedor ratnikov pro_se justin d scheid for respondent goldberg special_trial_judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect at the time the petition was filed pursuant to sec_7463 the decision to be entered is not reviewable by any other court and this opinion shall not be treated as precedent for any other case unless otherwise indicated subsequent section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure the sole issue for decision is whether salary payments petitioner received during and from rutgers university are exempt from federal_income_tax under the convention for the avoidance of double_taxation u s -russ date tax_treaties cch par treaty background some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference petitioner resided in illinois when he filed his petition for at least three decades rutgers the state university of new jersey rutgers has received grants from the national science foundation nsf and has contributed its own funds to send personnel predominantly faculty and students to conduct research in elementary particle physics at fermi national accelerator laboratory fermilab near batavia illinois close to chicago a significant feature of fermilab is the tevatron a powerful particle accelerator miles in circumference on date at the invitation of rutgers petitioner a citizen of the russian federation entered the united_states under exchange visitor status on a j-1 visa petitioner’s entrance document from the united_states information agency shows that he was joining an existing rutgers research program as a postdoctoral research scholar in the area of high- energy experimental physics to promote the general interests of international education and cultural exchange the document signed by the associate director of rutgers’s center for international faculty and student services notes that rutgers agreed to pay petitioner dollar_figure for the first year of research date to date and that petitioner had not secured funding from any other source petitioner promptly began conducting research for rutgers at fermilab and settled nearby one year later petitioner’s wife joined him in the united_states and she began working directly for fermilab throughout the years at issue they continued to reside in illinois and continued to work at fermilab in date petitioner began employment with the university of maryland college park however he continued to reside near and conduct research at fermilab rutgers maintained petitioner’s appointments at fermilab through annual 1-year employment contracts in a letter dated date rutgers’s dean of educational initiatives offered to hire petitioner for date through date at the rank of research associate in the department of physics and astronomy in the faculty of arts and sciences the letter states that rutgers’s hiring is a grant-funded appointment contingent on the availability of funds to support it the dean enclosed with the letter a copy of rutgers’s faculty employment agreement for petitioner to sign petitioner had no teaching responsibilities rutgers provided petitioner with its standard vacation sick leave and retirement benefits rutgers’s grant proposal to nsf for the 3-year period starting date consisted of four main ongoing projects and the completion of two earlier projects however because of nsf streamlining of proposal requirements rutgers combined the projects into one broad proposal entitled experimental research in elementary particle physics rutgers requested a total of dollar_figure from nsf based on annual requests of dollar_figure dollar_figure and dollar_figure the proposal noted that rutgers’s science faculty had requested their university to contribute about dollar_figure per year of its own funds to directly support the projects rutgers’s proposal listed senior physicists as leading its overall research effort of which petitioner was not one rutgers’s four main projects were the observation of the highest-energy cosmic rays with the fly’s eye detector operation and upgrade of the cdf collider detector at fermilab preparation of the cms compact muon solenoid for future operation at cern acronym for conseil européen pour la recherche nucléaire european organization for nuclear research and preparation of chemical-vapor-deposition diamond detectors for the cms although petitioner was not one of the senior physicists rutgers did list him in the technical detail section of the second main project the cdf operation and upgrade the detail listed in apparently the order of responsibility seven senior physicists one professional staff member five doctoral researchers including petitioner four graduate students and three undergraduate summer students the detail further highlighted five rutgers senior personnel who are key members of the leadership of the cdf collaboration including petitioner as follows postdoc fedor ratnikov heads the tau working group in cdf and has written the backbone of the tau finding and triggering code for the experiment the cdf project incorporated collaboration from about physicists from around the world specifically petitioner was responsible for leading a group of about people who were supporting the data handling for the tau particles reconstruction experiment this group made it possible for the experiment to store petabytes of data petitioner reported to dr terence watts the head of the rutgers cdf data handling group who was based in new brunswick new jersey but petitioner exercised independent discretion day to day and he presented findings at international conferences beijing in san diego in and samar the philippines in rutgers paid petitioner biweekly for and rutgers issued petitioner forms w-2 wage and tax statement reporting that petitioner had federal taxable wages tips other compensation of dollar_figure and dollar_figure respectively before preparing his federal_income_tax return petitioner consulted a certified_public_accountant c p a recommended by his colleagues the c p a advised petitioner that the treaty exempted petitioner’s first years of income from federal_income_tax because petitioner was receiving the payments from a governmental scientific or educational_organization and not from a private source on the c p a ’s advice petitioner filed his through tax returns excluding the rutgers payments from income for petitioner filed a form 1040nr-ez u s income_tax return for certain nonresident_aliens with no dependents reporting his filing_status as married filing separate and dollar_figure in nontaxable salary resulting in an overpayment equal to his withholdings of dollar_figure petitioner reported no other income deductions allowances or credits on page of the form petitioner fully disclosed that he was from russia the purpose of his visit was research in high-energy physics he had filed a form 1040nr-ez his income was exempt from federal_income_tax under article paragraph c of the treaty and he was not subject_to income_tax in russia for the income he was excluding in the united_states petitioner reported the payments from rutgers in a similar manner he filed a form 1040nr-ez reporting dollar_figure as nontaxable wages the only material difference from was that for petitioner reported dollar_figure in taxable wages which represented the final months of the payments because petitioner calculated that the 5-year exemption under the treaty ended on date after subtracting a personal_exemption of dollar_figure petitioner computed a tax of dollar_figure and netted the tax against his withholdings of dollar_figure yielding an overpayment of dollar_figure in the irs examined petitioner’s and tax returns the examiner determined that petitioner should have reported all of his salary from rutgers as taxable wages on the basis of the examiner’s findings the irs issued a notice_of_deficiency dated date determining deficiencies in income taxes of dollar_figure and dollar_figure for and respectively petitioner timely petitioned this court seeking redetermination of the deficiencies concurrently the irs issued a notice_of_deficiency to petitioner’s wife pertaining to her and tax returns in which she had similarly excluded her income from fermilab because of the treaty and filed using married filing separate status the irs again maintained its position that the treaty did not exclude her wages from federal_income_tax and issued a notice_of_deficiency petitioner’s wife also timely petitioned the court for redetermination of the deficiencies petitioner and his wife sent their petitions to the court in one envelope the court assigned docket no 3770-07s to petitioner’s petition and docket no 3771-07s to his wife’s petition subsequently petitioner and his wife established to respondent’s satisfaction that as a couple they were jointly entitled in and to dependency_exemptions for their two children and itemized_deductions in the following amounts dependency_exemptions real_estate_taxes home mortgage interest contributions dollar_figure big_number big_number dollar_figure big_number big_number -0- petitioner also established that he was separately entitled to deductions in and for state_income_tax that he had paid in amounts of dollar_figure and dollar_figure respectively however sec_6013 provides a limitation such that once an individual and his spouse have filed separate returns for a year and either spouse has petitioned the court after receiving a notice_of_deficiency from the commissioner then the spouses are precluded from filing a joint_return for that year the court heard petitioner’s case at a trial session in chicago the court did not hear petitioner’s wife’s case which was set for trial on the same calendar because she and respondent had reached a settlement agreement before trial on date the court entered an agreed decision in the petitioner’s wife’s case at docket no 3771-07s apparently the settlement provided that the petitioner’s wife’s wages from fermilab were taxable as income to her she was entitled to all of the dependency_exemptions for the two children for and and she was entitled to one-half of the above-mentioned joint itemized_deductions accordingly with respect to the exemptions and deductions for petitioner’s case the court ordered respondent and petitioner to enter into a supplemental stipulation of facts which the court filed on date the supplemental stipulation provided that petitioner is entitled to the following amounts dependency_exemptions personal_exemption real_estate_taxes home mortgage interest contributions state_income_tax -0- dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure -0- dollar_figure dollar_figure dollar_figure -0- dollar_figure consequently at trial respondent requested that the court enter its decision under rule to take into account petitioner’s entitlement to personal exemptions and itemized_deductions listed above discussion in general the commissioner’s determination set forth in a notice_of_deficiency is presumed correct and the taxpayer bears the burden of showing that the determination is in error rule a 290_us_111 under sec_7491 the burden regarding factual matters may shift to the commissioner if the taxpayer produces credible_evidence and meets the other requirements of the section petitioner did not argue for a burden shift and therefore the burden remains with him the role of the judiciary in interpreting tax_treaty provisions is to decide their underlying intent or purpose 120_tc_430 n w life assurance co of can v commissioner 107_tc_363 we therefore begin our analysis by examining the treaty itself the pertinent part of article students trainees and researchers provides as follows an individual who is a resident of a contracting state at the beginning of his visit to the other contracting state and who is temporarily present in that other state for the primary purpose of c studying or doing research as a recipient of a grant allowance or other similar payments from a governmental religious charitable scientific literary or educational_organization shall be exempt from tax by that other state with respect to payments from abroad for the purpose of his maintenance education study research or training and with respect to the grant allowance or other similar payments the exemption in paragraph shall apply only for such period of time as is ordinarily necessary to complete the study training or research except that no exemption for training or research shall extend for a period exceeding five years this article shall not apply to income from research if such research is undertaken not in the public interest but primarily for the private benefit of a specific person or persons treaty art tax_treaties cch par at big_number reviewing article we conclude that petitioner satisfies the requirements in that he was a resident of russia at the beginning of his visit to the united_states he was temporarily present in the united_states for the purpose of conducting research the payments came from a governmental scientific or educational_organization and he undertook the research for the public interest and not for private benefit the sole remaining issue then is whether under article paragraph c petitioner was the recipient of a grant allowance or other similar payments in a case with nearly identical facts the u s court of federal claims had to decide whether mr sarkisov a russian citizen was doing research as a recipient of a grant according to the meaning and application of that phrase as it appears in the treaty sarkisov v united_states aftr 2d ustc par big_number fed cl mr sarkisov had entered the united_states in from russia on a temporary basis on a j-1 visa to conduct research in physics optics spectroscopy for the university of nevada id pincite ustc par big_number at big_number on the entrance document mr sarkisov stated that he had financial support from no other sponsor id the university of nevada’s funding for the project came from several grants including grants from cornell university the department of energy and the u s navy id pincite ustc par big_number at big_number mr sarkisov was not a direct recipient of any of the grants and none of the grants specified that the funding depended on the university’s continued employment of mr sarkisov id the university paid mr sarkisov a salary and withheld federal_income_tax id pincite ustc par big_number at big_number mr sarkisov filed refund claims for through which the irs denied id mr sarkisov then commenced an action against the united_states in the court of federal claims for refunds contending that the salary payments were exempt under the treaty as grants for research pursuant to article c id in granting summary_judgment in favor of the united_states the court of federal claims while acknowledging that mr sarkisov met the basic requirements of the treaty held that his salary from the university of nevada was not exempt from federal_income_tax as a grant for the following reasons first the record was replete with references to mr sarkisov as an employee of the university but the record contained no references to mr sarkisov as a grant recipient id pincite ustc par big_number at big_number although mr sarkisov’s employment contract emphasized that the university made his hiring contingent on the university’s receiving grant funding the court found that the university incorporated the contingency into the contract simply to protect itself against a shortfall of funds for research which in no manner converted mr sarkisov’s salary into a grant id second although mr sarkisov argued that in the modern environment grantors make grants to universities not to individuals the court held that treaty terms are matters for contracting states to address not the judiciary id third the term grant carries a special meaning and the court concluded that it would create unintended benefits to parties outside the scope of the treaty’s language to interpret the term so broadly as to incorporate all payments to researchers including a monthly salary as a grant id pincite through ustc par big_number at big_number now we compare the facts in petitioner’s case with those in sarkisov v commissioner supra first many documents in the record such as the faculty employment agreement and the forms w-2 refer to petitioner as an employee receiving a salary the year rutgers grant proposal of about pages mentions petitioner only briefly as leading one of the subprojects never as leading one of the main projects and not as a senior physicist we believe petitioner and his colleagues when they say petitioner performed well and that rutgers could not have proceeded on the cdf data-handling without his participation petitioner led a team of people and gave international presentations however he reported to another physicist who rutgers listed as one of the senior physicists on the cdf project similarly the court received into evidence annual nsf grant approval letters for citing the names of other rutgers physicists but not petitioner further and importantly petitioner himself acknowledged that without his presence rutgers’s other nsf projects would have continued and rutgers might have substituted a different subproject in its grant request in summary we find first that rutgers conditioned petitioner’s employment on rutgers’s receipt of funding from the nsf but critically rutgers’s nsf funding was not contingent on petitioner’s participation second if the modern funding environment has shifted to providing grants to universities instead of to individuals we agree with the court of federal claims that the contracting states have the responsibility to modify their treaty terms if they choose not the judiciary third in accord with the court of federal claims we too recognize that the term grant has a precise meaning we likewise hold that it would be overly broad to construe all payments for research as a grant in summary we hold that petitioner was not the recipient of a grant allowance or other similar payments under article paragraph c of the treaty between the united_states and the russian federation as a result the salary that petitioner received during and from rutgers is includable in income to reflect our disposition of the issues decision will be entered under rule


t c memo united_states tax_court johann t and johanna hess petitioners v commissioner of internal revenue respondent docket no filed date timothy c frautschi and maureen a mcginnity for petitioners george w bezold and mark j miller for respondent memorandum findings_of_fact and opinion ruwe judge respondent determined a deficiency of dollar_figure in petitioner johann hess’s federal gift_tax for taxable_year respondent also determined a deficiency of dollar_figure in petitioner johanna hess’s federal gift_tax for taxable_year the issue for decision is the fair_market_value under section of shares of stock in a certain company hess industries inc that mr hess gave to an irrevocable_trust for the benefit of his daughter findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference at the time of filing the petition petitioners resided in granger indiana petitioners are husband and wife petitioners owned stock in hess industries inc hii hii is a closely_held_c_corporation which was formed in date hii through its subsidiaries primarily manufactures metal processing machines and automation systems for the automotive industry the industry in which hii and its subsidiaries operates is cyclical hii’s principal customer markets automotive and steel processing are also cyclical hii relies heavily on long-term_contracts for special machines that take more than a year to complete it builds special machines often one-of-a-kind hii acquires its business on the basis of bids hii’s sales and earnings are erratic and not readily predictable hii operates on a fiscal and taxable_year ending on july of each year through hii accounted for its sales on a 1all section references are to the internal_revenue_code in effect for the taxable_year in issue and all rule references are to the tax_court rules_of_practice and procedure completed contract basis meaning a sale is not booked until percent of the costs of the contract are expended and the equipment is substantially complete as of date hii held stock in four subsidiaries hess engineering inc hei capital technologies hess mae and x-cel steel fabricating hei is a wholly owned subsidiary of hii it is hii’s largest subsidiary and it operates as a consulting engineering firm engages in the business of designing special machines and also manufactures equipment for the steel wheel and metal process industries capital technologies the second largest subsidiary builds tools and dies for the automotive and appliance industries and also builds factory automation systems for the automotive industry hess mae builds straightening machines and spin-forming lathes x-cel steel fabricating fabricates and supplies steel weldments and burnouts for the machine building industries including hii’s affiliates in date hei hired fritz kucklick as vice president of sales and service mr kucklick had previously worked with mr hess at grotnes machine works where mr hess was the director of engineering and mr kucklick was a project engineer mr kucklick assumed responsibility at hei for application engineering preparation of quotations cost estimates and 2between and hii made a number of acquisitions and the company grew to employees customer presentations and service mr hess’s responsibilities were product design purchasing production oversight and general management from the outset of mr hess’s and mr kucklick’s discussions regarding hei’s employment of mr kucklick they agreed that mr kucklick would have the opportunity to purchase stock to become an owner in hei mr kucklick entered into an employment agreement which gave him the option to purchase up to percent of hei stock in mr kucklick purchased shares of hei stock at that same time mr kucklick and mr hess entered into an agreement to exchange all of their shares of hei stock for an equal number of shares of hii stock mr kucklick then became an officer and director of hii from to mr kucklick had primary responsibility for both hei’s and hii’s customer relationships he was the point man for all domestic and international customers traveled extensively and got to know the customers personally mr kucklick was also intimately involved in establishing pricing formulas mr hess mrs hess mr kucklick and hii executed a stockholders agreement the stockholders agreement dated date the stockholders agreement restricted the transfer of hii’s stock by the shareholders it provided a right_of_first_refusal in favor of hii and the other shareholders before a shareholder could transfer his or her stock the agreement also provided regarding the purchase_price d determination of purchase_price except as otherwise provided in this agreement the corporation and each stockholder agree that the purchase_price per share for the shares of any stockholder sold and purchased pursuant to this agreement shall be i in the case of a bona_fide offer by a third party the price offered by the prospective purchaser named in the offer to sell the offer price or ii in all other circumstances the adjusted_value per share determined pursuant to sub sec_2 d hereof adjusted_value per share the adjusted_value per share is equal to x divided by y where x is an amount equal to the greater of i eight times the average earnings_of the corporation before taxes for the corporation’s three most recent fiscal years ending on the valuation_date as determined in accordance with generally_accepted_accounting_principles consistently applied or ii two times the net_worth of the corporation as of the valuation_date determined in accordance with sub sec_2 d hereof and y equals the number of issued and outstanding shares of common_stock of the corporation as of the valuation_date the agreement provided however that hii and its stockholders could agree in writing among themselves to a specified value per share to govern purchases for the time period specified in the written_agreement the initial employment agreement with mr 3the stockholders agreement was applicable only in the continued kucklick contained a covenant by mr kucklick not to compete with hei during the term of his employment and for years thereafter at any location within a 300-mile radius of south bend indiana this 2-year covenant_not_to_compete remained in effect under the stockholders agreement in the time frame approximately percent of hii’s overall sales and percent of its overall earnings were attributed to hei in mr kucklick became president of hei and was responsible for the management and operation of that subsidiary at that time mr hess’s responsibilities shifted to hii’s other subsidiaries customer relationships continued to be one of mr kucklick’s major strengths and he remained very involved in sales for hei he was recognized as one of the foremost experts in the field of wheel-making manufacturing and under his leadership hei had received a number of prestigious awards in the second half of mr kucklick told mr hess that he wanted to sell his shares of hii stock and plan for his retirement in date mr hess and mr kucklick continued limited circumstances identified in the agreement one of the principal circumstances identified in the agreement was the death of one of the shareholders in that circumstance the shareholder’s heirs or estate would receive a put to the corporation for the formula price stated in the agreement personally negotiated the basic terms of a transaction4 whereby a hii would redeem mr kucklick’s stock b mr kucklick would enter into an employment agreement c mr kucklick agreed to a covenant_not_to_compete and d mr kucklick would be paid dollar_figure million the price to be paid in this transaction was not determined by and did not involve an appraiser and it was not determined by reference to the pricing formula in the stockholders agreement on date mr hess and mr kucklick contemporaneously entered into three formal agreements to memorialize the terms of their deal a redemption agreement the redemption agreement an employment agreement the employment agreement and an unsecured installment note the installment note the redemption agreement provided for the redemption of mr kucklick’s shares and included the covenant_not_to_compete and 4mr hess and mr kucklick were not represented by attorneys until the basic terms of this transaction were put into writing 5in agreeing to pay this amount mr hess testified that he took into consideration mr kucklick’s longstanding years service contributions and self-sacrifice toward the growth and success of the company mr kucklick’s belief that he had overpaid for shares relative to mr hess’s investment and mr hess’s desire to make a payment that was fair to mr kucklick on which he could live comfortably and that the company could afford 6on date mr hess held shares mrs hess held shares and mr kucklick held shares of the outstanding_stock of hii mr kucklick’s agreement to enter into an employment agreement the redemption agreement required hii to pay mr kucklick dollar_figure million at closing and to deliver the installment note in the principal_amount of dollar_figure for the balance a total_payment of dollar_figure the redemption agreement terminated the stockholders agreement the redemption agreement contained an 8-year worldwide covenant_not_to_compete the 8-year covenant to commence after mr kucklick retired from hii and its subsidiaries the duration and the scope of the 8-year covenant were very important provisions to mr hess and hii mr hess believed that the year covenant was important to him because mr kucklick was still relatively young and with his knowledge and contacts he could set up a competing company he could consult and he could be a partner in or work for another company mr hess believed that without the 8-year covenant mr kucklick could have done considerable damage to hii perhaps resulting in millions of dollars in lost profits in a relatively short time period with respect to the duration of the 8-year covenant mr kucklick originally wanted it to cover the period of his employment and years thereafter the same duration as the 7mr hess derived the total_payment by reducing his dollar_figure million offer to reflect an increase in the interest rate for the installment note 8mr kucklick was approximately years old in parties’ previous agreements mr hess on the other hand insisted that the covenant extend years after the termination of mr kucklick’s employment with respect to the scope of the covenant mr kucklick originally wanted to be able to sell technical consulting services to rim wheel or ring manufacturers worldwide other than direct competitors of hii mr kucklick also proposed that the covenant_not_to_compete apply only to machinery not machine tools and only to the extent that hii was manufacturing such machinery as of the termination of mr kucklick’s employment in contrast mr hess insisted that mr kucklick disclose in advance the nature and duration of his proposed consulting services and that hii retain the right to veto any such agreement he also insisted on a much broader worldwide covenant_not_to_compete covering all products manufactured or marketed by hii or any of its subsidiaries the restrictions that mr hess insisted upon were reflected in the redemption agreement the employment agreement provided that mr kucklick would work full time for hii for years at a base salary of dollar_figure per year mr kucklick would continue as president of hei subject_to hii’s discretion to reassign him mr kucklick retired from his employment with hii and its subsidiaries in after he completed the 3-year period specified in the employment agreement the installment note obligated hii to pay the principal of dollar_figure in equal quarterly installments with interest accruing pincite percent the 5-percent interest rate specified in the installment note was below the prevailing market rate of percent the note was for a period of years mr hess and mr kucklick treated the redemption the employment agreement and the 8-year covenant as a package deal they did not separately negotiate the value of mr kucklick’s shares and the value of the 8-year covenant nor did they ever discuss making any separate payment for or allocation of the amount_paid for that covenant the redemption agreement which was executed on date did not specifically allocate any of the purchase_price to the 8-year covenant and it did not provide for separate consideration it provides therefore in consideration of the mutual agreements and covenants set forth herein the sufficiency of which consideration is expressly acknowledged the parties agree as follows redemption of shares at the closing on the closing date kucklick will surrender to the corporation certificate number representing the shares and the corporation shall repurchase and redeem the shares for the consideration set forth below such repurchase is a complete redemption of all of the stock of the corporation owned by kucklick and is intended to qualify as a complete redemption pursuant to the provisions of sec_302 of the internal_revenue_code_of_1986 as amended payment for shares in full payment for the shares and in complete termination of kucklick’s entire equity_interest in the corporation at the closing on the closing date the corporation shall pay to kucklick the aggregate sum of dollar_figure the redemption price payable as follows a the sum of dollar_figure by check and b by delivery of the corporation’s unsecured installment note the note in the principal_amount of dollar_figure the note shall be in the form of exhibit a hereto hii and mr kucklick have consistently treated the price paid under the redemption agreement as paid exclusively for the shares of stock that were redeemed thus hii has treated the price paid as the cost of treasury_stock and mr kucklick has treated it as a capital_gain hii’s consolidated and consolidating financial statements for its years ended date and include projections for the years ending date through hii prepares financial projections as a normal practice to motivate its employees hii’s philosophy in establishing projections is to provide goals that will take a lot of effort to achieve the projections typically are made on the basis of information from the subsidiaries regarding outstanding quotations without considering customers’ price negotiations the projections typically cover a period of to months into the future however the projections that hii prepared for the years ending date and cover a period of years and are not made on the basis of input from hii’s subsidiaries the purpose of hii’s projections for to was to pump up the troops demonstrating to employees what they could earn in bonuses deferred income and profit sharing under a new plan if they worked hard hii had a lot of luck and everything fell into place hii’s projections historically have been unreliable particularly with respect to net_income because of the difficulty in predicting the costs to complete contracts for large custom machines hii’s projections were even more unreliable for the years through hii did not use the projections for purposes of analyzing cashflow to finance plant expansion instead it greatly reduced net_income in its cashflow analysis because it knew the goals in the projections probably would not be reached on paper hii had an outstanding year in exceeding by more than dollar_figure million its budgeted sales of dollar_figure million hii 9for example hii originally budgeted net_income for the fiscal_year ending date at dollar_figure for the first months of that fiscal_year its actual net_income was only dollar_figure hii made a midyear adjustment of budgeted net_income to dollar_figure its actual net_income for the fiscal_year ending date was dollar_figure only percent of the original budgeted net_income and percent of the midyear adjusted_net_income for the fiscal_year ending date hii budgeted first quarter net_income at dollar_figure it actually suffered a loss of dollar_figure for the first quarter for the first months of fiscal_year hii had a net_loss of dollar_figure as opposed to budgeted net_income of dollar_figure at the end of months hii had net_income of dollar_figure as compared with budgeted net_income for that period of dollar_figure for fiscal_year hii’s budgeted net_income was dollar_figure its actual reported net_income was dollar_figure million a shortfall of percent realized net_income of dollar_figure million as compared with budgeted net_income of dollar_figure million as of date the first quarter financial results for fiscal_year were available hii’s business plan for fiscal_year called for approximately dollar_figure million in revenue building upon the record year in hii actually realized only dollar_figure million in revenues for the first quarter further although hii had forecast an annual net profit of approximately dollar_figure million for fiscal_year it actually had a net_loss of dollar_figure for the first quarter on date mr hess gave shares of hii stock to an irrevocable_trust for the benefit of his daughter under sec_2513 petitioners elected to treat mrs hess as the donor of one-half of the gift of stock that mr hess had madedollar_figure petitioners filed form sec_709 u s gift and generation-skipping_transfer_tax return for their taxable_year the gift_tax returns that petitioners filed reported the fair_market_value of the hii stock to be dollar_figure per share at the time of the gift respondent issued gift_tax statutory notices of deficiency to mr hess and mrs hess for their taxable_year respondent determined that the value of the hii stock on date was dollar_figure per share 10immediately before the gift shares of hii stock were outstanding of which mr hess owned shares and mrs hess owned shares opinion this case involves the valuation for gift_tax purposes of shares of the outstanding_stock of a closely_held_c_corporation under sec_2501 a tax is imposed for each calendar_year on the transfer of property by gift during such calendar_year by any individual if the gift is made in property the value of the property at the date of the gift shall be considered the amount_of_the_gift sec_2512 the value of property for gift_tax purposes is the price at which the property would change hands between a willing buyer and a willing seller neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant factsdollar_figure sec_25_2512-1 gift_tax regs generally in valuing shares of a closely_held_corporation actual arm’s-length sales of stock in the normal course of business within a reasonable_time before or after the valuation_date are the best indicators of fair_market_value estate of 11the willing buyer and willing seller are hypothetical persons rather than specific individuals or entities and their characteristics are not necessarily the same as those of the donor and the donee 120_tc_358 the hypothetical willing buyer and seller are presumed to be dedicated to achieving the maximum economic advantage 706_f2d_1424 7th cir this advantage must be achieved in the context of market conditions the constraints of the economy and the financial and business experience of the corporation existing at the valuation_date 94_tc_193 andrews v commissioner 79_tc_938 dollar_figure however where actual sales prices are unavailable the value of the shares is determined by taking into account the company’s net_worth prospective earning power and dividend-paying capacity and other relevant factorsdollar_figure sec_25_2512-2 gift_tax regs see also revrul_59_60 1959_1_cb_237 these factors cannot be applied with mathematical precision and therefore the weight to be given to each factor must be tailored to account for the particular facts of each case estate of andrews v commissioner supra pincite as is often the case where the value of stock in a closely_held_corporation is at issue the separation in the values that the parties and their experts argue is substantial the gift_tax returns that petitioners filed reported the fair_market_value of a minority interest in hii stock as dollar_figure per sharedollar_figure in the 12since the same factors are used for gift and estate_tax purposes in determining the fair_market_value of property we cite both gift and estate_tax cases see 87_tc_78 estate of true v commissioner tcmemo_2001_167 13the regulations provide that some of the other_relevant_factors to consider are the goodwill 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 sec_25_2512-2 gift_tax regs 14the gift_tax values which petitioners reported on their continued statutory notices of deficiency issued to mr hess and mrs hess respondent determined that the fair_market_value of hii stock was dollar_figure per share on the date of the gift petitioners’ expert gregory s heebink concluded that the fair_market_value of hii stock was dollar_figure per share respondent’s expert eric engstrom concluded that the fair_market_value of hii stock was dollar_figure per sharedollar_figure we are not bound by the opinion of any expert witness and we may accept or reject expert testimony in the exercise of sound judgment 94_tc_193 further we are entitled to accept the opinion of one party’s expert over the opinion of the other party’s expert and we are also entitled to accept certain portions of the opinion of an expert while rejecting the remaining portions 120_tc_358 moreover the figure at which we arrive need not be directly traceable to specific continued gift_tax returns were made on the basis of an appraisal by gary g gaynor petitioners’ and hii’s accountant and tax adviser mr gaynor concluded that the fair_market_value of a minority interest in hii’s stock as of date was dollar_figure per share petitioners request that we consider mr gaynor’s conclusion because he was very familiar with hii’s business we do not consider mr gaynor’s conclusion in our determination of the value of the hii shares mr gaynor was not offered as an expert his report was not accepted as the report of an expert witness and he did not testify at trial 15respondent does not request that we find an additional deficiency on the basis of his expert’s conclusion testimony if it is within the range of values that may be properly derived from consideration of all the evidence id after considering the parties arguments all the facts and circumstances relevant to this case and the opinions of petitioners’ and respondent’s experts we conclude that the fair_market_value of the shares of hii stock that mr hess gave to the trust falls somewhere in the middle of the range of values suggested by the parties and their expertsdollar_figure mr heebink’s expert opinion mr heebink arrived at a value of dollar_figure per share for the hii stockdollar_figure his valuation relied upon a discounted cashflow analysis and a market comparable analysis however as we explain in more detail below mr heebink’s valuation analysis relies upon an adjustment to hii’s financial information which resulted in a significant decrease in hii’s earnings figures for 16generally the commissioner’s determination of fair_market_value bears a presumption of correctness and the burden of proving that determination is incorrect rests with the taxpayer see rule a however in certain circumstances the burden_of_proof as to that determination shifts to the commissioner under sec_7491 petitioners do not argue that sec_7491 applies and the record does not disclose the date the examination commenced 17mr heebink prepared four reports for this case he determined the fair_market_value of hii shares as of date he prepared a supplemental report in which he addressed items that respondent’s expert relied upon in his report he valued hii shares as of date the date the redemption agreement was executed and he valued the 8-year covenant as of that date its fiscal_year since we conclude that this adjustment should not have been made mr heebink’s valuation analysis significantly understates the value of hii stock for hii’s fiscal_year mr heebink adjusted hii’s cost of sales upward and thus its earnings figures downward by approximately dollar_figure million he used this adjusted cost of sales in developing his cost of sales assumption for his discounted cashflow analysis and the adjusted earnings amount in his market comparable analysis this adjustment was made on the basis of information contained in a memorandum from personnel at hii to mr heebink regarding a purported overstatement of income attributable to an alleged understatement of reserves for expenses associated with machine construction projects for we cannot agree that mr heebink properly adjusted earnings to account for the alleged understatement petitioners have not established the existence of an understatement of reserves for the nature of the understatement or its amount we cannot conclude from the evidence presented that a hypothetical buyer or seller would have discovered or even considered the understatement of reserves in at the time of the gift indeed the memorandum from hii personnel that mr heebink relied upon in making the adjustment states rather equivocally dear mr heebink the actual income reported for was probably overstated based on additional costs incurred over amounts reserved on jobs reported as sold shipped at the end of the year we have attempted to quantify what those impacts might have been based on an outlook as of date in addition since the forecast was based on results that forecast was overly optimistic hii’s financial statement for was not restated to reflect the alleged understatement of reservesdollar_figure hii’s income_tax return for was not amended to reflect the alleged understatement hii had a substantial tax_liability for its fiscal_year hii reported taxable_income of dollar_figure and a total_tax of dollar_figure hii’s return was prepared by mr gaynor in or about date any additional expenses represented by the alleged reserves were deducted in later years the alleged understatement was not discovered by hii’s accountant gary gaynor in his appraisal of hii as of date and even petitioners admit that the alleged understatement 18petitioners allege that hii did not restate its financial statement for because bonuses and profit sharing had been paid to employees on the basis of the originally reported results and management did not want to penalize employees and destroy morale based on errors and misstatements by a few people petitioners also allege that hii did not want to incur the expense of redoing its financial statements and audits however petitioners do not explain how hii’s employees would have been affected by a restatement we are not satisfied that this factor and the expense of redoing the financial statements and audits fully explain hii’s failure to restate its financial statement considering the extent of the alleged understatement of reserves and the resulting overstatement of earnings was not quantified by hii management at the time of the giftdollar_figure petitioners fail to convince us that the alleged understatement was known or knowable as of the gift date further as a general_rule subsequent events are not considered in fixing fair_market_value except to the extent that they were reasonably foreseeable at the date of valuation 763_f2d_891 7th cir 88_tc_38 the record reflects that the alleged understatement was not discovered or quantified until almost years after the gift of hii stock and after the audit of petitioners’ gift_tax returns on the basis of the evidence in the record we are not convinced that the discovery of the alleged understatement was reasonably foreseeable on the gift datedollar_figure the adjustment proposed in the memorandum should not have been considered in valuing the hii stockdollar_figure making this 19petitioners allege that hii management informally recognized the understatement of reserves as of date but they had not quantified the amounts they allege that the understatement would have been discovered and quantified by an investor conducting due diligence as of the date of the gift we are not convinced that due diligence or any other investigation would have sufficiently disclosed the alleged understatement 20mr engstrom testified that in his opinion the adjustment was not foreseeable as of the valuation_date 21petitioners also allege that hii failed to follow the substantial completion accounting rules in booking its sales for ie it booked sales prematurely they claim that if continued adjustment resulted in a significant understatement of the value that mr heebink derived in his valuation analysis nevertheless we believe mr heebink’s valuation analysis is entitled to some consideration although his valuation analysis should not have included the adjustment for the alleged understatement of reserves that analysis provides some indication of the fair_market_value of hii stock mr heebink’s analysis was thorough and his investigation leading up to that analysis included a site visit and interviews with hii personnel mr heebink prepared additional reports to supplement his principal report further mr heebink’s valuation analysis unlike mr engstrom’s analysis gave consideration to an income-based method the discounted cashflow method generally in valuing the shares of an operating company such as hii primary consideration should be given to earnings see revrul_59_60 continued hii’s financial statement had been restated to correct these errors and to account for the understatement of reserves hii’s pretax income would have been reduced by approximately dollar_figure million petitioners fail to convince us that there was a premature booking of income or that the premature booking of income was known or reasonably foreseeable on the valuation_date further it does not appear that these alleged errors were identified until trial and mr heebink did not make any adjustments with respect to any premature booking of income in his reports these alleged errors were not discovered by mr gaynor hii’s financial statement for was not restated and its income_tax return for was not amended to reflect these errors sec_5 c b pincite however respondent argues that the discounted cashflow method should not be used where future income is unpredictable as with hii and the results of such an analysis provide little perhaps no indication of value and should be accorded like weight we agree that an income-based method such as the discounted cashflow method is not particularly reliable where the subject company’s future income is relatively unpredictable see wall v commissioner tcmemo_2001_75 pratt et al valuing small businesses and professional practices 3d ed petitioners agree that hii’s sales and earnings are erratic and not readily predictable given these circumstances we are not convinced that the value mr heebink derived under the discounted cashflow method is entitled to the weight that he gave to it however we believe mr heebink’s conclusions with respect to the discounted cashflow analysis are entitled to some considerationdollar_figure 22mr engstrom gave no weight to the discounted cashflow method because small changes in certain assumptions resulted in large changes in the value of hii shares indeed mr engstrom opined that if hii’s expenses were increased or decreased by percent of sales it would result in a dollar_figure per share increase or decrease in the value of hii shares he also opined that a percent increase in the discount rate would cause the implied value to go down by dollar_figure per share a 1-percent decrease in the discount rate would cause the implied value to go up by dollar_figure per share and a combination of a decrease in expenses by percent of sales and a 1-percent decrease in the discount rate would result in the implied value to go up by about dollar_figure per share as we explain later on we do not agree that this requires us to completely reject the discounted cashflow method continued another factor which makes mr heebink’s analysis less persuasive is his application of a minority interest discount to the total business_enterprise value he determined in his analysis a significant component of this total business_enterprise value is attributable to his market comparable analysis applying a minority interest discount to the market comparable analysis which already reflects transactions involving minority interests is inappropriate see estate of mitchell v commissioner tcmemo_2002_98 if the stock to be valued by the market approach represents a minority interest no discount for the lack of control is applied because the method reflects a minority interest we do not agree with respondent that mr heebink’s discounted cashflow analysis is entitled to no consideration we will consider mr heebink’s valuation analysis bearing in mind the circumstances identified above especially the fact that his analysis significantly understated the value of hii stock in making the erroneous adjustment for the alleged understatement of reservesdollar_figure continued in valuing hii stock however we agree that it detracts from the persuasiveness of mr heebink’s conclusions 23mr heebink does not present an alternative valuation which does not contain this adjustment however it is clear that this adjustment if corrected would bring mr heebink’s conclusions considerably closer to those of mr engstrom’s continued mr engstrom’s expert opinion mr engstrom concluded that the fair_market_value of a minority interest in the common_stock of hii as of date was dollar_figure per sharedollar_figure he relied upon four valuation methods and he applied varying weights to the per share values computed under those methods to arrive at the fair_market_value of dollar_figure per share valuation method per share value weight applied net asset value method dollar_figure prior stock transaction_method big_number stockholder agreement method big_number guideline public company method big_number continued indeed respondent points out that the adjustment for the alleged understatement accounts for the biggest difference between the values derived by mr heebink in his market comparable analysis and by mr engstrom in his guideline companies analysis respondent submits that without this adjustment hii’s debt-free earnings would have increased by approximately dollar_figure million dollar_figure million x 39-percent income_tax rate to a total of dollar_figure million dollar_figure dollar_figure million after applying his current earnings multiplier of to the dollar_figure million increase total enterprise value would have increased approximately dollar_figure million or dollar_figure per share before discounts and its per share value would have increased to dollar_figure after applying a 15-percent minority discount and a 30-percent marketability discount 24the report that mr engstrom prepared was the second report that philip schneider associates inc prepared for respondent the first report arrived at a value of dollar_figure per share the amount that respondent determined in the statutory notices of deficiency issued to petitioners we discuss these valuation methods in turn net asset value method mr engstrom used the net asset value method25 as an asset- based approach to his valuation of hii stock mr engstrom assumed that the book_value of hii’s assets and liabilities provided a reasonable approximation of fair_market_value he determined that the fair_market_value of the stockholders’ equity in hii was dollar_figure book_value on a controlling marketable basis as of date both parties agree that the value mr engstrom derived under the net asset value method provides some indication of the fair_market_value of hii stock on the gift date however they disagree regarding the weight to be given that value mr engstrom applied only 10-percent weight to his net asset value analysis because he concluded that hii is a very profitable company and it appears that the company had a significant amount of goodwill as of date petitioners argue that mr engstrom’s net asset value analysis supports the value they reported on their gift_tax returns and they suggest that the value derived under that analysis is entitled to more weight than was given in mr engstrom’s report 25the net asset value method is based upon the net value of a company’s assets less liabilities after adjusting both to fair_market_value using a going-concern assumption in valuing stock of a closely_held_corporation one of the factors to be considered is the book_value of the stock see revrul_59_60 sec_4 c c b pincite thus the value derived under the net asset value method is entitled to some weight in valuing hii stock however in deciding the relative weight to give to the net asset value in valuing a corporation we must consider the extent to which the company is actively engaged in producing income as opposed to simply holding property for investment see estate of andrews v commissioner t c pincite 53_f3d_924 8th cir if the company is an operating company as opposed to a holding_company the net asset value method should be accorded less weight see 87_tc_78 hii and its subsidiaries represent an ongoing business actively engaged in producing income as opposed to simply holding assets for investment hii was relatively profitable in the years leading up to the valuation_date indeed hii experienced a banner year in fiscal_year with dollar_figure million in sales and dollar_figure million in net_income the financial information for the prior fiscal years indicated that hii was a growing company and hii’s financial projections reflected that hii expected to expand upon its growth and profitability in the years that followed the gift under these circumstances the net asset value is not particularly reflective of the fair_market_value of hii stock although we agree with petitioners that the net asset value is entitled to some weight in valuing hii the net asset value method in this case fails to identify other elements of value in hii which we believe a hypothetical buyer and seller would have considered as of the gift date for example we are convinced that hii had a significant element of intangible value in its goodwilldollar_figure the essence of goodwill is a preexisting business relationship founded upon a continuous course of dealing that can be expected to continue indefinitely 99_tc_223 citing 64_tc_223 it is the value of a trade_or_business that is attributable to the expectancy of continued customer patronage 307_f2d_339 9th cir affg 35_tc_720 sec_1_197-2 income_tax regs respondent requests that we find as fact and petitioner agrees that hii acquires its business on the basis of bids without much continuing or recurring customer relationships petitioners point to this requested finding and suggest that hii did not have a significant amount of goodwill however petitioners also argue in the context of the redemption transaction and mr hess’s testimony makes clear that hii had established customer relationships through mr kucklick and mr kucklick could have exploited those relationships if he had left hii we find hii had a considerable element of goodwill or other intangible value see revrul_59_60 sec_4 f c b pincite while the element of goodwill may be based primarily on earnings such factors as the prestige and renown of the business the ownership of a trade or brand name and a record of successful operation over a prolonged period in a particular locality also may furnish support for the inclusion of intangible value stockholders agreement method mr engstrom relies upon the valuation formula contained in the date stockholders agreement as an indication of the fair_market_value of hii stock applying the valuation formula he determined that the value of the company was equal to dollar_figure million or dollar_figure per share as of date this amount represents the value he derived under the net_worth book_value formula ie the higher value derived under the formula in the stockholders agreement respondent argues that although the redemption agreement terminated the stockholders agreement the values derived under it reflect an agreed methodology for establishing fair_market_value between knowledgeable parties and as such are part of the facts and circumstances that may be taken into consideration in 27mr engstrom determined that the valuation formula would most likely be applied to transactions involving minority interests because the owner of a controlling_interest would most likely liquidate his ownership_interest through a sale of the entire company mr engstrom opined that the formula price times book_value contained built-in marketability and minority interest discounts we are not persuaded that this is the case the formula provision by its terms applies to both the majority shareholder mr hess and the minority shareholder mr kucklick in the circumstances specified in the agreement we also point out that mr engstrom applied discounts in his net asset value analysis respondent submits that the indicated value under the stockholders agreement would be dollar_figure dollar_figure x dollar_figure x if the discounts determined by mr engstrom were applied establishing valuedollar_figure mr heebink did not consider the formula in the stockholders agreement in his valuation analysis moreover petitioners contend that formula does not provide a reliable indicator of the fair_market_value of hii stock as of date a stockholders agreement which restricts the sale or transfer of stock is not determinative for gift_tax purposes however it is a factor to be considered with other_relevant_factors in determining fair_market_value revrul_59_60 sec c b pincite see also ward v commissioner supra pincite estate of lauder v commissioner tcmemo_1994_527 we agree that the stockholders agreement provides some indication of value however we are convinced the value derived under the formula provision is much greater than the fair_market_value of hii stock first the buy-sell_agreement upon which respondent’s expert relies was not in effect at the time of the gift that agreement was terminated as of the date of the redemption of mr kucklick’s shares on date no transactions ever occurred under the stockholders agreement 28mr engstrom testified that the valuation formula in the stockholders agreement just like a prior stock transaction would influence people’s opinion as to what the value of the stock is also the agreement was among mr hess mrs hess mr kucklick and hii it provided specific rights and obligations with respect to those shareholders it defined their relationship as shareholders and accounted for factors peculiar to that relationship although we disagree with petitioners’ contention that the agreement was not entered into at arm’s length we do agree that factors other than those factors that a hypothetical buyer might consider went into the agreement indeed mr hess testified on this point there were a couple of important points that took place at that time first of all my wife became--my wife johanna hess became a shareholder therefore she had to be included in a stockholder’s agreement secondly at that point the company had grown in size very substantially and in net assets we were able to afford to buy substantial life_insurance on mr kucklick’s and my lives--the company was able to and we wanted to make sure at that point in time that first of all both families would be taken care of in case of death of one of the partners and secondly also that any stock repurchase by the company under the agreement would be done in a very orderly fashion-- mr hess testified that the pricing formula allowed for a higher price in the case of death of one of the shareholders which could be funded in part with the life_insurance_proceeds it is also clear that the shareholders were not bound to the value per share derived under the formula provision since they could agree in writing among themselves to a specified value per share further the stockholders agreement was applicable only in the limited circumstances identified in that agreement principally if any of the three shareholders had died that shareholder’s heirs or that shareholder’s estate would have had a put to the corporation for the formula price under the agreementdollar_figure it is not at all clear whether the formula in the agreement applies to voluntary sales among shareholders respondent relies upon the phrase in all other circumstances which appears in the formula and he contends that the formula_clause applies to voluntary sales among shareholders as well as other sales and purchases the formula covers only shares that are sold and purchased pursuant to this agreement the agreement by its terms applies only to offers to sell arising from a shareholder’s intent to transfer or encumber shares deemed offers to sell in the case of bankruptcy or insolvency of a shareholder and mandatory offers to sell coincident to the termination of a shareholder’s employment by hiidollar_figure in these circumstances we cannot agree that the stockholders agreement is determinative of the fair_market_value of hii stock we consider the value that mr engstrom determined 29respondent agrees the formula provision was binding only in certain circumstances not involved in this case 30mr kucklick referred to pricing formulas in negotiating for a higher price as part of the redemption transaction however the final purchase_price was not determined on the basis of the pricing formula in the stockholders agreement under that agreement however we give it relatively little weight prior stock transaction_method mr engstrom relied upon the date redemption of mr kucklick’ sec_12 shares of common_stock he concluded that since the redemption occurred in close proximity to the gift date for the hii shares the purchase_price of mr kucklick’s shares provided a reliable indication of the fair_market_value of hii stock mr engstrom concluded that the values of the 8-year covenant and the 3-year employment agreement were not material and his valuation assumes that the entire purchase_price in the redemption transaction was a payment for the shares of common_stock mr engstrom determined that the price that mr kucklick received in the redemption transaction indicates that the fair_market_value of hii stock was approximately dollar_figure per share as of date mr engstrom gave a significant amount of weight percent to the value resulting from his prior stock transaction_method we agree with mr engstrom that the proximity of the redemption transaction in relation to the gift of shares makes that transaction relevant to the question of fair_market_value of hii stock see rabenhorst v commissioner tcmemo_1996_92 however we are not convinced that the value mr engstrom derived from that transaction accurately reflects the value of hii stock first it appears that at least some portion of the purchase_price was attributable to the 8-year covenant mr kucklick posed a significant competitive threat to hii and its future profitability given his age his experience in the metal forming and cutting industry his knowledge and his customer contacts for these reasons and to protect his investment in hii mr hess insisted upon a broad and relatively lengthy covenant_not_to_compete although the parties did not specifically allocate any amount of the purchase_price to the 8-year covenant it is clear that this covenant was a key component of the agreement and represented valuable consideration coming from mr kucklick mr hess testified with respect to the dollar_figure million purchase_price i considered the price basically a package deal for all the services past for the stock for the noncompete for the employment continuing employment and his willingness to train people at hess engineering during that time he testified that the entire purchase_price of dollar_figure million was allocated to the redemption of mr kucklick’s shares to provide favorable tax treatment to mr kucklickdollar_figure 31respondent suggests that petitioners must present strong_proof that the redemption agreement does not accurately reflect the agreement of the parties that nothing should be allocated to the 8-year covenant generally taxpayers cannot ignore the unambiguous terms of a binding agreement and they must present strong_proof that an allocation of consideration in an agreement is other than that specified 102_tc_406 steel v commissioner continued petitioners also argue that the redemption agreement was not entered into at arm’s length and therefore is not reflective of fair_market_value we cannot agree with this contention we do agree however that there were present considerations that would not be present if the seller in that transaction were not mr kucklick and if the buyer were not hii there were certain elements of consideration exchanged which cannot be quantified we agree that the redemption transaction provides some indication of the value of hii stock however we are convinced that the particular circumstances of that transaction indicate that the value of hii stock was less than the value that mr engstrom derived from that transactiondollar_figure continued tcmemo_2002_113 see also 762_f2d_580 7th cir affg tcmemo_1984_68 however in the instant case the agreement and the allocation therein represent a transaction which is entirely collateral to mr hess’s gift of hii shares and the valuation of those shares we are not persuaded that the strong_proof rule applies in these circumstances 32mr engstrom did not apply a minority interest discount to the value he derived from the redemption transaction because he concluded that mr kucklick’s shares represented a minority interest in hii stock petitioners argue that the redemption of mr kucklick’s stock did not involve a minority interest because mr hess and mr kucklick treated each other as equals in all aspects of their relationship at hii however the redemption was clearly of a minority interest in hii stock regardless of whether mr hess and mr kucklick treated each other as equals further there is evidence that they were not in fact equals in all such aspects indeed the negotiations leading up to the redemption transaction suggest this much in mr heebink’s valuation analysis he did not rely upon the transaction involving the redemption of mr kucklick’s shares however mr heebink prepared two additional reports and a supplemental report in which he concluded separate values for mr kucklick’s redeemed shares and the 8-year covenant mr heebink determined the value of the 8-year covenant using an income analysis estimating the opportunity losses focusing on hei that would occur if mr kucklick were allowed to compete the opportunity losses were projected over an 8-year period beginning after the completion of the 3-year period of the employment agreement mr heebink applied a discount rate to discount the future cashflows he determined to present_value he concluded that the value of the 8-year covenant was dollar_figure million he allocated dollar_figure million of the purchase_price stated in the redemption agreement to the 8-year covenant and he also allocated dollar_figure to the favorable financing contained in the installment note he determined that the redemption transaction reflected a value of dollar_figure per share for hii stock after applying a 15-percent minority interest discount and a 30-percent marketability discount we find mr heebink’s attempts to quantify the value of the 8-year covenant flawed his analysis fails to consider the intentions of the parties to that agreement and instead he seeks to calculate the value of the covenant on the basis of potential opportunity losses we are not persuaded that the parties considered the potential opportunity losses that potential opportunity losses in this instance provide an acceptable measure of value for a covenant_not_to_compete and that mr heebink’s determinations and calculations of those opportunity losses are correctdollar_figure we are not convinced that hii or a hypothetical buyer would pay the present_value of potential opportunity losses for a covenant_not_to_compete as mr engstrom testified in rebuttal if the projected losses were dollar_figure million then there’d be no reason why hess would be willing to pay dollar_figure million because then they’d be in the same position they would have been in if the covenant had never been entered into in the first place further we are not convinced that hii would pay mr kucklick a salary of only dollar_figure per year during the 3-year term of the employment agreement yet pay mr kucklick dollar_figure million for the 8-year covenant_not_to_compete again as mr engstrom testified if he was willing to work full time for the company and not work for anyone else for dollar_figure per year there’s no reason to believe you’d have to pay him substantially more than that to not work we are not persuaded by mr heebink’s attempts to quantify the value of the 8-year covenant we cannot agree that the 33for example mr heebink’s analysis assumes that hii would realize losses immediately upon mr kucklick’s leaving and competing against hii year covenant had a value of dollar_figure million instead we believe that the value of the 8-year covenant was less and the value of the redeemed stock was much greater than the amounts determined by mr heebink guideline companies analysis mr engstrom also relied upon a guideline companies analysis based on comparisons with publicly traded stocks he determined that the fair_market_value of hii stock was dollar_figure on a minority marketable basis after applying a marketability discount of percent mr engstrom determined the fair_market_value of hii stock to be dollar_figure million or dollar_figure per share he gave a significant amount of weight percent to the value resulting from the guideline companies analysis in his guideline companies analysis mr engstrom relied solely on price earnings ratios p e ratio s to compare hii to the guideline companiesdollar_figure petitioners argue that mr engstrom’s use of p e ratios to compare hii to the guideline companies was erroneous they claim that p e ratios are a crude measure for calculating value and do not consider important differences in interest levels tax levels and depreciation levels between the subject company hii and the guideline companies petitioner sec_34mr engstrom determined the p e ratios from value line investment survey a publication that does not provide information for other measures of performance such as ebit earnings before interest and taxes and ebitda earnings before interest taxes depreciation and amortization contend that mr engstrom should have used other measures of comparison besides p e ratios we agree with petitioners that mr engstrom’s guideline companies method would have been more complete and more persuasive if it had employed additional measures of comparison see wall v commissioner tcmemo_2001_75 however it is clear that p e ratios bear a well-recognized relationship in the valuation of companies learner v commissioner tcmemo_1983_ and mr engstrom’s reliance on p e ratios was not inherently flaweddollar_figure petitioners base their objections to mr engstrom’s analysis on his failure to consider certain pretax methods of comparison such as ebit earnings before interest and taxes or 35the p e ratios of publicly held companies do not compare to the p e ratios of a closely held company if the companies themselves are not comparable learner v commissioner tcmemo_1983_122 whether the stock price of one company with a given earnings stream will be similar to that of another company with the same earnings depends upon a wide variety of factors including management policy management ability past performance and dividend policy id although petitioners suggest that the guideline companies do not compare to hii we point out that two of the four guideline companies used by mr engstrom in his analysis giddings lewis inc and monarch machine tool co were companies used by hii to benchmark its performance three of the four guideline companies used by mr engstrom cincinnati milacron inc giddings lewis inc and monarch machine tool co were also used by mr heebink in his market comparable analysis and the remaining company gleason corp builds machines for the manufacture of gears and its major customers are in the automotive and truck industries mr engstrom made appropriate adjustments to the p e ratios from the guideline companies to account for differences in size and net profit margins with these adjustments we find the companies selected by mr engstrom comparable to hii ebitda earnings before interest taxes depreciation and amortization however they fail to explain how consideration of those measures would have influenced or changed mr engstrom’s conclusionsdollar_figure mr engstrom’s explanations were thorough and complete and it was his opinion that those measures would not have affected his analysis he agreed that significant differences in interest taxes level of debt etc might necessitate adjustments to make the companies more comparable however imposing those adjustments where the differences are not significant runs the risk of imposing your judgment over the actual data that’s in there and the risk that your subjective determination is wrong the p e ratios for the guideline companies that mr engstrom selected were based on those companies’ earnings for the two most recent quarterly filings and the forecasts of the earnings for the next two cyclesdollar_figure the p e ratio for hii however was based on that company’s financial information for the fiscal_year 36mr heebink’s testimony in rebuttal regarding the use of p e ratios was somewhat confusing he could not explain why these other items are necessarily important or how they might have influenced or changed mr engstrom’s conclusions mr heebink testified in the context of what an acquirer would consider in a typical mergers-and-acquisitions situation wherein he claims p e ratios would seldom be used 37this information was derived from value line investment survey which uses the most recent 6-month period reported to the securities exchange commission and an estimate of the next month period ending date petitioners claim that good appraisal practice requires use of the same period of time for the guideline companies and the subject company we agree with petitioners that the preferable comparison of historical and or projected_earnings should be made using consistent time periods however petitioners do not explain how the use of consistent time periods in the instant case would change mr engstrom’s conclusions although this flaw in mr engstrom’s analysis leads us to question its persuasiveness we are not convinced that it renders his analysis wholly erroneous mr engstrom relied solely on hii’s fiscal_year financial information in making his conclusions fiscal_year was a banner year for hii it realized sales and net_income exceeding the sales and net_income that it realized in prior years petitioners contend that it was in error to rely solely on the fiscal_year information respondent argues that use of the fiscal_year information alone was justified because hii was experiencing strong growth which hii’s projections indicated would continue and it comports with common sense that more current information and expectations are more indicative of the value that an investor would place on stock than are historic earnings we might agree with respondent that the hypothetical buyer would give primary consideration to the most recent year’s financial information in purchasing stock of a company however we also believe that a hypothetical buyer would consider a company’s historical earnings placing greater emphasis on relevant information from the more recent years this is especially true of companies such as hii which are in cyclical industries and use the completed_contract_method of accounting in these circumstances the use of longer periods of time or averages over a peak to trough sort of cycle would seem preferable thus we agree with petitioners that reliance solely on financial information for one particular year might overstate the fair_market_value of stock in a company at the same time reliance on more recent financial information might be justified in certain circumstancesdollar_figure for example mr engstrom testified 38we also point out that revrul_59_60 sec_4 d c b pincite states on the subject of future earning power potential future income is a major factor in many valuations of closely-held stocks and all information concerning past income which will be helpful in predicting the future should be secured prior earnings records usually are the most reliable guide as to the future expectancy but resort to arbitrary five- or-ten-year averages without regard to current trends or future prospects will not produce a realistic valuation if for instance a record of progressively increasing or decreasing net_income is found then greater weight may be accorded the most recent years’ profits in estimating earning power revrul_59_60 supra has been widely accepted as setting forth the appropriate criteria to consider in determining fair_market_value estate of newhouse v commissioner t c at continued well with regard to these particular industries and with regard to hess i mean even though they are in a cyclical industry it appeared that they were going through a period of secular growth which would mean a growth without regard to the normal patterns of the industry and certainly that’s borne out in the growth rate of the company’s sales the growth rate of the company’s earnings and the budget data regarding what expectations were for the future so for this particular company i don’t think that it’s appropriate to measure it over a period of years under these circumstances we cannot agree that mr engstrom’s use of the fiscal_year information alone renders his analysis unreliabledollar_figure we are not convinced that his reliance on the financial information necessarily overstates the fair_market_value of hii stock nevertheless we recognize this possibility and consider it in reaching our conclusions petitioners also suggest that mr engstrom should have made a downward adjustment to the p e ratios to reflect the fact that hii’s asset utilization sales to total assets was higher than that of the guidelines in mr heebink’s market comparable analysis he made a downward adjustment to reflect the differences in hii’s asset utilization according to mr continued 39mr heebink testified generally regarding the benefits and preferability of using longer periods for comparison and the potential of an overstatement when using financial information for only year however he did not testify regarding whether the use of a longer period or averages would have affected mr engstrom’s conclusions heebink asset utilization affects earnings growth because a company with low asset utilization can increase earnings through more efficient management of assets mr engstrom on the other hand made a 35-percent adjustment to the p e ratio he derived from the guideline companies to account for the fact that the average net profit margin of the guideline companies was approximately percent less than hii’s net profit margin according to mr engstrom companies with higher profit margins tend to have lower price earnings ratios because it is more difficult for the company to achieve future growth we agree with respondent that these adjustments were designed to capture the same thing hii’s relative difficulty of achieving future growthdollar_figure thus we cannot agree that mr engstrom’s analysis was flawed in this respect 40mr engstrom agrees that hii had a higher return on assets than the guideline companies this results in greater risk and normally this risk translates into a lower price earnings multiple however mr engstrom testified that this was one of the primary issues that we addressed when we were looking at an appropriate price earnings multiple for hii he further testified that he made two adjustments one is the adjustment for size and one’s an adjustment for other factors and if you look at the text of our report the primary motivation of that other adjustment factor was the fact that hess’s profit margins are higher than the guideline companies’ so it’s taking account of the fact that their profitability is higher and whether you’re measuring that profitability in terms of profit margins or in terms of returns on assets it’s higher and therefore we would reduce the multiple petitioners also claim that mr engstrom erred in failing to consider hii’s financial information for the most recent quarter before the gift of shares ie the quarterly results for august to date we are not convinced that this was error indeed petitioners’ expert did not consider this information in his market comparable analysis also mr gaynor did not update his valuation for the gift_tax returns to account for hii’s performance after date further mr engstrom explained that a prospective buyer might ask questions regarding the more recent quarterly information but would not consider a loss in that quarter overly alarming where the company uses the completed_contract_method of accounting although we question certain aspects of mr engstrom’s guideline companies analysis and we cannot agree that the value he derived under that analysis is entitled to the weight he gave it ie percent we find that value provides at least some indication of the fair_market_value of hii stock indeed it appears to us that the major separation in the value that mr heebink derived in his market comparable analysis and in the value that mr engstrom derived in his guideline companies analysis is attributable to the erroneous dollar_figure million adjustment that mr heebink made to cost of sales in his analysis see supra note discounted cashflow method mr engstrom considered the discounted cashflow method and determined that the fair_market_value of common_stock in hii was dollar_figure or dollar_figure per share as of date he concluded that this amount supported his conclusions with respect to his overall valuation analysis mr engstrom gave no weight to that amount because he concluded that relatively small changes in certain assumptions which were used resulted in large changes to the indicated value of the company we cannot agree that this provides a basis for wholly rejecting a discounted cashflow analysis indeed as mr heebink testified this same problem is apparent in other valuation methods it is axiomatic that even small changes in certain assumptions in a valuation analysis can result in dramatic changes in the value derived of course in the case of certain companies the distortions in value may be more pronounced however this does not preclude any reliance on a discounted cashflow analysis and we would in those circumstances apply less weight to the value derived thereunderdollar_figure 41respondent argues on brief that mr engstrom’s conclusion that the dcf method did not provide reliable information is completely correct any conclusion reached using it should be disregarded respondent discussed mr engstrom’s discounted cashflow method in his reply brief however he considers any errors in that method irrelevant since mr engstrom did not rely on the discounted cashflow method it is clear to us that respondent places no reliance upon mr engstrom’s discounted continued other items in a letter of intent dated date dover diversified proposed to purchase all the outstanding_stock of hii for dollar_figure million or approximately dollar_figure per share throughout these proceedings respondent has alluded to this letter of intent as evidence of the fair_market_value of hii stockdollar_figure however we are not convinced that the proposed purchase_price is a reliable indicator of the fair_market_value of hii stock the letter of intent was not binding on the parties and dover diversified decided not to purchase hii it is not at all clear whether dover diversified conducted the type of investigation or due diligence which might produce a reliable value indicator neither petitioners’ expert nor respondent’s expert relied upon the letter of intent indeed mr engstrom testified to the extent that there is an amount that was communicated in the letter of intent as a possible acquisition price then you know possibly there’s some valuation information but as we said in our report we didn’t place any reliance upon it so it’s pretty weak valuation information continued cashflow method we likewise give mr engstrom’s discounted cashflow analysis no weight 42respondent’s position on this item is confusing considerable time was spent at trial and on brief regarding the letter of intent however respondent’s expert did not rely upon that item and respondent does not object to petitioners’ requested finding of fact that the dover diversified non-binding letter of intent is not a reliable indicator of the value of hii’s stock we likewise do not rely upon the letter of intent at trial mr hess testified to a number of factors which petitioners argue a hypothetical buyer would have considered in purchasing shares of hii stock the trend toward the use of aluminum wheels was creating competition for hei’s steel wheel manufacturing customers the penetration of hei’s most prominent competitor fontijne into the american market with the advantage of favorable exchange rates hei’s and hess mae’s dependence on exclusive license agreements hii’s continued problems with technical and sales employees the costs to support hii’s new sales and service_organization in switzerland and the scheduled retirement of mr kucklick in date the experts discussed several of these items in their general discussions of the economy and the industry in which hii and its principal customers were involved these items were factored into their various analyses and we have considered them as part of our discussion relating theretodollar_figure 43we note that petitioners’ expert indicated that employee turnover had not been a significant problem 44other than mr hess’s testimony we have no basis from which to conclude that the remaining factors were apparent at the time of the gift whether they would have been considered by a hypothetical buyer and to what extent these factors would affect the fair_market_value of hii stock discounts the parties and their experts agree that a 15-percent minority interest discount should be applied where appropriate to reflect the lack of control inherent in a minority interest in hii stock they also agree that a marketability discount is appropriate to reflect the lack of a ready market for the hii stock on the gift date however they disagree as to the appropriate marketability discount to be applied mr heebink applied a 30-percent discount and mr engstrom applied a percent discount our review of mr heebink’s report shows a potential overlap and an apparent failure to make a proper separation between the lack of control and the lack of marketability apparent in a minority interest in hii see estate of andrews v commissioner t c pincite explaining the difference between minority interest discount and marketability discount mr heebink states that minority interest shares are significantly less marketable and liquid than controlling_interest shares because few investors are interested in minority interest investments in closely held companies and he concludes considering that this valuation relates to a minority interest in a company with extensive owner involvement significant technical expertise high earnings and profitability variation and above average automobile industry concentration a marketability and liquidity discount was selected for hess industries this potential overlap and the apparent failure to separate the minority interest and marketability discounts cause us to question mr heebink’s conclusion on the other hand mr engstrom’s conclusion of a 25-percent marketability discount is reasonable under the circumstances of this case where appropriate we consider a 15-percent minority interest discount and a 25-percent marketability discount in determining the fair_market_value of hii stock conclusion the record reflects a range of values per share for hii stock which we summarize as follows redemption analysis - mr heebink1 dollar_figure net asset value analysis - mr engstrom1 big_number valuation analysis - mr heebink1 big_number guideline companies analysis - mr engstrom2 big_number prior redemption transaction - mr engstrom3 big_number stockholders agreement - mr engstrom3 big_number 1minority interest and marketability discounts applied 2marketability discount applied only 3no discounts applied because valuation necessarily results in an approximation the valuation figure we determine need not be one as to which there is specific testimony as long as it is within the range of values that may properly be arrived at from consideration of all the evidence see estate of magnin v commissioner tcmemo_2001_ after considering all the evidence the values that petitioners’ and respondent’s experts derived in their various analyses other factors and appropriate minority interest and marketability discounts we find that the value of hii stock falls somewhere in the middle of this range of values we hold that the value of the shares of hii stock that were gifted on date was dollar_figure per share decision will be entered under rule