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Articles From Brisbane Consulting Group

Grieve v. Commissioner - Subsequent Events: Tax Court Rejects Speculative Assumption

In Grieve v. Commissioner, the taxpayer transferred a nonvoting stake in a limited liability company (LLC) to a grantor retained annuity trust (GRAT). The LLC held roughly $9.1 million of cash and publicly traded stock, and the taxpayer’s valuation expert applied a 35% combined discount for lack of control and marketability to the value of the gift.

The IRS issued a $4.3 million deficiency notice, plus accuracy-related penalties for a substantial gift tax valuation understatement. Here’s how the taxpayer prevailed in the U.S. Tax Court.

Background

The LLC had two types of ownership interests:

  • 20 voting class A units (0.2% of the total units), and
  • 9,980 nonvoting class B units (99.8% of the total units).

All class A units were owned by the taxpayer’s daughter. Owners of class B units couldn’t vote on or participate in any proceedings in which the entity or its members took action. The LLC agreement also contained various provisions that restricted transfers of membership units, including full consent of all owners of class A units for transfers to nonfamily members.

The taxpayer hired a valuation expert to value the transfer of the class B units to the GRAT on November 1, 2013. The expert valued the gift at only $5.9 million on a minority, nonmarketable basis, using the adjusted net asset method. The value included a 13.4% discount for lack of control and a 25% discount for lack of marketability. Valuation discounts are multiplicative, not additive. So, the effective combined discount was 35%.

The IRS disputed the fair market value of the gift. The IRS’s expert assumed that a hypothetical seller of the class B units would first look to acquire control of the 0.2% interest held by the class A unit holder to avoid the large discounts that a willing buyer would seek for buying the class B units. He valued the Class B units at $9 million.

Taxpayer Victory

The value set forth by the IRS’s expert was contingent on an additional action from a hypothetical buyer: the purchase of the class A voting units. The IRS’s expert testified that a buyer would pay a 5% premium to acquire control. However, the sole owner of these units, the taxpayer’s daughter, testified that she had no intention of selling the units. (As of the date of the court opinion, no sales or offers had occurred.)

Additionally, the taxpayer’s daughter told the court that she’d demand a substantial premium if she ever decided to sell the units. Plus, if a sale were made to someone outside of her family, she’d also expect to receive a management fee.

Citing Olson v. United States, the Tax Court said it could consider subsequent events only if they’re “fairly shown to be reasonably probable.” Conversely, considering improbable subsequent events would “allow mere speculation and conjecture to become a guide for the ascertainment of value.”

The taxpayer’s expert supported his valuation discounts with empirical studies and tied them to facts of the case at hand. The IRS’s expert didn’t provide any detailed analysis related to these discounts. So, the court agreed with the $5.9 million valuation set forth by the taxpayer’s expert.

Building A Solid Foundation

Speculative assumptions that aren’t reasonably probable on the valuation date won’t stand up in Tax Court. A comprehensive written valuation report from a credentialed valuation expert can help the court understand the assumptions underlying a federal gift or estate tax return.

Grieve v. Commissioner - Subsequent Events: Tax Court Rejects Speculative Assumption

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Lou is the Managing Director of Brisbane Consulting Group, LLC, specializing in business valuations, forensic accounting, and litigation support services. He has extensive valuation experience and has served as a financial consultant and expert to attorneys in the economic aspects of matrimonial dissolution and other cases involving personal injury and commercial damages. He has been court-appointed throughout New York State and has testified as an expert witness on numerous occasions in State Supreme Court and Federal Court.

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