Opinion ID: 776467
Heading Depth: 2
Heading Rank: 3

Heading: The Sterling Stock Valuation

Text: 21 The Estate also challenged the Sterling stock valuation. The relevant valuation date is September 18, 1992 (the Estate's alternate valuation date). The wide disparity in valuations underscores the importance of documenting this determination. On its filed tax return, the Estate listed the 1,533 shares at $10 per share, for a total of $15,335, even though its accountant valued the shares at $462,000 only a month earlier. Just a year following the September 1992 valuation date, Sterling effected a redemption of the stock for $1,947,845 (including interest); the Commissioner adopted this later figure as the fair market valuation. Rejecting both of these valuations, the Tax Court concluded that the value was approximately $2,708,536. 22 The key to the stock valuation lies in the nature of this preferred stock. As a condition of the purchase agreement, Sterling was required to redeem the shares held by Trompeter and Sylvia by December 31, 1995. Among other things, the agreement contemplated that Sterling would use its best efforts to make payment — at the price of $1,000 per share plus accrued dividends 2 — for 1,000 of the shares on December 31, 1991, and an additional 1,000 shares the following year. If Sterling elected, however, to forego redemption during those years, Sterling was required to redeem 1,000 shares per year from 1993-95. Sterling was not permitted to make redemptions or dividend payments if it had, among other things, defaulted on its senior debt obligations. As of September 18, 1992, Sterling had elected not to make payment for any of the newly-issued preferred shares; although Sterling suffered some financial difficulties during the period when Trompeter owned the shares, it did have a positive cash flow dating back to 1989 — the year of the purchase agreement — and timely paid both the principal of and interest on its senior debt obligations. 23 In October 1993, Sterling proposed to redeem all of the Estate's preferred holdings at the price of $1,000 per share, plus, in lieu of the accrued dividends formulation set forth in the purchase agreement, interest that had accrued at a rate of five percent dating back to the shares' issuance to Trompeter. The co-executors of the Estate accepted the offer in January 1994, and the Estate consequently received $1,947,845 ($1,533,482 for the shares, plus $414,363 in interest). 24 At trial, the Commissioner argued that stock should have been valued at $1,947,845 — the redemption amount — and, supposedly, a fair market value as of September 1992. The Estate countered that the January 1994 redemption was irrelevant to the valuation of the stock in September 1992, because it was not foreseeable in light of Sterling's prior financial condition. 25 The Estate offered an expert who valued the stock based on comparable publicly-traded companies. The Tax Court, after an analysis of the comparable companies and Sterling's financial status, rejected the Estate's analysis, in large part because of major shortcomings in the comparability analysis. On this point the Tax Court's rationale is clear and its findings are well-grounded and not clearly in error. 26 The Tax Court then went on to reject the Commissioner's position that the redemption price in January 1994 was equivalent to fair market value some sixteen months earlier on September 18, 1992. The court concluded, however, that the mandatory obligation to redeem the stock... does establish a benchmark for determining the applicable value and that it was foreseeable in September 1992 that Sterling would redeem the Sterling preferred stock by December 1995 at or about the purchase agreement price. Using the benchmark figure, the court analyzed value based on a hypothetical willing buyer and seller scenario. We can easily follow and document the court's analysis and findings. So far, so good. 27 The court then stated, without elaboration, that it would apply a reasonable discount rate of 4 percent to the various interim figures to ascertain present value on September 18, 1992. Once again, we are left without the benefit of reasoning or analysis as to how the four-percent discount figure was chosen. The Tax Court did not specify why it elected to discount the payments at a four-percent rate — and why such a rate was reasonable. The discount figure is significant because it is determinative of whether the Estate has met its burden in challenging the Commissioner's fair market value determination. 28 Under the applicable statutory provisions, the Estate is permitted to value the stock either as of the date of Trompeter's death or on the alternate evaluation date six months after his death. Internal Revenue Code § 2032(a). Here, the Estate elected the latter; using that date as a benchmark, the Tax Court discounted anticipated future payments to the Estate using what it described as well accepted present value formulae. This conclusory approach, however, fails to provide a reasoned basis as mandated by Leonard Pipeline. The Tax Court did not explain why a hypothetical purchaser of Sterling preferred stock in 1992 would accept a four-percent discount rate as reasonable. See Estate of Mitchell, 250 F.3d at 704 (Because the [discount] range is unsupported by the testimony of any of the experts, singularly or together, it is unclear whether the Tax Court's combined discount actually falls within any particular range that might be supported in the record.). On its face, it seems a bit of a stretch to conclude that a buyer would have accepted a discount rate of only four percent to account for the time value of money and the risk that Sterling would not meet its contractual obligations. 29 On remand, therefore, we direct the Tax Court to clarify its methodology, and to document the rationale for its present value calculations.