Judges: Beghe
Attorneys: Buford P. Berry , Emily A. Parker , and Ronald M. Morris, for petitioners. Richard D. D'Estrada and Robert A. Varra , for respondent.
Filed: Jul. 06, 2001
Latest Update: Nov. 21, 2020
Summary: T.C. Memo. 2001-167 UNITED STATES TAX COURT ESTATE OF H.A. TRUE, JR., DECEASED, H.A. TRUE, III, PERSONAL REPRESENTATIVE, AND JEAN D. TRUE, ET AL.1, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 10940-97, 3408-98, Filed July 6, 2001. 3409-98. Buford P. Berry, Emily A. Parker, and Ronald M. Morris, for petitioners. Richard D. D’Estrada and Robert A. Varra, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION Contents Introduction . . . . . . . . . . . . . . . . . . . .
Summary: T.C. Memo. 2001-167 UNITED STATES TAX COURT ESTATE OF H.A. TRUE, JR., DECEASED, H.A. TRUE, III, PERSONAL REPRESENTATIVE, AND JEAN D. TRUE, ET AL.1, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 10940-97, 3408-98, Filed July 6, 2001. 3409-98. Buford P. Berry, Emily A. Parker, and Ronald M. Morris, for petitioners. Richard D. D’Estrada and Robert A. Varra, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION Contents Introduction . . . . . . . . . . . . . . . . . . . . ..
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T.C. Memo. 2001-167
UNITED STATES TAX COURT
ESTATE OF H.A. TRUE, JR., DECEASED, H.A. TRUE, III, PERSONAL
REPRESENTATIVE, AND JEAN D. TRUE, ET AL.1, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 10940-97, 3408-98, Filed July 6, 2001.
3409-98.
Buford P. Berry, Emily A. Parker, and Ronald M. Morris, for
petitioners.
Richard D. D’Estrada and Robert A. Varra, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . 8
1
Cases of the following petitioners are consolidated
herewith: Jean D. True, docket No. 3408-98 and Estate of H.A.
True, Jr., Deceased, H.A. True, III, Personal Representative,
docket No. 3409-98.
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Issue 1. Does Book Value Price Specified in Buy-Sell
Agreements Control Estate and Gift Tax Values of
Subject Interests in True Companies? . . . . . . . . . . 10
FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 10
I. Background . . . . . . . . . . . . . . . . . . . . 11
A. True Family . . . . . . . . . . . . . . . . . 11
B. Formation and Growth of True Companies . . . . 12
1. Reserve Drilling . . . . . . . . . . . . . 12
2. True-Brown Partnerships . . . . . . . . . . 13
3. True Oil and True Drilling . . . . . . . . 14
4. Belle Fourche Pipeline Co. . . . . . . . . 15
5. Black Hills Oil Marketers, Inc./True Oil
Purchasing Co./Eighty-Eight Oil Co./Black
Hills Trucking, Inc. . . . . . . . . . . 18
6. True Ranches . . . . . . . . . . . . . . . 20
7. White Stallion Ranch, Inc. . . . . . . . . 21
8. Other True Companies . . . . . . . . . . . 22
C. Methods of Accounting Used by True Companies . 23
D. Family Members’ Employment in True Companies . 24
E. Family Gift Giving and Business Financing
Practices . . . . . . . . . . . . . . . . . 27
II. True Family Buy-Sell Agreements . . . . . . . . . 28
A. Origin and Purpose . . . . . . . . . . . . . . 28
B. First Transfers of Interests in Belle
Fourche, True Oil, and True Drilling to
True Children . . . . . . . . . . . . . . . 30
C. Wyoming U.S. District Court Cases on Belle
Fourche and True Oil Transfers . . . . . . . 35
D. Tamma Hatten’s Withdrawal From True Companies . 39
E. Use of Similar Buy-Sell Agreements in All
True Companies Except White Stallion;
Amendments and Waivers . . . . . . . . . . . 42
F. Unique Provisions of White Stallion Buy-Sell
Agreement . . . . . . . . . . . . . . . . . 48
G. Future of True Family Buy-Sell Agreements . . . 50
III. Transfers in Issue . . . . . . . . . . . . . . . . 51
A. 1993 Transfers of Partnership Interests by
Dave True . . . . . . . . . . . . . . . . . 51
Barb. 1994 Estate Transfers . . . . . . . . . . . . .
53
Cow. 1994 Transfers by Jean True . . . . . . . . . . 55
IV. Subsequent Income Tax Litigation Regarding
Ranchland Exchange Transactions . . . . . . . . 55
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OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
I. Do Family Buy-Sell Agreements Control
Estate Tax Value? . . . . . . . . . . . . . . . 59
A. Framework for Analyzing Estate Tax Valuation
Issues . . . . . . . . . . . . . . . . . . . 59
B. Development of Legal Standards . . . . . . . . 61
1. Case Law Preceding Issuance of Regulations . 62
2. Regulatory Authority and Interpretive
Rulings . . . . . . . . . . . . . . . . . 67
3. Case Law Following Issuance of Regulations
and Revenue Ruling 59-60 . . . . . . . . 70
a. Was Agreement Entered Into for Bona Fide
Business Reasons? . . . . . . . . . . 71
b. Was Agreement a Substitute for
Testamentary Dispositions? . . . . . . 72
1. Testamentary Purpose Test . . . . . . 73
2. Adequacy of Consideration Test . . . . 74
4. Statutory Changes . . . . . . . . . . . . . 79
II. Do 1971 and 1973 Gift Tax Cases Have Preclusive
Effect? . . . . . . . . . . . . . . . . . . . . . 81
A. Petitioners’ Collateral Estoppel Argument . . . 81
B. Legal Standards for Applying Collateral
Estoppel . . . . . . . . . . . . . . . . . . . 82
C. Collateral Estoppel Impact of 1971 and 1973
Gift Tax Cases . . . . . . . . . . . . . . . . 85
1. Bona Fide Business Arrangement Issue . . . . 86
2. Whether Book Value Equaled Fair Market
Value as of Agreement Date Issue . . . . . 87
III. Do True Family Buy-Sell Agreements Control
Estate Tax Values? . . . . . . . . . . . . . . . 90
A. Was the Offering Price Fixed and Determinable
Under the Agreements? . . . . . . . . . . . . 91
B. Were Agreements Binding During Life
and at Death? . . . . . . . . . . . . . . . . 91
C. Were Agreements Entered Into for Bona
Fide Business Reasons? . . . . . . . . . . . 99
D. Were Agreements Substitutes for Testamentary
Dispositions? . . . . . . . . . . . . . . . . 101
1. Testamentary Purpose Test . . . . . . . . . 101
a. Decendent’s Health When He Entered Into
Agreements . . . . . . . . . . . . . . 101
b. No Negotiation of Buy-Sell Agreement
Terms . . . . . . . . . . . . . . . . . 102
c. Enforcement of Buy-Sell Agreement
Provisions . . . . . . . . . . . . . . . 107
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d. Failure To Seek Significant Professional
Advice in Selecting Formula Price . . . 109
e. Failure To Obtain or Rely on Appraisals
in Selecting Formula Price . . . . . . . 112
f. Exclusion of Significant Assets From
Formula Price . . . . . . . . . . . . . 114
g. No Periodic Review of Formula Price . . . 115
h. Business Arrangements With True Children
Fulfilled Dave True’s Testamentary
Intent . . . . . . . . . . . . . . . . . 118
2. Adequacy of Consideration Test . . . . . . . 120
a. Petitioners’ Brodrick v. Gore/Golsen
Argument . . . . . . . . . . . . . . . 121
b. Petitioners’ Assertion That Respondent
Impermissibly Applied Section 2703
Retroactively . . . . . . . . . . . . . 124
c. Did Tax Book Value Pricing Formula
Represent Adequate and Full
Consideration? . . . . . . . . . . . . 128
3. True Family Buy-Sell Agreements Were
Substitutes for Testamentary Dispositions 140
E. Conclusion: True Family Buy-Sell Agreements
Do Not Determine Estate Tax Values . . . . . 141
IV. Do True Family Buy-Sell Agreements Control
Gift Tax Values? . . . . . . . . . . . . . . . . 144
A. Framework for Analyzing Gift Tax Valuation
Issues . . . . . . . . . . . . . . . . . . . 145
B. Buy-Sell Agreements Do Not Determine Value
for Gift Tax Purposes . . . . . . . . . . . . 146
C. Application of Gift Tax Rules to Lifetime
Transfers by Dave and Jean True . . . . . . . 149
1. True Family Buy-Sell Agreements Do Not
Control Gift Tax Values . . . . . . . . . 149
2. Lifetime Transfers by Dave and Jean True
Were Not in Ordinary Course of Business . 151
V. Impact of Noncontrolling Buy-Sell Agreements
on Estate and Gift Tax Valuations . . . . . . . 153
Issue 2. If True Family Buy-Sell Agreements Do Not
Control Values, What Are Estate and Gift Tax
Values of Subject Interests? . . . . . . . . . . . 155
FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 155
I. True Oil . . . . . . . . . . . . . . . . . . . . . 156
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II. Belle Fourche . . . . . . . . . . . . . . . . . . 158
III. Eighty-Eight Oil . . . . . . . . . . . . . . . . . 161
IV. Black Hills Trucking . . . . . . . . . . . . . . . 164
V. True Ranches . . . . . . . . . . . . . . . . . . . 166
VI. White Stallion . . . . . . . . . . . . . . . . . . 168
OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 169
I. Expert Opinions . . . . . . . . . . . . . . . . . 169
II. Experts and Their Credentials . . . . . . . . . . 171
A. Petitioners’ Expert, John H. Lax . . . . . . . 171
B. Petitioners’ Expert, Curtis R. Kimball . . . . 172
C. Petitioners’ Expert, Dr. Robert H. Caldwell . . 173
D. Petitioners’ Expert, Michael S. Hall . . . . . 174
E. Respondent’s Expert, John B. Gustavson . . . . 174
III. Preliminary Matters Regarding Valuation . . . . . 175
A. Respondent’s Alleged Concessions Regarding
Valuation Discounts . . . . . . . . . . . . 175
B. Role of Burdens and Presumptions in
Cases at Hand . . . . . . . . . . . . . . . 180
C. Petitioners’ Aggregation and Offset Argument . 183
IV. Valuations of True Companies in Dispute . . . . . 186
A. True Oil . . . . . . . . . . . . . . . . . . . 186
1. Marketable Minority Interest Value . . . . 186
a. Kimball Reports . . . . . . . . . . . . . 186
b. Final Lax Report . . . . . . . . . . . . 191
c. Gustavson Report and Respondent’s
Position . . . . . . . . . . . . . . . 193
d. Court’s Analysis . . . . . . . . . . . . 196
2. Marketability Discounts . . . . . . . . . . 204
a. Kimball Reports . . . . . . . . . . . . . 204
b. Final Lax Report . . . . . . . . . . . . 207
c. Gustavson Report/Rebuttals and
Respondent’s Position . . . . . . . . . 207
d. Court’s Analysis . . . . . . . . . . . . 208
3. Summary of Proposed Values and Court’s
Determinations of Values of Interests in
True Oil . . . . . . . . . . . . . . . . 215
B. Belle Fourche . . . . . . . . . . . . . . . . 217
1. Value of Total Equity on a Marketable
Basis . . . . . . . . . . . . . . . . . . 217
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a. Kimball Report . . . . . . . . . . . . . 217
b. Initial and Final Lax Reports . . . . . . 218
c. Gustavson Report and Respondent’s
Position . . . . . . . . . . . . . . . 221
d. Court’s Analysis . . . . . . . . . . . . 224
2. Marketability Discounts . . . . . . . . . . 233
a. Kimball Report . . . . . . . . . . . . . 233
b. Initial and Final Lax Reports . . . . . . 235
c. Respondent’s Position . . . . . . . . . . 235
d. Court’s Analysis . . . . . . . . . . . . 236
3. Summary of Proposed Values and Court’s
Determinations of Values of Interests
in Belle Fourche . . . . . . . . . . . . 240
C. Eighty-Eight Oil . . . . . . . . . . . . . . . 241
1. Marketable Minority Interest Value . . . . 241
a. Kimball Reports . . . . . . . . . . . . . 241
b. Final Lax Report . . . . . . . . . . . . 241
c. Respondent’s Position . . . . . . . . . . 242
d. Court’s Analysis . . . . . . . . . . . . 243
2. Marketability Discounts . . . . . . . . . . 246
a. Kimball Reports . . . . . . . . . . . . . 246
b. Final Lax Report . . . . . . . . . . . . 247
c. Respondent’s Position . . . . . . . . . . 247
d. Court’s Analysis . . . . . . . . . . . . 247
3. Summary of Proposed Values and Court’s
Determinations of Values of Interests
in Eighty-Eight Oil . . . . . . . . . . . 250
D. Black Hills Trucking . . . . . . . . . . . . . 252
1. Value of Total Equity on a Marketable
Basis . . . . . . . . . . . . . . . . . . 252
a. Kimball Report . . . . . . . . . . . . . 252
b. Initial and Final Lax Reports . . . . . . 253
c. Respondent’s Position . . . . . . . . . . 255
d. Court’s Analysis . . . . . . . . . . . . 256
2. Marketability Discounts . . . . . . . . . . 261
a. Kimball Report . . . . . . . . . . . . . 261
b. Initial and Final Lax Reports . . . . . . 262
c. Respondent’s Position . . . . . . . . . . 262
d. Court’s Analysis . . . . . . . . . . . . 263
3. Summary of Proposed Values and Court’s
Determinations of Values of Interests
in Black Hills Trucking . . . . . . . . . 266
E. True Ranches . . . . . . . . . . . . . . . . . 268
1. Marketable Minority Interest Values . . . . 268
a. H&H Report . . . . . . . . . . . . . . . 268
b. Kimball Reports . . . . . . . . . . . . . 270
c. Final Lax Report . . . . . . . . . . . . 270
d. Respondent’s Position . . . . . . . . . . 272
- 7 -
e. Court’s Analysis . . . . . . . . . . . . 273
2. Marketability Discounts . . . . . . . . . . 274
a. Kimball Reports . . . . . . . . . . . . . 274
b. Final Lax Report . . . . . . . . . . . . 275
c. Respondent’s Position . . . . . . . . . . 275
d. Court’s Analysis . . . . . . . . . . . . 275
3. Summary of Proposed Values and Court’s
Determinations of Values of Interests
in True Ranches . . . . . . . . . . . . . 278
F. White Stallion . . . . . . . . . . . . . . . . 280
1. Marketable Minority Interest Values . . . . 280
a. Kimball Report . . . . . . . . . . . . . 280
b. Initial and Final Lax Reports . . . . . . 280
c. Respondent’s Position . . . . . . . . . . 281
d. Court’s Analysis . . . . . . . . . . . . 281
2. Marketability Discounts . . . . . . . . . . 284
a. Kimball Report . . . . . . . . . . . . . 284
b. Initial and Final Lax Reports . . . . . . 284
c. Respondent’s Position . . . . . . . . . . 285
d. Court’s Analysis . . . . . . . . . . . . 285
3. Summary of Proposed Values and Court’s
Determinations of Values of Interests
in White Stallion . . . . . . . . . . . . 287
Issue 3. Did Jean True Make Gift Loans When She Transferred
Interests in True Companies to Sons in Exchange for
Interest-Free Payments Received Approximately 90
Days after Effective Date of Transfers? . . . . . . 288
FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 289
OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 297
I. Summary of Arguments . . . . . . . . . . . . . . . 297
II. Jean True’s Sales Were Completed on Notice Dates . 300
III. Sections 483 and 1274 Do Not Prevent Below-Market
Loan Treatment Under Section 7872 . . . . . . . 308
IV. Deferred Payment Arrangements Are Below-Market
Gift Loans Subject to Section 7872 . . . . . . . 313
A. Loan . . . . . . . . . . . . . . . . . . . . . 313
B. Below-Market Loan . . . . . . . . . . . . . . . 314
C. Gift Loan . . . . . . . . . . . . . . . . . . . 315
V. Amounts of the Gifts--Application of Section 7872 . 317
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Issue 4. Are Petitioners Liable for Valuation Understatement
Penalties Under Section 6662(a), (g), and (h)? . 320
FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 320
OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 322
Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . 334
Schedule 1 . . . . . . . . . . . . . . . . . . . . . . . 334
Schedule 2 . . . . . . . . . . . . . . . . . . . . . . . 335
Schedule 3 . . . . . . . . . . . . . . . . . . . . . . . 336
BEGHE, Judge: Respondent determined Federal gift and estate
tax deficiencies and accuracy-related penalties under sections
6662(a), (g), and (h)2 in the following amounts:
Docket No. Tax Year Deficiency Penalties
10940-97 Gift 12/31/93 $15,201,984 $6,080,794
3409-98 Estate 06/04/941 43,639,111 17,455,644
3408-98 Gift 12/31/94 17,094,788 6,791,715
Totals 75,935,883 30,328,153
1
Date of death.
Introduction
In each of these consolidated cases, respondent determined a
gift or estate tax deficiency and penalty arising from a gross
valuation understatement. The deficiencies and penalties relate
to valuations of ownership interests in various corporations and
partnerships (collectively, the True companies), subject to buy-
sell agreements, transferred individually in 1993 by H.A. True,
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect as of the date of Dave True’s
death (for estate tax purposes) or dates of Dave and Jean True’s
alleged gifts (for gift tax purposes). All Rule references are
to the Tax Court Rules of Practice and Procedure.
- 9 -
Jr., deceased, (docket No. 10940-97),3 reported by the Estate of
H.A. True, Jr., H.A. True, III, personal representative (estate)
by reason of H.A. True, Jr.’s death in 1994 (docket No. 3409-98),
or transferred by Jean True individually in 1994 (docket No.
3408-98) (collectively, petitioners).4 Petitioners timely filed
petitions with this Court contesting the deficiencies and
penalties and claiming a refund of whatever overpayment of estate
tax might arise from payments of administration expenses not
claimed on the estate tax return. After concessions, the
following issues are to be decided:
1. Does the book value price specified in the buy-sell
agreements control estate and gift tax values of the subject
interests in the True companies (buy-sell agreement issue);
2. If the True family buy-sell agreements do not control
values, what are the estate and gift tax values of the subject
interests (valuation issue);
3
Jean True is a party to docket No. 10940-97 solely because
she elected to be treated as donor of one-half of the gifts H.A.
True, Jr. made during 1993. See sec. 2513.
4
We include the estate in the collective term, petitioners,
for ease of reference only. This reference does not suggest
whether we regard the personal representatives’ residences, or
the decedent’s domicile at death, to be controlling for appellate
venue purposes under sec. 7482(b)(1). See Estate of Clack v.
Commissioner, 106 T.C. 131 (1996). The issue is not implicated
in the cases at hand because Dave True and the estate’s personal
representatives were all domiciled in the same jurisdiction
(Wyoming) at all relevant times. See infra pp. 11-12.
- 10 -
3. Did Jean True make gift loans when she transferred
interests in the True companies to her sons in exchange for
interest-free payments received approximately 90 days after the
effective date of the transfers (gift loan issue); and
4. Are petitioners liable for valuation understatement
penalties under section 6662(a), (g), and (h) (penalty issue)?
We hold in respondent’s favor that the buy-sell agreements
do not control estate and gift tax values. We value the subject
interests at amounts greater than the prices paid under the buy-
sell agreements and hold that understatement penalties apply to
parts of the resulting deficiencies. We hold for respondent on
the gift loan issue.
For convenience and clarity, findings of fact and opinion
are set forth separately under each issue. The findings of fact
regarding any issue incorporate, by this reference, the facts as
found with respect to any issue previously addressed.
Issue 1. Does Book Value Price Specified in Buy-Sell Agreements
Control Estate and Gift Tax Values of Subject Interests in True
Companies?
FINDINGS OF FACT
Some of the facts have been stipulated by the parties and
are so found. The stipulation of facts, supplemental stipulation
of facts, associated exhibits, and oral stipulations are
incorporated by this reference.
- 11 -
I. Background
A. True Family
Henry Alphonso True, Jr. (known as H.A. True, Jr. or Dave
True) was born June 12, 1915, and resided in Casper, Wyoming,
from 1948 until his death on June 4, 1994, 1 week before his 79th
birthday. He was survived by his wife, Jean True, his children,
Tamma True Hatten (Tamma Hatten), H.A. True, III (Hank True),
Diemer D. True (Diemer True), and David L. True (David L. True)
(collectively, the True children), his grandchildren, and great-
grandchildren.
The Natrona County, Wyoming, probate court (probate court)
appointed Jean True, Hank True, Diemer True, and David L. True
(personal representatives) as co-personal representatives of the
estate. After approving the estate’s final accounting, the
probate court discharged the personal representatives on
December 13, 1995.
Dave True’s Last Will and Testament, dated September 14,
1984 (will), provided that the residue of his estate should be
paid to the trustees under the H.A. True, Jr. Trust dated
September 14, 1984 (living trust), as amended. Under the living
trust, Jean True, Hank True, Diemer True, and David L. True were
appointed as first successor trustees (trustees) upon Dave True’s
death.
- 12 -
The personal representatives, trustees, and Jean True
individually, resided in Casper, Wyoming, at the times they filed
their petitions with this Court.
B. Formation and Growth of True Companies
1. Reserve Drilling
Dave True graduated from college and married Jean True in
1938. During the next 10 years, he worked in the oil and gas
business for the Texas Co. (later known as Texaco) in various
positions, eventually becoming Wyoming State superintendent of
drilling and production, based in Cody, Wyoming. During this
time, Tamma (1940), Hank (1942), and Diemer (1946) were born.
In 1948, Dave True left the Texas Co., moved his family to
Casper, Wyoming, and became manager of Reserve Drilling Co.
(Reserve Drilling), a one-rig contract drilling business. Dave
and Jean True’s youngest child, David L. True, was born in 1950.
By 1951, Dave True owned 15 percent of Reserve Drilling, Doug
Brown, an attorney, owned 10 percent, and unrelated companies
owned the remaining interests. Reserve Drilling generated
substantial profits and acquired additional rigs under Dave
True’s management. Eventually, the unrelated companies sold
their interests to Dave True and Doug Brown, who financed their
purchases with borrowed funds.
- 13 -
2. True-Brown Partnerships
Dave True and Doug Brown jointly pursued other business
ventures (collectively, True-Brown partnerships). Among them was
True & Brown Drilling Co., a partnership formed in 1951 that
engaged in contract drilling and also acquired working interests
in oil and gas properties. Dave True worked long hours in the
field on the drilling rigs, while Doug Brown worked regular hours
in the Casper office. Dave True came to believe that he was
contributing more than 50 percent of the efforts required to run
the company. In 1954, Dave True offered to sell his interest, or
to buy Doug Brown’s interest, at a stated price. Doug Brown
chose to sell his interests in all the True-Brown partnerships,
and Dave True financed his purchase through an oil payment (bank
loan payable out of oil production).5
These experiences influenced Dave True’s business philosophy
and generated his interest in using buy-sell agreements. Dave
True decided that he never again would incur outside debt to
finance acquisitions and that he would allow only family members
to be his partners in future business ventures.
5
Other than intimations that the purchases and sales of the
outsiders’ interests in Reserve Drilling and the True-Brown
partnerships were at arm’s length, there is no indication in the
record how the purchase prices in these transactions were
established. See infra pp. 16-17 with respect to purchases-
redemptions of outside shareholders’ interests in Belle Fourche
Pipeline Co.
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3. True Oil and True Drilling
Following termination of the True-Brown partnerships in
1954, Dave and Jean True formed True Oil Co. (True Oil) and True
Drilling Co. (True Drilling). These were Wyoming general
partnerships in which Dave and Jean True initially owned 95-
percent and 5-percent interests, respectively.
True Oil acquired working interests in oil and gas
properties and looked for new reserves. In general, True Oil
would do farm-in deals (do exploratory drilling on prospects
identified by others) rather than develop its own deals. Dave
True was an operator, who actually drilled and operated wells and
arranged to sell production, rather than a promoter, who sells
non-operating royalty interests to third parties. True Oil’s
customers included both related and unrelated parties; however,
on average, about half of its production was purchased by related
entities.
True Drilling owned and operated drilling rigs and performed
contract drilling services for related and unrelated customers.
True Oil was one of True Drilling’s largest customers.
Dave True was a “wildcatter”. He enjoyed the challenge of
drilling exploratory wells on leased acreage far from established
fields, rather than drilling developmental wells on established
fields. True Oil’s early efforts were rewarded with discoveries
of fields in the Rocky Mountain region (Wyoming, North Dakota,
- 15 -
Montana). Dave True was also a pioneer in the successful use of
water flooding to increase recoverable reserves.
Dave True believed that the only way to perpetuate his
business would be to find and develop replacement reserves and
that doing so would require substantial exploration and
development outlays. True Oil expended considerable funds
without generating substantial additional production. From 1972
to 1998, True Oil spent approximately $174 million on exploration
and drilling costs that resulted in dry holes.6 Dave True’s
continuing commitment to exploration for new reserves, and his
aversion to incurring outside debt, required the partners to
channel their profits from True Drilling and other True companies
into True Oil in order to finance continued exploration
activities.
Effective August 1, 1973, Dave True gave each of his
children 8-percent general partnership interests in True Oil and
True Drilling. The owners and ownership percentages immediately
after the gifts were: Dave True (63 percent), Jean True (5
percent), and each of the four True children (8 percent).
4. Belle Fourche Pipeline Co.
In 1957, Dave True and other Wyoming operators organized
Belle Fourche Pipeline Co. (Belle Fourche) as a Wyoming
6
True Oil’s total intangible drilling costs from 1972
through 1998 were $301,016,235, which included costs of drilling
on proven properties, developmental drilling, and exploratory
drilling. Fifty-eight percent of total intangible drilling costs
(approximately $174 million) were spent on nonproductive wells.
- 16 -
corporation to build and operate a gathering system for the
Donkey Creek field in the Powder River Basin. Dave True and the
other local operators organized Bell Fourche because they had
encountered difficulty in getting their crude oil to market from
newly discovered, remote fields. They therefore decided to build
their own pipeline, rather than transport crude oil by truck to
trunk lines or connect new wells to existing gathering pipelines
owned by others. In later years, Belle Fourche substantially
expanded its operations to serve other fields as a common carrier
gathering system with multiple outlets to trunk lines.
Belle Fourche generated substantial cash-flow from fees for
transporting crude oil. Its customers included both True
companies and unrelated entities. However, the majority of its
business was from unrelated entities.
In the 1960's, Dave and Jean True acquired full ownership of
the shares of Belle Fourche through redemptions of the share
interests of the other holders.7 There were no buy-sell
agreements that would have dictated the redemption prices for
Belle Fourche stock. All but one of the redemptions were at
preceding yearend book value (determined on a GAAP basis, see
7
Petitioners’ direct testimony characterized these
transactions as stock purchases by Dave and Jean True, while the
appraisal of Standard Research Consultants (SRC)(see infra pp.
37-39) characterized them as corporate redemptions. The SRC
appraisal provided more detailed information regarding the
transactions and appears to be more reliable.
- 17 -
infra p. 23); the exception, which amounted to 24 percent8 of the
total shares initially issued, was for more than book value.
In 1967, after having acquired all outstanding shares, the
Trues caused Belle Fourche to make an S corporation election.
Belle Fourche relied on shareholder loan, rather than equity, as
its main source of financing after electing S status. Between
March 31, 1971 (the company’s fiscal yearend), and June 15, 1971,
Dave and Jean True received earnings distributions of
approximately $2.8 million,9 thereby reducing reported book value
from $99.90 to $38.69 per share.
In August 1971, the True children each purchased a 1-percent
interest in Belle Fourche from the corporation. The True
family’s accountant, Cloyd Harris (Mr. Harris), advised the True
children also to lend money to Belle Fourche so that each
stockholder’s pro rata share of outstanding loans to the
corporation would reflect his or her percentage interest. This
was intended to preserve Belle Fourche’s S corporation status by
avoiding the appearance of a second class of stock. The True
children paid $38.69 per share to purchase the stock (476 shares
each) and lent the company $127.26 per share at 8-percent
8
29,244 shares (redeemed December 1962 at $17/share vs. book
value of $13.13/share) divided by 120,004 shares (issued at
formation) equals approximately 24 percent (rounded).
9
$4,569,000 (book value at 3/31/71) less $1,769,500 (45,734
shares outstanding x $38.69 book value/share at 6/15/71) equals
$2,800,000 (rounded) decrease in book value due to distributions
made within 2-1/2 months after fiscal yearend.
- 18 -
interest, payable on demand. The children financed the
transaction with cash gifts from their parents over the years and
with earnings distributions from their prior investments in other
True companies. The owners and ownership percentages immediately
after the purchases were: Dave True (91 percent), Jean True (5
percent), and each of the four True children (1 percent).
5. Black Hills Oil Marketers, Inc./True Oil
Purchasing Co./Eighty-Eight Oil Co./Black Hills
Trucking, Inc.
Black Hills Oil Marketers, Inc. (Black Hills Oil), was
formed by Dave True in 1963 to market and transport crude oil.
Initially, the activities of Black Hills Oil centered on
supporting Belle Fourche’s pipeline operation by moving and
accumulating marketable quantities of oil. However, Black Hills
Oil’s business quickly expanded to include purchasing oil from
unrelated parties and providing shipping services.
Black Hills Oil’s marketing activities consisted of buying
crude oil from lease operators, shipping it through a pipeline
while retaining title, and reselling it with a markup at the
other end. In the late 1970's, the True family began conducting
oil marketing activities through True Oil Purchasing Co. (TOPCO)
rather than through Black Hills Oil. In 1980, one of TOPCO’s
customers could not fulfill a purchase obligation and filed for
bankruptcy. The Trues became concerned that this default might
adversely affect TOPCO’s ability to meet its own obligations.
- 19 -
They therefore liquidated TOPCO and transferred its crude oil
marketing business to a preexisting Wyoming general partnership,
Eighty-Eight Oil Co. (Eighty-Eight Oil).
Dave and Jean True owned 95 percent and 5 percent,
respectively, of Eighty-Eight Oil when they formed it in 1956.
In 1975, the four True children each purchased an 8-percent
general partnership interest from Dave True, which reduced his
partnership interest to 63 percent.
The crude oil marketing business operated by Eighty-Eight
Oil and its predecessors generated considerable cash-flows; the
Trues regarded it as a “cash cow”. Eighty-Eight Oil often served
its partners as a repository of excess cash. At times, due to
disproportionate capital contributions or withdrawals, the
capital accounts of the partners varied widely from their
interests in profits and losses. During the 1990's, Eighty-Eight
Oil transacted most of its business with unrelated parties.
Black Hills Trucking, Inc. (Black Hills Trucking), began as
a division of Black Hills Oil that transported crude oil to
pipelines. Its services grew to include moving drilling rigs and
hauling water, livestock, products, and pipe for related and
unrelated customers. As a result of the expansion of the
activities of Black Hills Trucking, and regulatory price caps
imposed on Black Hills Oil, the True family decided to make Black
Hills Trucking a separate entity.
- 20 -
In 1977, Black Hills Trucking was organized as a Wyoming
corporation; it was initially owned by Dave True (63 percent),
Jean True (5 percent), and the four True children (8 percent
each). The company elected S corporation status in December
1977. The market for trucking services was competitive and
depended heavily on demand from the oil industry. As a result,
Black Hills Trucking generally lost money after the drop in oil
prices that occurred in the mid-1980's.
6. True Ranches
Dave True individually owned and operated cattle ranches as
early as 1957. In 1976, the True family incorporated the ranches
and their operations as True Ranches, Inc., a Wyoming corporation
that elected to be treated as an S corporation from its formation
(ranching S corporation). The True children each purchased a 1-
percent interest in the ranching S corporation on formation.
Later, the True family formed Double 4 Ranch Co., a Wyoming
partnership, to engage in ranching operations in Australia. The
initial partners and ownership percentages were: Dave True (63
percent), Jean True (5 percent), and the True children (8 percent
each). In 1983, the partnership’s name was changed to True
Ranches, a Wyoming partnership (ranching partnership), and it
began leasing ranching assets from the ranching S corporation.
The ranching S corporation was dissolved in 1986; thereafter, all
ranching activities were conducted by the ranching partnership.
- 21 -
True Ranches operated on 350,000 acres of owned and leased
land in Wyoming. It is a vertically integrated cattle operation,
running herds of cows and their offspring from conception through
finishing ready for slaughter. True Ranches also operated
feedlots and farmed to produce feed for its own cattle, including
grass hay, alfalfa hay, and corn.
True Ranches maintained a year-round breeding herd on eight
operational units and cross-bred three breeds of cattle, Angus,
Charolais, and Hereford. The weaned, heavier steer calves went
into one of the feedlots for finishing, while the lighter steers
were wintered on hay and energy feeds and were subsequently sent
to feedlots at heavier weights. When finished cattle were ready
for slaughter, True Ranches would sell them to the packers
directly, without using auctions or third parties. Besides
finishing all its own raised cattle, True Ranches also purchased
outside cattle to maximize the use of its feedlot capacity.
7. White Stallion Ranch, Inc.
White Stallion Ranch, Inc. (White Stallion), an Arizona S
corporation, was formed in 1965 to operate a dude ranch.
Initially, the stock was owned by Dave True (47.5 percent) and
Jean True (2.5 percent), and by Dave True’s brother, Allen True
(25 percent), and his wife, Cynthia True (25 percent).
The shareholders contracted to restrict the transfer of
White Stallion stock outside the families of Allen True
- 22 -
(designated Group 1) and Dave True (designated Group 2). The
contract required the transferring shareholder first to offer any
shares for sale to the remaining member of his group. If no such
member remained, the transferring shareholder had to offer the
shares to members of the other group, equally. In all cases, the
purchase price was book value (excluding intangibles), which was
to be determined by White Stallion’s certified public accountant.
In 1982, the True children each purchased 4-percent interests
from Dave True at book value, thereby becoming members of Group
2. In the same year, Allen True and Cynthia True gave 12.5-
percent interests to each of their two children, who then became
members of Group 1.
8. Other True Companies
The True family owned and operated at least 19 other
businesses, including a bank holding company (Midland Financial
Corp.), a drilling supplies wholesaler (Toolpushers Supply Co.),
and an environmental cleanup company (True Environmental
Remediating LLC). Those that were formed as corporations were
incorporated under the laws of Wyoming, except for Midland
Financial Corp., a Delaware corporation. Those that were formed
as general partnerships (and limited liability companies) were
also organized under Wyoming law.
- 23 -
C. Methods of Accounting Used by True Companies
Most of the True companies maintained their books and
records on a tax basis and not in accordance with generally
accepted accounting principles (GAAP). There were two
exceptions: (1) Belle Fourche had GAAP basis books before the
Trues obtained 100-percent ownership, and (2) Midland Financial
Corp. kept its books according to bank regulatory requirements,
which approximated GAAP.
For certain True companies, there were substantial
differences between book value computed on a tax basis and book
value computed on a GAAP basis. For Black Hills Trucking and
Belle Fourche, the differences resulted primarily from deducting
accelerated depreciation of tangible personal property for income
tax purposes. No significant tax to GAAP differences existed for
Eighty-Eight Oil (and its predecessors) because the bulk of the
assets held after spinning off the trucking division consisted of
cash and cash equivalents. True Oil’s tax to GAAP discrepancies
resulted from: (1) Deduction of intangible drilling costs for
tax purposes versus capitalization under either the successful
- 24 -
efforts10 or full cost11 methods permitted by GAAP and (2)
deduction of the higher of cost or percentage depletion for tax
purposes. In the case of True Ranches, tax to GAAP differences
arose primarily from the deduction of prepaid feed expenses for
tax purposes. Because feed expenses and other costs of raising
livestock were deducted in the years paid, no cost basis was
allocated to raised (as opposed to purchased) livestock.
True Oil maintained a qualified profit-sharing plan. The
contribution formula required that intangible drilling costs not
be deducted in computing annual profit for plan purposes.
Without this adjustment, True Oil might never have reported a
profit and therefore, would not have been required to make any
contributions to the plan to provide retirement benefits for
employees.
D. Family Members’ Employment in True Companies
Jean True worked in the family businesses in various
capacities. She coordinated construction, renovation, and
maintenance of the True companies’ buildings and managed customer
10
The successful efforts method capitalizes oil and gas
exploration costs if they produce commercial reserves but
otherwise currently deducts the cost of dry holes. See Brock et
al., Petroleum Accounting Principles, Procedures, & Issues, at
224-225 (3d ed. 1990).
11
The full cost method capitalizes all oil and gas
exploration costs whether or not they result in dry holes. An
annual (downward) adjustment may be required if such capitalized
costs exceed the market value of underlying reserves. See id. at
230, 337-338, 350.
- 25 -
and employee relations. She attended business meetings and
industry functions with Dave True, entertained customers and
business associates in their home, and administered various
employee awards programs.
The True children, and sometimes grandchildren and
children’s spouses, also worked for the True companies over the
years. From junior high school through college, the True sons
spent summers, holidays, and weekends working as roustabouts and
lease scouts in the oil fields, roughnecks on the drilling rigs,
and ranch hands on the family ranch.
After graduating from college, the True sons worked full
time for the family businesses in various capacities. In 1973,
Hank True became the manager of Black Hills Oil, and eventually
assumed responsibility for Belle Fourche, Eighty-Eight Oil, and
True Environmental Remediating LLC. Diemer True went to work for
Black Hills Oil’s trucking division in 1971, and thereafter
managed Black Hills Trucking as a separate company. He also took
charge of Toolpushers Supply Co. in 1980. David L. True
graduated from college in 1973 and became manager of True Ranches
in 1976 and of True Drilling in 1980.
While Dave True yielded operating responsibilities to his
sons over time, he retained overall decision-making authority.
However, he exercised this authority by building consensus
through discussions with his wife and sons rather than by edicts.
- 26 -
After Dave True died, the True sons added joint management
responsibility for True Oil to their other duties.
Tamma Hatten briefly worked for the True companies as
personnel coordinator. Her husband, Donald Hatten (Don Hatten),
worked full time for the True companies from 1973 to 1984. His
positions included assistant drilling superintendent and
assistant treasurer of True Drilling.
The True children (including Tamma Hatten before her
withdrawal, see infra pp. 39-42) always owned equal percentage
interests in each True company, regardless of the extent of their
individual participation in managing the various businesses.
Starting as high school students, the True children
participated in the True companies’ annual supervisors’ meetings
and semiannual family business meetings. Once they became
owners, the True children and their spouses began attending
monthly Partners, Officers, Directors, and Shareholders meetings
(PODS meetings). The PODS meetings followed an agenda and kept
the family informed of the True companies’ operations.
All the True children had children of their own by the time
Dave True died; Tamma Hatten and Diemer True also had
grandchildren. Only two of Diemer True’s children, out of all of
the grandchildren and great-grandchildren, worked full time for
the True companies.
- 27 -
E. Family Gift Giving and Business Financing Practices
Dave and Jean True made gifts to some or all of their
children (and their children’s spouses) every year but one
between 1955 and 1993; gifts were not made in 1984 due to the
oversight of an in-house accountant-bookkeeper. They gave cash
or ownership interests in various True companies valued at the
maximum allowable amount that would not trigger gift tax (except
for 1973, the only year in which taxable gifts occurred).
When the True children were minors, the gifts were
administered through a guardianship arrangement established by
Dave True, as guardian. In later years, cash gifts to True
children and their spouses were deposited into business bank
accounts that were separately designated by recipient. Gifts to
a spouse were first lent to the True child, and then those
combined funds were invested in the True companies, either by
purchasing ownership interests or by making interest-bearing
loans, or both. The True companies’ bookkeepers maintained
detailed records of these transactions.
The True children and their spouses never received their
gifts as cash in hand; however, the donees were generally aware
that their gifts were being invested on their behalf. They had
no specific knowledge of how or when they acquired their earliest
interests in the True companies.
- 28 -
II. True Family Buy-Sell Agreements
A. Origin and Purpose
The True-Brown partnership experience convinced Dave True
not to own businesses with outsiders. He therefore used buy-sell
provisions to restrict a related owner’s ability to sell outside
the True family. Such provisions were included in partnership
agreements, for True companies that were partnerships, and in
stockholders’ restrictive agreements, for those that were
corporations (collectively, buy-sell agreements).
The original Eighty-Eight Oil, True Oil, and True Drilling
partnership agreements, entered into by Dave and Jean True in the
mid-1950's, prohibited a partner from transferring or encumbering
his or her interest. In addition, they provided that if Jean
True were to die or become disabled, Dave True would be obligated
to purchase her interests at book value. Alternatively, the
partnership would terminate with Dave True’s death or disability.
These agreements served as prototypes for later buy-sell
agreements. Dave True incorporated the provisions restricting
transfers to outsiders and setting the transfer price at book
value into all subsequent versions of the True companies’
corporate and partnership buy-sell agreements (except for White
Stallion--see infra p. 48).
Dave True also felt strongly that owners should actively
participate in the family business to avoid any divergence of
- 29 -
interests between active and passive owners. He had witnessed
the conflicts that arose in other families when active owners
wanted to retain profits and grow the business, while passive
owners sought to distribute and consume profits. Accordingly, in
1973, after all the True children (or their spouses) were working
full time in the business, Dave True incorporated an active
participation requirement into the True family buy-sell
agreements. In general, the active participation requirement
provided that if an owner (or owner’s spouse) ceased to devote
all or substantial time to the business, he or she would be
deemed to have withdrawn from the business, absent unanimous
agreement to the contrary by the active owners.
Dave True’s philosophy was further memorialized in the
August 1988 “Policy for the Perpetuation of the Family Business”
(policy), which was executed by the then-active participants and
spouses. The policy articulated and adopted Dave True’s goal “to
perpetuate the family business by providing for ownership
succession through family members who qualify as active
participants”. The policy defined “active participants” as
follows:
Active participants are those family member-owners who
actively participate in the decision-making process for
family business decisions and policies or who work full
time in the businesses. The goal in designating active
participants is to avoid fragmentation of the family
business in future generations and to meld it into a
rational business organization. A family member who
limits their involvement principally to disbursing
- 30 -
dividends or cash payments to him or herself or other
family members shall not be an active participant nor
retain ownership. * * * A non-active family member-
owner may designate his or her spouse who does work
full time in the business to be considered for
qualification of the family member-owner as an active
participant. * * *
B. First Transfers of Interests in Belle Fourche, True Oil,
and True Drilling to True Children
In the early 1970's, the True children acquired interests in
three True companies: Belle Fourche, True Oil, and True
Drilling. Dave True’s purpose in enabling his children to
acquire these interests was to perpetuate the family businesses
by fostering the children’s interest in owning and managing them.
Dave True was in good health in 1971 and 1973 when he
orchestrated these acquisitions by his children.
In August 1971 (as described supra pp. 17-18), Belle Fourche
sold stock, representing a 1-percent ownership interest, to each
True child for a combination of cash and loans made to the
corporation by the child.12 At that time, the True children
ranged from approximately 21 to 31 years of age. The purchase
price ($38.69 per share) was based on Belle Fourche’s book value
as of the end of the preceding fiscal year, less dividends paid
within 2-1/2 months thereafter. Subsequently, the stockholders
12
Mr. Harris testified that Dave True sold 1-percent
interests in Belle Fourche to each of his four children.
However, the minutes of the Belle Fourche Board of Directors
meeting and the SRC appraisal indicate that the company sold its
stock to the children.
- 31 -
executed a Stockholders’ Restrictive Agreement (corporate buy-
sell agreement), which provided that if a stockholder died or
otherwise wished to sell stock, the remaining stockholders would
purchase it in amounts directly proportional to their preexisting
holdings. The purchase price was to be the book value of the
stock at the end of the preceding fiscal year, less any dividends
paid to stockholders within 2-1/2 months immediately following
the fiscal yearend. The corporate buy-sell agreement stated that
it was binding upon the heirs and executors of a deceased
stockholder. It did not include an active participation
requirement because David L. True was still in college when the
agreement was executed.
Effective August 1, 1973, Dave True gave each of his
children an 8-percent interest in True Oil and in True Drilling.
At that time, the True children ranged from approximately 23 to
33 years of age. As a result of these gifts, the new partners
made the following identical amendments (among others) to both
companies’ partnership agreements (partnership buy-sell
agreements):
5. No partner shall in any way attempt to dispose of,
sell, encumber, or hypothecate his interest in the
partnership except in accordance with the provisions of
the Partnership Agreement relating to withdrawal or
death of a partner, or, except in the normal course of
business, any of the assets thereof.
6. If any partner shall resign, become legally
disabled or bankrupt, assign his interest in the
partnership for the benefit of his creditors, or
- 32 -
institute any proceedings for temporary or permanent
relief from his liabilities, or shall suffer an
attachment or execution to be levied on his share or
interest in the partnership, or a judgment shall be
entered against him and stay of execution thereupon
shall expire, or if he shall attempt to encumber or
hypothecate his partnership interest, he shall be
deemed to have filed a Notice of Intent to Withdraw,
and his interest in the partnership shall be disposed
of as provided in this Agreement.
7. In the event of the death of a partner or the
filing with the partnership by a partner of Notice of
Intent to Withdraw (the deceased partner or the partner
filing such notice shall hereinafter be referred to as
the “Selling Partner”), the Selling Partner shall be
obligated to sell and the remaining partners shall be
obligated to purchase the Selling Partner’s interest in
the partnership for the purchase price described
herein. The remaining partners shall purchase the
Selling Partner’s interest in proportion to their
respective shares in the net profits of the partnership
and the purchase price shall be payable within six
months after death or the filing of the Notice of
Intent to Withdraw. The purchase price of the Selling
Partners’s interest shall be the book value of the
partnership multiplied by the Selling Partner’s
percentage interest in the net profits of the
partnership, [13] said book value to be determined as
of the end of the month immediately preceding the date
of the death or filing of Notice of Intent to Withdraw
less any withdrawals made by the partners subsequent to
end of the preceding month. The book value of the
partnership shall be determined in accordance with the
accounting methods and principles customarily followed
by the partnership. Appropriate adjustments shall be
made for over or under withdrawals by a partner.
8. The partnership shall continue in business and
shall not be terminated unless the holders of 50% or
more of the total interest in partnership capital and
profits sell their interests as provided herein, or
unless all of the partners agree to such termination.
13
See infra p. 47 and note 20.
- 33 -
9. In the event that a partner or partner’s spouse
ceases to devote all or a substantial part of his time
to the business of the partnership, he shall be deemed
to have filed with the partnership a Notice of Intent
to Withdraw, unless the remaining partners unanimously
agree to permit such partner to continue as a partner.
The True children received no independent legal or
accounting advice when they entered into the buy-sell agreements.
They did not know who drafted the agreements or why, in the case
of Belle Fourche, they were required to structure the purchase
with a combination of stock and debt. However, the True
children, having been exposed from childhood to Dave True’s
business philosophy, understood his reasons for including the
active participation and book value purchase price requirements
in the buy-sell agreements.
Dave True consulted with Mr. Harris, the family’s longtime
accountant and principal tax and economic adviser, and C.L.
Tangney (Mr. Tangney), Mr. Harris’s employer, before entering
into the buy-sell agreements. On one occasion, Dave True also
discussed the True Oil and True Drilling buy-sell agreements with
Claude Maer (Mr. Maer), an attorney who was assisting the True
companies on an unrelated income tax matter.
Dave True mainly consulted with Mr. Harris regarding using a
tax book value purchase price formula under the buy-sell
agreements. Mr. Harris was not a professional appraiser and had
no significant practical experience in valuing businesses.
- 34 -
The buy-sell agreements did not provide a mechanism for
periodic review or adjustment to the book value purchase price
formula, other than what would occur as a result of changes in
book value.
Messrs. Harris and Tangney recommended that Dave True obtain
an appraisal of True Oil’s oil and gas reserves contemporaneously
with the gifts to the children because they expected the book
value gift valuation to be challenged by the Internal Revenue
Service (IRS). Either the True Companies or Dave and Jean True,
personally, had been audited for income tax purposes regularly in
all tax years preceding the gifts. The appraisal was prepared by
Bernie Allen14 (B. Allen report), an engineer from Casper,
Wyoming, before Dave True made the gifts of True Oil interests to
his children. No appraisal of Belle Fourche was prepared
contemporaneously with the sale of 1-percent interests to the
True children.
The B. Allen report indicated that as of August 1, 1973,
True Oil had reserves of 5,297,528 barrels of proved developed
oil and 8,551,994 thousand cubic feet (Mcf) of proved developed
gas, and that the fair market value of its oil and gas properties
14
The B. Allen report was not admitted into evidence because
it could not be located at the time of trial. However, the SRC
appraisal prepared for purposes of the subsequent True Oil gift
tax case cited valuation data derived from the B. Allen report.
We assume that the information contained in the SRC appraisal
accurately reflects the data set forth in the B. Allen report.
- 35 -
(including leases) was $9,941,000. The results of the B. Allen
report were generally discussed at True family meetings; however,
there is no evidence in the record that the True children
reviewed the report in detail before signing the True Oil buy-
sell agreement. Mr. Harris did not use the B. Allen report to
advise members of the True family (at the time of signing the
True Oil buy-sell agreement) that tax book value was the
appropriate standard; he reviewed the report only in connection
with subsequent gift tax litigation.
C. Wyoming U.S. District Court Cases on Belle Fourche
and True Oil Transfers
Dave True timely filed a 1973 Federal gift tax return
reporting gifts of an 8-percent interest in True Oil and in True
Drilling to each of his children. Jean True consented to treat
the gifts as having been made one-half by each spouse. Each True
Oil gift was reported to have a fair market value of $54,653,
which represented the tax book value of an 8-percent interest as
of August 1, 1973. The 1971 transfers of Belle Fourche stock to
the True children (valued at $38.69 per share) had not been
reported on a gift tax return because they were structured as
sales by the corporation.
The Commissioner determined gift tax deficiencies against
Dave and Jean True for the 1971 Belle Fourche transfers. The
Trues paid the gift taxes assessed and filed a refund suit in the
U.S. District Court for the District of Wyoming, designated as
- 36 -
True v. United States, Docket No. C79-131K (D. Wyo., Oct. 1,
1980) (1971 gift tax case). On October 1, 1980, after a trial,
the District Court (Judge Kerr) issued Findings of Fact and
Conclusions of Law that stated: “Taking into consideration all
of the facts and circumstances including the reasonable
inferences to be drawn therefrom, * * * the fair market value of
the stock in question as of the date of August 2, 1971 was $38.69
per share”, the book value price at which the sales to the True
children had been made. Judgment was entered accordingly, and
the United States did not appeal.
The Commissioner also determined gift tax deficiencies
against Dave and Jean True for the 1973 gifts to the True
children of partnership interests in True Oil and True Drilling.
However, the Commissioner conceded the deficiency relating to
True Drilling. The Trues paid the True Oil gift tax deficiencies
and filed a refund suit with the same court as the 1971 gift tax
case, designated as True v. United States, Docket No. C81-158,
reported as 547 F. Supp. 201 (D. Wyo. 1982) (1973 gift tax case).
On September 27, 1982, after a trial, Judge Kerr issued a
Memorandum Opinion that concluded:
Taking into consideration all the facts and
circumstances and the reasonable inferences to be drawn
therefrom, * * * the method of valuation used by the
plaintiffs in this case offers a more complete and fair
estimation of the fair market value to be used in the
valuation of the 8% interests given as gifts to
plaintiffs’ children. Application of plaintiffs’
valuation method results in a finding * * * that the
- 37 -
fair market value of each 8% interest was properly
determined at $54,653.
Judgment was entered accordingly, and the United States did not
appeal.
Although members of the True family asserted at trial that
they believed that the book value buy-sell provisions were valid
and enforceable as a result of the favorable outcomes of the 1971
and 1973 gift tax cases, neither they nor Dave True engaged
counsel to advise them of the legal effects of those cases on
future transfers pursuant to the buy-sell agreements. In fact,
as described infra pp. 51-52, Dave True saw the 1993 transfers as
his opportunity to test the ability of the buy-sell agreements to
fix Federal gift tax value.
In preparing for litigation of the 1971 and 1973 gift tax
cases, Dave True obtained appraisals for the transferred
interests in Belle Fourche (valued as of August 2, 1971) and True
Oil (valued as of August 1, 1973) from Standard Research
Consultants (SRC). The SRC appraisals supported the True family
positions in the 1971 and 1973 gift tax cases.
After evaluating Belle Fourche’s historical performance,
along with overall economic and industry trends, SRC used the
earnings and book value approaches to derive a “freely traded
value” for the transferred stock. The earnings approach required
determining various price-earnings multiples for comparable
public companies, adjusting them for Belle Fourche’s unique
- 38 -
characteristics, and applying them to Belle Fourche’s actual
earnings data. Similarly, the book value approach analyzed rates
of return on common stock equity and price-to-book value ratios
of comparable public companies and applied them (after
adjustments) to Belle Fourche’s actual book value at the
valuation date. After assigning more weight to the earnings
approach, SRC derived a freely traded value for Belle Fourche
stock of $120 per share. SRC explained that the freely traded
value “would have been * * * [the] fair market value on the
valuation date * * * had there been an active public market for
the stock at that time.”
SRC opined that, because Belle Fourche lacked a public
market for its stock and the transferred shares represented
minority interests, a willing, knowledgeable buyer would demand a
discount from the freely traded value. While SRC examined
average marketability discounts15 used in public company
transactions, it did not use this information in its analysis.
Instead, SRC concluded that, because the minority interest
shareholders (the True children) could never look forward to a
public market and were limited to the sales price fixed in the
15
SRC described the transferred interests’ lack of
marketability and control as being “infirmities” that must be
accounted for in any sale to a hypothetical purchaser. However,
SRC’s analysis seemed to blend the two concepts, and, ultimately,
referred only to a marketability discount and not to a minority
discount.
- 39 -
buy-sell agreement, the fair market value of their shares on
August 2, 1971, was the book value calculated under the buy-sell
agreement, or $38.69 per share.
SRC generally followed the same methodology in valuing the
partnership interests in True Oil transferred by Dave True as of
August 1, 1973. However, instead of using the book value
approach, SRC used the net asset value (NAV) approach combined
with the earnings approach. This required a two-step process:
(1) Marking the balance sheet to market to derive NAV, and
(2) applying a discount to NAV based on comparable public
companies’ ratios of price to NAV. After again assigning greater
weight to the earnings approach, SRC determined the freely traded
value of an 8-percent interest in True Oil to be $535,000
(rounded) on the valuation date. Finally, SRC applied the same
lack of public market rationale, as in its Belle Fourche
appraisal, to disregard the freely traded value and to conclude
that fair market value was limited to the buy-sell agreement
formula price, or $54,653 for an 8-percent interest.
D. Tamma Hatten’s Withdrawal From True Companies
Tamma Hatten had never shown an avid interest in
participating in the True family businesses, and her husband had
played a relatively minor role in the management of the True
companies. On July 23, 1984, when Tamma Hatten was 44 years old,
she notified her family (in writing) of her intent to withdraw
- 40 -
from and sell her interests in the True companies, as required
under the buy-sell agreements. She and her husband were eager to
purchase and independently run their own ranching operation.
Tamma Hatten did not seek separate legal or other professional
counsel in connection with the sale of her interests in the True
Companies. Instead, she relied on Dave True and his advisers to
determine the sales prices of all those interests under the buy-
sell agreements and to structure the methods of payment.
Dave True’s legal advisers drafted the Agreement for
Purchase and Sale of Assets, dated August 10, 1984, which
outlined the terms for sale of Tamma Hatten’s business holdings
(including partnership interests, corporate stock, notes, and
lease interests). The total purchase price was $8,571,296.22,
composed of a cash payment of $4,234,000 and payment to a
specially created escrow account for the balance. The escrow,
established by Dave True and his advisers, deviated from the
requirements of the True companies’ buy-sell agreements. Its
purpose was to provide security for payment of Tamma Hatten’s
share of accrued contingent liabilities (if any) and a management
vehicle for her investments.
Tamma Hatten received over $8.5 million in aggregate value
for her True companies’ interests, but that amount included
certain offsets. For example, both Eighty-Eight Oil and True Oil
had negative book values at the buy-sell agreements’ valuation
- 41 -
dates; as a result, Tamma Hatten in effect was required to pay
the other owners in order to dispose of her interests in those
companies (i.e., her overall sales proceeds were reduced). The
negative offsets were $1,405,449.35 for Eighty-Eight Oil and
$466,560.35 for True Oil. In the case of True Oil, the negative
book value was attributable to the deductions, which had been
taken for tax purposes, of intangible drilling and development
costs.
After the sale, Tamma and Don Hatten moved from Casper to
Thermopolis, Wyoming, where they bought a ranch and were no
longer involved in True family business activities. Dave and
Jean True thereafter ceased making annual gifts to Tamma and
amended their wills (and other estate planning documents) to
delete any specific provision for Tamma Hatten and her family.16
This was done because the Trues believed that Tamma Hatten was
financially secure as a result of the sale. Moreover, Dave True
believed that his estate should go to his sons so that they might
invest the assets in the family businesses. One of Dave True’s
testamentary documents entitled “Appointment of Trust Estate”
(appointment document), see infra p. 53, characterized the
circumstances as follows:
16
However, under sec. 5.3 of the Appointment of Trust Estate
dated Sept. 14, 1984, if Dave True were to have been predeceased
by his wife, sons, and his sons’ lineal descendants, then Tamma
Hatten would have been the taker in default of Dave True’s
estate.
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2.5 Advancement. Prior to the time of execution
[of this Appointment], my daughter, Tamma T. Hatten,
* * * severed her financial ties with the True
companies, and thus her potential inheritance has been
fully satisfied during my lifetime.
There is no current expectation by Tamma Hatten, her mother, or
her brothers, that Jean True or any other member of the True
family will make any further financial provision for Tamma or her
family.17
E. Use of Similar Buy-Sell Agreements in All True
Companies Except White Stallion; Amendments and Waivers
The buy-sell agreements (and related amendments) used by the
True family were substantially identical, except for White
Stallion. In general, the partnership buy-sell agreements
mirrored True Oil’s partnership agreement, and the corporate buy-
sell agreements mirrored Belle Fourche’s Stockholders’
Restrictive Agreement. The buy-sell agreements were not tailored
to the specific type of business or industry in which each True
company operated, and they all shared the following attributes:
(1) Transfer restrictions, (2) mandatory purchase and sale
requirements, (3) book value purchase price formulas derived
using the company’s customary accounting methods (tax basis), and
(4) active participation (by owner or spouse) requirements.
17
The only exception is the True Family Education Trust,
created by Dave and Jean True in 1983 (before Tamma Hatten’s
withdrawal) for the benefit of all the True children’s
descendants. Dave and Jean True contributed to this trust, which
is irrevocable, after their daughter’s withdrawal. Therefore,
Tamma Hatten’s descendants have continued to derive financial
benefits from this trust.
- 43 -
Over the years, the buy-sell agreements were amended on
several occasions. Generally applicable amendments included:
(1) Clarifying that owners could transfer their interests to
qualified revocable living trusts without triggering the buy-sell
provisions, (2) applying the buy-sell provisions to sales of
partial interests, and (3) making special allowances for an
owner’s legal disability. In addition, the Belle Fourche buy-
sell agreement was amended as of August 1, 1973, to include,
inter alia, an active participation requirement that previously
had been omitted due to David L. True’s status as a student at
the time of the original sales to the children in 1971.
All the preexisting buy-sell agreements were amended and
restated as of August 11, 1984 (1984 amendments), to reflect,
among other things, Tamma Hatten’s withdrawal from the True
companies.18 In most cases, the 1984 amendments were the last
amendments made to the buy-sell agreements before Dave True’s
death.19
The parties to the corporate buy-sell agreements, as amended
and restated by the 1984 amendments, were: Dave and Jean True,
the True sons, and the subject corporation. The amended
18
Except White Stallion, which was amended on Sept. 20,
1984.
19
True Environmental Remediating LLC’s operating agreement
was not entered into until June 30, 1992. However, its
provisions were consistent with the 1984 amendments to the other
True companies’ buy-sell agreements.
- 44 -
corporate buy-sell agreements included the following relevant
provisions:
1. Restriction of Stock. a. Until termination of
this agreement none of the stock of the company shall
pass or be disposed of in any manner whatsoever,
whether by voluntary or involuntary action, to any
person, partnership or corporation except in accordance
with the terms of this agreement; * * *. * * *
b. Each share of stock shall remain subject to
this agreement, and each corporation (including the
Company), partnership, trust, and person who now holds
or may acquire any of the stock, in any manner,
nevertheless shall hold it subject to the provisions of
this agreement whenever and as often as any of the
sales events herein mentioned may occur.
2. Events requiring the mandatory sale and
purchase include any attempt to pass or dispose of the
stock in any manner whatsoever, whether by voluntary or
involuntary act, specifically including, but not
limited to, the following events (hereinafter called
“sales events”):
2a. Sale. In the event any Shareholder desires
at any time to sell all or part of his or her stock in
the Company, he or she shall so notify the Purchasing
Shareholders in writing. * * * Thereafter, the Selling
Shareholders shall sell and the Purchasing Shareholders
shall purchase such stock in accordance with the terms
of paragraphs 3, 4, and 5 hereof. Such sale and
purchase shall be consummated within six (6) months
after receipt by the Purchasing Shareholders of such
written notice.
2b. Death of Shareholder. In the event of the
death of any one of the * * * [Shareholders], the
deceased Shareholder, as the Selling Shareholder, shall
sell and the Purchasing Shareholders shall purchase all
the stock of the Selling Shareholder in accordance with
paragraphs 3, 4, and 5 hereof. This agreement shall be
binding upon the heirs and personal representatives of
such decedent and the trustees of any qualified trust,
all of which shall be included in the term “Selling
Shareholder.” The actual transfer relating to such
sale and purchase as herein provided shall be made
- 45 -
within six (6) months after such Shareholder’s death.
* * *
* * * * * * *
2d. Shareholders’ Required Activities. In the
event a Shareholder or his or her spouse ceases to
devote all or a substantial part of his or her time to
the business of the company or any one of its
affiliates for any reason, * * * such Shareholder shall
be deemed to be the Selling Shareholder and to have
notified the other Shareholders of a desire to sell his
or her stock as provided in paragraph 2a unless the
remaining Shareholders unanimously agree to permit such
a Shareholder to continue as a Shareholder.
3. Buy and Sell Agreement. The parties hereto
agree that on the occurrence of each and every sale
event, the Selling Shareholder, shall sell to the
Purchasing Shareholders, and the Purchasing
Shareholders shall purchase, in direct proportion to
the interest which each owns in said corporation
represented by stock ownership in the company * * * all
of the shares of stock owned by or for the benefit of
the Selling Shareholder or all of the shares offered
for sale by the Selling Shareholder for the purchase
price as set forth in paragraph 4 below.
4. Price. The price of any shares sold hereunder
shall be the book value of the stock at the end of the
preceding fiscal year, less any and all dividends paid
to the Shareholders prior to the effective date of
sale, plus income computed in accordance with the
Internal Revenue regulations generally requiring
allocation on a per share, per day basis. The book
value of the stock shall be determined in accordance
with the accounting methods and principles customarily
followed by the corporation. [Emphasis added.]
5. Effective Date. The effective date for the
determination of purchase price and transfer of stock
will be the earliest of (A) the date of death of the
Selling Shareholder * * * or (C) the date of notice of
desire to sell as herein defined. Except that for
purposes of (A) * * * above, if such date falls within
two and one-half (2-1/2) months following the end of a
fiscal year, the effective date will be two and one-
half (2-1/2) months after the end of that fiscal year.
- 46 -
6. Termination. This agreement shall remain in
force until death of the survivor of the Shareholders
* * * and shall then terminate.
Before the 1984 amendments, the book value price
formula in the corporate buy-sell agreements was different.
Formerly, the price was computed by taking the stock’s book value
at the end of the preceding fiscal year less dividends paid
within 2-1/2 months immediately following the fiscal yearend.
Furthermore, there was no reference to a per share, per day
allocation of income before the 1984 amendments.
The partnership buy-sell agreements, as amended and restated
by the 1984 amendments, included substantively identical
provisions to those cited above. However, the following
modifications, which were unique to partnerships, were included:
20. Price. The price of any partnership interest
or portion thereof shall be the book value of the
Selling Partner’s capital account as of the close of
business of the day immediately preceding the sales
event. The book value of such capital account shall be
determined in accordance with the accounting methods
and principles customarily followed by the partnership,
and in accordance with the Internal Revenue Code and
appropriate regulations relating to the determination
of the Partner’s distributive share of income, expenses
and other partnership items. [Emphasis added.]
21. Effective Date. The effective date for the
transfer of partnership interest shall be the date of
death of a Partner, * * * or the date of an event
requiring a mandatory sale and purchase.
22. Termination of Partnership. The partnership
shall continue in business and shall not be terminated
unless the holders of 50% or more of the total interest
in partnership capital and profits sell their interests
within the same year as provided herein, or unless all
- 47 -
of the Partners agree to such termination. In such
event, the interest of the Partners shall be settled
and adjusted in the same manner, and upon the same
basis as provided in the death or disability of a
Partner.
Before the 1984 amendments, the book value price formula in
the partnership buy-sell agreements was different. Formerly, the
purchase price was determined as of the end of the month
immediately preceding the sales event and was computed by
multiplying the book value of the partnership (less any
withdrawals made by the partners after the end of the preceding
month) by the Selling Partner’s percentage interest in
partnership net profits (percentage of total partners’ capital
formula).20
At times, members of the True family formally waived their
purchase rights under the various True companies’ buy-sell
agreements. For example, in connection with the merger of Black
Hills Oil into Black Hills Trucking in 1980, the True family
agreed to waive any Black Hills Trucking buy-sell provision that
would restrict the exchange of stock between the two companies.
In April 1981, the True family waived the Belle Fourche buy-sell
provision requiring all purchases to be in proportion to the
20
The percentage of total partners’ capital formula first
appeared in the amended partnership agreement between Dave True,
Jean True, and the True children dated Aug. 1, 1973. However,
the original partnership agreement between Dave and Jean True
dated June 1, 1954, calculated the purchase price based on the
selling partner’s capital account balance at the close of the
month closest to the sales event.
- 48 -
owners’ preexisting ownership percentages in order to allow Jean
True and the True children (but not Dave True) to purchase
additional shares from the company. Similarly, Jean True waived
her purchase rights under the Rancho Verdad buy-sell agreement in
July 1983, when Dave True sold 8-percent interests to each of the
True children, thereby allowing them to enter that partnership.
Lastly, in October 1985, the True family waived their purchase
rights under the Toolpushers buy-sell agreement to allow the
trustee of the True Companies Employees’ Profit Sharing Trust
(Employees’ Trust) to sell its Toolpushers stock back to the
company.21
F. Unique Provisions of White Stallion Buy-Sell Agreement
In July 1982, the original White Stallion buy-sell
agreement, see supra p. 22, was amended to reflect the admission
as stockholders of Dave and Jean True’s children and Allen and
Cynthia True’s children. While the White Stallion buy-sell
agreement shared some of the common characteristics of other True
company agreements, it also contained certain unique provisions.
For example, under the provision entitled “Buy and Sell
Agreement”, if a stockholder were to die, become legally
disabled, or desire to sell all or part of his stock, the
21
Under the Nov. 20, 1976, Toolpushers Stockholders’
Restrictive Agreement, Employees’ Trust was specifically exempted
from the buy-sell restrictions. As a result, the October 1985
purchase price for Employees’ Trust’s shares was not limited to,
and in fact exceeded, book value.
- 49 -
remaining members of his group (Allen True’s family comprised
group 1, and Dave True’s family comprised group 2) were obligated
to purchase the stock on a pro rata basis. The stockholder, his
heirs, and trustees, etc., were likewise obligated to sell to
those group members. Similar to the other True companies’ buy-
sell agreements, the purchase price reflected the transferred
shares’ book value at the end of the preceding fiscal year, less
dividends paid within 2-1/2 months of such fiscal yearend.
An additional restriction, found only in White Stallion’s
buy-sell agreement, provided:
13. First Right of Refusal. If the Shareholders
holding 100% of the stock held in either Group 1 or
Group 2, above, desire to transfer by lifetime sale all
of the interests held by Shareholders comprising that
group (hereinafter “Selling Group”) to someone other
than the Shareholders comprising the other group
(hereinafter “Nonselling Group”), the Selling Group
shall not do so without first offering in writing to
sell such interests to the Shareholders comprising the
Nonselling Group on the same terms and conditions as
any bona fide offer received (in writing) by the
Selling Group for its interests. The Nonselling Group
shall have thirty (30) days from the date the written
offer and proof of the bona fide offer are mailed to
the Nonselling Group within which to accept such offer
in writing. Each Shareholder comprising the Nonselling
Group shall have the right to purchase the Selling
Group’s interest, in the ratio that his or her stock
bears to the total stock held by the Nonselling Group.
If a Shareholder in the Nonselling Group declines to
exercise his or her rights to purchase a portion of the
Selling Group’s stock interest, the remaining
Shareholders comprising the Nonselling Group desiring
to purchase such portion shall have an additional
fifteen (15) days to do so in the ratio that their
stock ownership bears to the total stock ownership of
the Shareholders comprising the Nonselling Group
exercising such right to purchase.
- 50 -
This provision was included in the White Stallion buy-sell
agreement at Allen True’s request.
The White Stallion buy-sell agreement was amended and
restated again on September 20, 1984, to reflect, inter alia,
Tamma Hattan’s withdrawal from the partnership.
G. Future of True Family Buy-Sell Agreements
After Dave True’s death and Jean True’s subsequent sale of
most of her interests ,see infra pp. 53-55, the True sons alone
owned a majority of the True companies,22 and they have continued
the preexisting buy-sell agreements. Under those agreements,
upon a brother’s death, his estate would be required to sell, and
the surviving brothers would be required to purchase, the
deceased brother’s interest at book value. At the death of the
last surviving brother, the beneficiaries of his estate would
receive 100-percent ownership of the True companies. This
scenario assumes that none of the True sons’ children become
actively participating owners of the True companies, which may or
may not happen in the future.
The True sons have considered this problem and discussed it
with Mr. Harris. They have decided to wait until the conclusion
of this litigation before making any changes to the buy-sell
agreements.
22
Jean True retained her interests in only True Drilling,
White Stallion, and Smokey Oil Co.
- 51 -
III. Transfers in Issue
A. 1993 Transfers of Partnership Interests by Dave True
Effective January 1, 1993, Dave True sold part of his
ownership interest in all True companies that were partnerships
to his wife and sons, pursuant to the buy-sell agreements.
Before the transfers, Dave True held a greater than 50-percent
general partnership interest in each company. Mr. Harris
recommended that Dave True reduce his ownership interest to less
than 50 percent, in order to avoid termination of the
partnerships (for income tax purposes) at his death. Mr. Harris
was concerned that as a result of such termination, the
partnership agreements, which embodied the buy-sell provisions,
would become subject to new valuation rules under Chapter 14 of
the Internal Revenue Code (Chapter 14).23 To prevent this from
happening, Dave True sold enough of his interests to reduce his
and Jean True’s combined ownership to below 50 percent. Although
Dave True had health issues before the 1993 transfers, including
back problems and a chronic pulmonary insufficiency that required
him to be on oxygen full time, the True family and Mr. Harris did
23
The parties stipulated that the True companies’ existing
partnership agreements and shareholders’ restrictive agreements
were entered into before Oct. 9, 1990 (effective date for Chapter
14 rules), and were not substantially modified after Oct. 8,
1990.
- 52 -
not consider Dave True’s ailments to be life threatening or his
death to be imminent at the time of his 1993 transfers.24
Dave True timely filed a 1993 Federal gift tax return (Jean
True signed as consenting spouse) disclosing the transfers but
treating them as sales, thereby reporting no taxable gifts.
Mr. Harris expected the return to be audited and the transaction
to be challenged by the IRS. Dave True saw this risk as his
opportunity to test (through litigation) the existing buy-sell
agreements’ ability to fix transfer tax value of the True
companies.
On March 3, 1997, respondent issued to the estate and to
Jean True, individually, duplicate Notices of Deficiency
(collectively, 1993 gift tax notice), determining that the values
of interests transferred by Dave True in 1993 were higher than
reported book value.25 However, since issuing the original 1993
gift tax notice, respondent has conceded the reported values of
interests in Rancho Verdad and True Drilling that were
transferred by Dave True in 1993. Appendix schedule 1, infra,
24
In response to a question from the Court, Mrs. True
testified that Dave True had been a smoker, but that he hadn’t
smoked for some time before his death. Mrs. True had previously
testified that Dave True was “on oxygen for chronic bronchitis
for about 2-1/2 years before he died.”
25
Jean True’s notice of deficiency was identical to the
estate’s and was issued solely because she consented to split
gifts made by Dave True for calendar year 1993.
- 53 -
lists the transferred interests and compares the 1993 gift tax
notice values to amounts paid by the purchasers.
B. 1994 Estate Transfers
Dave True died of a heart attack on June 4, 1994. Before
his death, he had transferred substantially all his assets to his
living trust. Under section 5.2 of the living trust, Dave True
reserved the power to appoint the trust estate at the time of his
death to “such persons, corporations or other entities and in
such shares and interests as I may specify by appropriate
provisions in any instrument executed and acknowledged by me and
delivered to the [trustees of the living trust].” On September
14, 1984, Dave True had exercised his power of appointment by
executing the appointment document.
Under the appointment document Dave True bequeathed to his
sons the maximum amount that could pass without estate tax by
reason of the unified credit (equally and free of trust) and the
remainder of the trust estate to a qualified terminable interest
property trust (QTIP trust) for Jean True. At Jean True’s death
(or from the beginning, had Jean predeceased Dave), the balance
of the trust estate and any tangible personalty was to be divided
equally among his sons or their heirs. However, before these
bequests were funded, and pursuant to the terms of the buy-sell
agreements, the trustees of the living trust sold Dave True’s
interests in the True companies to Jean True, Hank True, Diemer
- 54 -
True, and David L. True at book value effective June 3, 1994.
The sales were effected by a closing that occurred on or about
September 20, 1994.
On March 3, 1995, the estate timely filed a Federal estate
tax return (estate tax return) reflecting, inter alia, the cash
proceeds received from the sale of the True companies under the
heading “H.A. True, Jr. Irrevocable [sic] Trust”.
On January 20, 1998, respondent issued the estate a notice
of deficiency (estate tax notice) determining that the underlying
values of the True companies that were reported on the estate tax
return were higher than book value. However, since issuing the
estate tax notice, respondent has conceded the reported values of
Dave True’s interests in Rancho Verdad, True Drilling,
Toolpushers Supply Co., Midland Financial Corp., Smokey Oil Co.,
Inc., and Roughrider Pipeline Co. that were sold by the estate in
1994. Appendix schedule 2, infra, lists Dave True’s interests
and compares the estate tax notice values to amounts paid by the
purchasers. In addition, respondent has stipulated that the
estate would be entitled to an increased marital deduction under
section 2056 if the value of interests in the True companies that
were sold to Jean True was determined to be greater than the
purchase prices under the buy-sell agreements.
- 55 -
C. 1994 Transfers by Jean True
After Dave True died, Jean True no longer wished to be
actively involved in all the True companies. Accordingly, on
June 30 and July 1, 1994, she gave notice to her sons of her
intent to sell most of her interests in the True companies. Jean
True sold her interests to her sons at book value, pursuant to
the terms of the buy-sell agreements.
Jean True timely filed a 1994 Federal gift tax return
disclosing the transactions but treating them as sales, thereby
reporting no taxable gifts.
On January 20, 1998, respondent issued to Jean True a notice
of deficiency (1994 gift tax notice), determining that the values
of interests she sold in 1994 were higher than reported book
values. However, since issuing the 1994 gift tax notice,
respondent has conceded the reported values of interests in
Roughrider Pipeline Co., Rancho Verdad, Toolpushers Supply Co.,
and Midland Financial Corp. that were sold by Jean True in 1994.
Appendix schedule 3, infra, lists the interests sold and compares
the 1994 gift tax notice values to amounts paid by the
purchasers.
IV. Subsequent Income Tax Litigation Regarding Ranchland
Exchange Transactions
During the 1980's, the True family (except Tamma Hatten)
purchased land and operating assets to add to their ranching
operations. Each purchase took place through the same series of
- 56 -
steps, described as follows (generally, ranchland exchange
transactions): First, instead of True Ranches directly acquiring
the ranchlands, the True family arranged for Smokey Oil Co.
(Smokey Oil) to purchase the parcels of real property for an
aggregate purchase price of over $6.8 million, while True Ranches
acquired the operating assets of each ranch. At the time, Smokey
Oil (a Wyoming S corporation) was owned by Dave True (72.3935
percent), Jean True (24.1316 percent), and the True sons (1.1583
percent each). Second, Smokey Oil transferred the ranchlands to
True Oil in exchange for selected productive oil and gas leases,
which the parties treated as a like-kind, tax-free exchange under
section 1031. Third, True Oil immediately distributed the newly
acquired ranchlands to the individual partners of True Oil (Dave
and Jean True and the True sons) as tenants in common. Fourth,
the partners then contributed their undivided interests in the
ranchlands to True Ranches by general warranty deed. The
partnership distribution and contribution transactions were
treated as nonrecognition transactions under sections 721 and
731.
The intent of the True family in carrying out this series of
acquisitions, transfers, and exchanges was to create income tax
benefits. Through the operation of section 1031(d), which
essentially provides that the basis of property received in a
nonrecognition exchange is the same as the basis of property
- 57 -
transferred, Smokey Oil received depletable oil and gas leases
with the same cost basis as the nondepreciable ranchlands it had
transferred in the exchange with True Oil. This allowed Smokey
Oil to claim cost depletion deductions for the leases on its tax
returns for 1989 and 1990 under section 612, which, if sustained,
would have resulted in substantial income tax savings to the True
family. True Oil, on the other hand, received the nondepreciable
ranchlands with a zero basis because the oil and gas leases it
exchanged pursuant to section 1031 were fully cost depleted.
Through subsequent transfers, True Ranches acquired the
ranchlands with the same zero basis as True Oil’s oil and gas
leases. By so doing, the True family intended to reap the tax
benefits of turning nondepreciable assets (ranchlands) into cost-
depletable assets (oil and gas leases) in the hands of Smokey
Oil. In addition, the ranchland exchange transactions rid True
Oil of fully cost-depleted assets (oil and gas leases) and gave
True Ranches a zero basis in otherwise nondepreciable assets
(ranchlands).
If these transactions had been effective for income tax
purposes, they would also have created transfer tax benefits by
reducing the prices payable under the True Ranches and Smokey Oil
buy-sell agreements. They would have reduced the book value of
the ranchlands to zero and thereby reduced the book value formula
prices to be paid for partnership interests in True Ranches under
- 58 -
the terms of the True Ranches buy-sell agreement. Because of the
transfer of basis to the depletable oil and gas properties, the
ultimate prices to be paid for interests in Smokey Oil under its
buy-sell agreement would have been expected to be reduced to less
than the costs of the purchased ranchlands.
On audit of the True Oil, Smokey Oil, and True Ranches tax
returns for 1989 and 1990, the IRS determined that the substance-
over-form and step transaction doctrines required that the
various intermediate steps of these transactions be collapsed and
that they be viewed as a unitary transaction in which True
Ranches acquired directly the land and depreciable assets of the
ranch properties. Because Smokey Oil was deemed not to have
acquired the ranchlands, the IRS treated these transactions as if
there had been no exchange between Smokey Oil and True Oil. The
IRS disallowed Smokey Oil’s cost depletion deductions claimed on
the leases received in the exchanges, and it allocated the income
from those leases back to True Oil.
The True family paid the deficiencies and filed
administrative claims for refund. After the IRS disallowed the
refund claims, the True family filed a refund suit in U.S.
District Court for the District of Wyoming. The Government filed
motions for partial summary judgment, contending (inter alia)
that under the step transaction doctrine the ranchland exchange
transactions were a single transaction in which True Ranches
- 59 -
alone acquired all the ranch property (real property and
operating assets). The District Court granted the Government’s
motion for summary judgment, designated as True v. United States,
No. 96-CV-1050-J, (Nov. 12, 1997), and held that the step
transaction doctrine required the recharacterization of the
ranchland exchange transactions as the IRS had determined. On
appeal, the Court of Appeals for the Tenth Circuit affirmed the
District Court’s decision regarding the ranchland exchange
transactions. See True v. United States, 190 F.3d 1165, 1177-
1180 (10th Cir. 1999). On November 15, 1999, the Court of
Appeals for the Tenth Circuit denied petitioners’ petition for
rehearing and rehearing en banc.
OPINION
I. Do Family Buy-Sell Agreements Control Estate Tax Value?
Case law and regulatory authority have interpreted the
general estate tax valuation provisions of section 2031 to
include special rules that allow qualifying buy-sell agreements
to control estate tax fair market value.
A. Framework for Analyzing Estate Tax Valuation Issues
Federal estate tax is imposed on the transfer of the taxable
estate of every United States citizen or resident. See sec.
2001(a); U.S. Trust Co. v. Helvering, 307 U.S. 57, 60 (1939).
The taxable estate is defined as the gross estate less prescribed
deductions. See sec. 2051. All property interests owned by the
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decedent at death are included in the gross estate; the value of
the gross estate generally is determined as of the date of death.
See secs. 2031(a), 2033; sec. 20.2031-1(b), Estate Tax Regs.
Fair market value is the standard for determining value of
transfers of property subject to Federal estate tax. See United
States v. Cartwright, 411 U.S. 546, 550 (1973). Fair market
value 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 facts.” Id. at 551; see sec. 20.2031-1(b),
Estate Tax Regs. The willing buyer and seller are hypothetical
persons, rather than specific individuals or entities, and their
characteristics are not necessarily the same as those of the
actual buyer or seller. See Estate of Newhouse v. Commissioner,
94 T.C. 193, 218 (1990) (citing Estate of Bright v. United
States,
658 F.2d 999, 1006 (5th Cir. 1981)). The hypothetical
willing buyer and seller are presumed to be dedicated to
achieving the maximum economic advantage. As stated in Estate of
Newhouse, 94 T.C. at 218: “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.”
Generally, the shares of a closely held corporation for
which there is no public market, in the absence of recent arm’s-
- 61 -
length sales, are to be valued by taking into account the
company’s net worth, prospective earning power, dividend-paying
capacity, and other relevant factors.26 See Estate of Andrews v.
Commissioner, 79 T.C. 938, 940 (1982); sec. 20.2031-2(f)(2),
Estate Tax Regs.; Rev. Rul. 59-60, 1959-1 C.B. 237. Similarly,
the valuation of partnership interests requires (1) a fair
appraisal (as of the valuation date) of all assets of the
business, tangible and intangible, including goodwill, (2) an
analysis of the business’ demonstrated earning capacity, and
(3) consideration of other “relevant factors” noted in the stock
valuation rules. See sec. 20.2031-3, Estate Tax Regs.
The value of property as of the decedent’s date of death is
a question of fact requiring the trier of fact to weigh all
relevant evidence of value and to draw appropriate inferences.
See Estate of Newhouse v. Commissioner, supra; Hamm v.
Commissioner, 325 F.2d 934, 938 (8th Cir. 1963), affg. T.C. Memo.
1961-347.
B. Development of Legal Standards
The legal standards for allowing buy-sell agreements to
determine estate tax value have developed over time. Some cases
26
“Other relevant factors” listed in the regulation include:
(1) Goodwill of the business, (2) economic outlook in the
particular industry, (3) company’s position in the industry and
its management, (4) degree of control represented by block of
stock to be valued, and (5) values of securities of corporations
engaged in the same or similar lines of business that are listed
on a stock exchange. See sec. 20.2031-2(f)(2), Estate Tax Regs.
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laid out fundamental objective requirements that, if met,
permitted the formula price provided by a buy-sell agreement to
establish fair market value under predecessors of section 2031.
Other cases and the estate tax regulations have expanded those
requirements to address such subjective concerns as whether the
buy-sell agreement was a bona fide business arrangement and not
merely a device to make a testamentary disposition at a bargain
price.
1. Case Law Preceding Issuance of Regulations
Before the issuance of regulations under section 2031,
courts addressed the effect of option contracts or buy-sell
agreements on the valuation of business interests by examining
whether restrictions in the agreement put a ceiling on the price
the owner (or his estate) could receive at disposition.
Specifically, buy-sell agreements were required (1) to be
enforceable against the parties, (2) to specify a price, and (3)
to bind transferors both during life and at death in order to be
given dispositive effect for estate tax valuation purposes. See
Lomb v. Sugden, 82 F.2d 166, 167 (2d Cir. 1936); Wilson v.
Bowers,
57 F.2d 682, 683 (2d Cir. 1932); Estate of Salt v.
Commissioner,
17 T.C. 92, 99-100 (1951) (generally, the Wilson-
Lomb test). Although these requirements were developed in the
context of corporate buy-sell agreements, they were also applied
to partnership buy-sell agreements. See Brodrick v. Gore, 224
- 63 -
F.2d 892, 896 (10th Cir. 1955); Estate of Weil v. Commissioner,
22 T.C. 1267, 1273-1274 (1954); Hoffman v. Commissioner,
2 T.C.
1160, 1178-1180 (1943), affd. sub nom. Giannini v. Commissioner,
148 F.2d 285 (9th Cir. 1945).
In addition, courts developed other tests to help decide
whether buy-sell agreements controlled estate tax value. In
Bensel v. Commissioner, 36 B.T.A. 246 (1937), affd.
100 F.2d 639
(3d Cir. 1938), the arm’s-length nature of the agreement
convinced the Court that a corporate buy-sell agreement
controlled estate tax value. In Bensel, 36 B.T.A. at 247, a
majority shareholder (father) had granted employee (son) an
option to purchase father’s stock at his death for a fixed price,
in order to retain son’s valuable services. Father and son were
estranged at all relevant times. See id. When son exercised the
option at father’s death, the fair market value of the stock
exceeded the option price. See id. at 249-250.
The Commissioner argued, in the alternative, for inclusion
in the gross estate at date of death value under the theory that
decedent (1) retained an interest to alter, revoke, or amend
under section 302(d) of the Revenue Act of 1926, ch. 27, 44 Stat.
71, or (2) made a transfer in contemplation of death under
section 302(c). See Bensel v. Commissioner, 36 B.T.A. at 251.
However, the hostilities and constant bargaining between father
and son convinced the Court that son was not the natural object
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of father’s bounty and that the option price was what adverse
parties dealing at arm’s length would have agreed to. See id. at
252-253. Accordingly, the Court concluded that the option was
neither a substitute for a testamentary disposition, nor a device
for avoiding estate tax, so that section 302(c) and (d) did not
apply. See id. at 253-254. Instead, son’s exercise of the
option was either a bona fide sale for adequate and full
consideration or, like Wilson and Lomb, completely outside the
scope of section 302 of the Revenue Act of 1926. See id. at 254.
Similarly, we stated in Estate of Littick v. Commissioner,
31 T.C. 181 (1958), that if “for the purpose of keeping control
of a business in its present management, the owners set up in an
arm’s-length agreement * * * the price at which the interest of a
part owner is to be disposed of by his estate to the other
owners, that price controls for estate tax purposes, regardless
of the market value of the interest to be disposed of”. Id. at
187 (emphasis added).
Other facts that courts considered in evaluating whether
buy-sell agreements should determine estate tax value included:
(1) Tax avoidance motives for entering into buy-sell agreements,
see May v. McGowan, 194 F.2d 396, 397 (2d Cir. 1952); Estate of
Littick, 31 T.C. at 186, (2) that the purchasers under the buy-
sell agreement were natural objects of the decedent-seller’s
bounty, see Hoffman v. Commissioner, 2 T.C. at 1179, and (3) that
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the buy-sell agreement’s price, when originally fixed,
represented full and adequate consideration and was not a
testamentary substitute, see id.; Bensel v. Commissioner, 36
B.T.A. at 254; Baltimore Natl. Bank v. United States, 136 F.
Supp. 642, 654 n.7 (D. Md. 1955).
The Court of Appeals for the Tenth Circuit indicated, in
Brodrick v. Gore, supra, that if a partnership buy-sell agreement
were entered into in bad faith, that could jeopardize the ability
of the agreement to control value for estate tax purposes. In
Brodrick v. Gore, 224 F.2d at 894, a father and his two sons
agreed to sell their interests in an oil and gas partnership,
during life or at death, only to each other at book value. After
the father’s death, the sons petitioned the probate court to be
compelled, as executors, to sell the father’s interest to
themselves at book value. See id. After a hearing, the probate
court found that the partnership agreement was valid, the estate
was obligated to sell at book value, the sons were obligated to
purchase, and book value27 was correctly calculated. See id. at
895.
The Commissioner determined a deficiency in estate tax on
the ground that the fair market value of the father’s interest
27
Neither the published report of Brodrick v. Gore, 224 F.2d
892, 896 (10th Cir. 1955), nor the briefs, which we have
reviewed, specify the basis on which book value was to be
computed (e.g., financial statement, tax, or cash basis) under
the partnership buy-sell agreement.
- 66 -
exceeded book value on his date of death. See id. at 895. The
sons paid the deficiency, brought a District Court refund suit,
and prevailed on a motion for summary judgment. See id. The
Commissioner appealed to the Court of Appeals for the Tenth
Circuit, which affirmed the judgment in favor of the executor-
sons. See id. at 897.
Applying the Wilson-Lomb test, the Court of Appeals for the
Tenth Circuit held that the estate tax value was properly limited
to book value because the sale to the sons at book value was
required under a reciprocal and enforceable agreement. See id.
at 896. The Court of Appeals held the probate court’s prior
judgment to be a binding determination that: (1) The executors
were obligated to sell to the surviving partners at book value
and (2) the calculation of book value was correct. See id.
The Court noted that if the Commissioner had pleaded
affirmatively that the partnership agreement was executed in “bad
faith,” or that the probate court proceeding was collusive or
nonadversarial, there might have been a genuine issue of material
fact. See id. at 897. However, as stated by the Court: “With
no such issues of fact joined, the question whether the estate
tax should be computed on the basis of the book value or the
market value was one of law.” Id.
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2. Regulatory Authority and Interpretive Rulings
In 1958, the Treasury issued final regulations under section
2031, concerning the valuation of stocks and bonds for estate tax
purposes, applicable to estates of decedents dying after August
16, 1954. See sec. 20.2031-2, Estate Tax Regs. In particular,
section 20.2031-2(h) addresses the valuation of securities owned
by a decedent at death subject to an option or contract to
purchase held by another person. See sec. 20.2031-2(h), Estate
Tax Regs. The regulation states that the effectiveness of the
agreement to determine the value of securities for estate tax
purposes depends on the circumstances of the case. See id. For
instance, the option or contract price is accorded little weight
if it did not bind the decedent equally during life and at death.
See id. The regulation further states:
Even if the decedent is not free to dispose of the
underlying securities at other than the option or
contract price, such price will be disregarded in
determining the value of the securities unless it is
determined under the circumstances of the particular
case that the agreement represents a bona fide business
arrangement and not a device to pass the decedent’s
shares to the natural objects of his bounty for less
than an adequate and full consideration in money or
money’s worth. [Id.; emphasis added.]
Although the regulation as a whole, and this subsection in
particular, have been subsequently amended, the changes do not
affect the cases at hand.28 Cases applying the regulation have
28
Sec. 20.2031-2, Estate Tax Regs., was amended June 14,
1965 by T.D. 6826, 1965-2 C.B. 367; Apr. 26, 1974 by T.D. 7312,
(continued...)
- 68 -
interpreted the “bona fide business arrangement” and “not a
testamentary device” tests to be conjunctive (i.e., both tests
must be satisfied independently to give the agreement dispositive
effect). See Dorn v. United States, 828 F.2d 177, 182 (3d Cir.
1987); St. Louis County Bank v. United States,
674 F.2d 1207,
1210 (8th Cir. 1982); Estate of Lauder v. Commissioner, T.C.
Memo. 1992-736 (Lauder II). This means that a buy-sell agreement
can be both a bona fide business arrangement and a testamentary
device, with the result that it will not be given dispositive
effect for estate tax valuation purposes. See Lauder II.
In 1959, the Commissioner issued Revenue Ruling 59-60, which
was intended to “outline and review in general the approach,
methods and factors to be considered in valuing shares of the
capital stock of closely held corporations for estate tax and
gift tax purposes.” Rev. Rul. 59-60, 1959-1 C.B. 237. Revenue
Ruling 59-60 has been widely accepted as setting forth the
appropriate criteria to consider in determining fair market
value. See Estate of Newhouse v. Commissioner, 94 T.C. at 217.
Section 8 of the ruling addresses the effect of agreements
28
(...continued)
1974-1 C.B. 277; Sept. 30, 1974 by T.D. 7327, 1974-2 C.B. 294;
Sept. 13, 1976 by T.D. 7432, 1976-2 C.B. 264, and Jan. 28, 1992
by T.D. 8395 (1992 amendment), 1992-1 C.B. 816. Only the 1992
amendment affected subsec. 20.2031-2(h), Estate Tax Regs., by
adding a cross-reference to sec. 2703 (and the regulations
thereunder) for special rules involving options and agreements
(including contracts to purchase) entered into (or substantially
modified after) Oct. 8, 1990. See infra pp. 79-81.
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restricting the sale or transfer of stock on estate and gift tax
value. See Rev. Rul. 59-60, 1959-1 C.B. at 243.
First, the ruling describes a situation in which stock was
acquired by a decedent subject to an option reserved by the
issuing corporation to repurchase at a certain price. The ruling
states that the option price usually will be accepted as fair
market value for estate tax purposes, under the rubric of Revenue
Ruling 54-76. See id.; Rev. Rul. 54-76, 1954-1 C.B. 194.
However, Revenue Ruling 59-60 further states that the option
price does not control fair market value for gift tax purposes.
See Rev. Rul. 59-60, 1959-1 C.B. at 244.
Second, the ruling provides another formulation of the
Wilson-Lomb test. It states that if the option or buy-sell
agreement (1) resulted from voluntary action by the stockholders
and (2) was binding during life and at death of the stockholders,
then the agreement may or may not, depending on the circumstances
of each case, fix the value for estate tax purposes. See id.
The ruling adds, however, that the agreement would be a factor to
evaluate with other relevant factors in determining fair market
value. See id.
Third, the ruling lists factors that must always be
considered in valuing closely held stock “to determine whether
the agreement represents a bonafide business arrangement or is a
device to pass the decedent’s shares to the natural objects of
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his bounty for less than an adequate and full consideration in
money or money’s worth.” Id. The factors mentioned are: The
relationship of the parties, the relative number of shares held
by the decedent, and other material facts. See id.
3. Case Law Following Issuance of Regulations and
Revenue Ruling 59-60
Cases decided after the issuance of section 20.2031-2(h),
Estate Tax Regs., and Revenue Ruling 59-60, supra, reflect new
expressions of the Wilson-Lomb test. Specifically, the formula
price under a buy-sell agreement was considered binding for
Federal estate tax purposes if: (1) The offering price was fixed
and determinable under the agreement; (2) the agreement was
binding on the parties both during life and after death, (3) the
agreement was entered into for bona fide business reasons,29 and
(4) the agreement was not a substitute for a testamentary
disposition30 (generally, the Lauder II test). See Lauder II
29
We refer to this requirement as the business purpose prong
of the Lauder II test. See Estate of Lauder v. Commissioner,
T.C. Memo. 1992-736 (Lauder II). This is equivalent to the
requirement of sec. 20.2031-2(h), Estate Tax Regs., that the
agreement represent a bona fide business arrangement. See Lauder
II (using the terminology of this Court and the regulation
interchangeably); sec. 20.2031-2(h), Estate Tax Regs.
30
We refer to this requirement as the nontestamentary
disposition prong of the Lauder II test. This is equivalent to
the requirement of sec. 20.2031-2(h), Estate Tax Regs., that the
agreement not be a device to pass the decedent’s shares to the
natural objects of his bounty for less than an adequate and full
consideration in money or money’s worth. See Lauder II (using
the terminology of this Court and the regulation
interchangeably); sec. 20.2031-2(h), Estate Tax Regs.
- 71 -
(tracing the origins of the test through case law and
regulations). The first two prongs of the Lauder II test had
been addressed directly by the courts in the Wilson-Lomb line of
cases. However, after the issuance of section 20.2031-2(h),
Estate Tax Regs., the attention of the courts shifted to the last
two prongs, which had only been adverted to in some early cases.
a. Was Agreement Entered Into for Bona Fide
Business Reasons?
In several cases, courts considered whether parties had bona
fide business reasons for entering into buy-sell agreements. For
example, instituting a buy-sell agreement to maintain exclusive
family control over a business repeatedly has been found to be a
bona fide business purpose. See Estate of Bischoff v.
Commissioner, 69 T.C. 32, 39-40 (1977); Estate of Littick v.
Commissioner, 31 T.C. at 187; Lauder II; Estate of Seltzer v.
Commissioner, T.C. Memo. 1985-519; Estate of Slocum v. United
States,
256 F. Supp. 753, 755 (S.D.N.Y. 1966). In addition,
using buy-sell agreements to assure continuity of company
management policies and to retain key employees also have been
held to be bona fide business purposes. See Estate of Reynolds
v. Commissioner,
55 T.C. 172, 194 (1970); Bommer Revocable Trust
v. Commissioner, T.C. Memo. 1997-380. However, as we noted in
Lauder II: “legitimate business purposes are often ‘inextricably
mixed’ with testamentary objectives where * * * the parties to a
restrictive stock agreement are all members of the same immediate
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family.” Lauder II, T.C. Memo. 1992-736, 64 T.C.M. 1643,
1657, 1992 T.C.M. (RIA) par. 92,736, at 92,3731 (quoting 5
Bittker, Federal Taxation of Income, Estates & Gifts, par.
132.3.10, at 132-54 (1984)). As a result, courts required
taxpayers independently to satisfy both the business purpose and
nontestamentary disposition prongs of the Lauder II test.
b. Was Agreement a Substitute for
Testamentary Dispositions?
In evaluating whether buy-sell agreements were substitutes
for testamentary dispositions, greater scrutiny was applied to
intrafamily agreements restricting stock transfers in closely
held businesses than to similar agreements between unrelated
parties. See Dorn v. United States, 828 F.2d 177, 182 (3d Cir.
1987); Lauder II; Hoffman v. Commissioner, 2 T.C. at 1178-1179
(“The fact that the option is given to one who is the natural
object of the bounty of the optionor requires substantial proof
to show that it rested upon full and adequate consideration.”).
Courts analyzed several factors and employed various tests
to ascertain whether buy-sell agreements were meant to serve as
substitutes for testamentary dispositions. In Lauder II, we
organized the analysis into two categories: (1) Factors
indicating that a buy-sell agreement was not the result of arm’s-
length dealing and was designed to serve a testamentary purpose
(testamentary purpose test), and (2) tests to determine whether a
buy-sell agreement’s formula price reflected full and adequate
- 73 -
consideration in money or money’s worth (adequacy of
consideration test). No particular factor or test was weighted
more heavily than another; but rather, courts considered all
circumstances to determine whether buy-sell agreements were
adopted for the principal purpose of achieving testamentary
objectives. See St. Louis County Bank v. United States, 674 F.2d
at 1210-1211; Lauder II; Estate of Carpenter, T.C. Memo. 1992-
653.
1. Testamentary Purpose Test
Under the testamentary purpose test, factors indicating that
a buy-sell agreement was not the result of arm’s-length dealing
and was designed to serve a testamentary purpose included (1) the
decedent’s ill health when entering into the agreement, see St.
Louis County Bank v. United States, 674 F.2d at 1210; Estate of
Lauder v. Commissioner, T.C. Memo. 1990-530 (Lauder I); Estate of
Slocum v. United States, 256 F. Supp. at 755, (2) lack of
negotiations between the parties before executing the agreement,
see Bommer Revocable Trust v. Commissioner, T.C. Memo. 1997-380;
Lauder II; Bensel v. Commissioner, 36 B.T.A. at 253 (finding no
testamentary purpose due to evidence of hostile negotiations),
(3) lack of (or inconsistent) enforcement of buy-sell agreements,
see St. Louis County Bank v. United States, 674 F.2d at 1211;
Estate of Bischoff v. Commissioner, 69 T.C. at 42 n.10 (finding
that agreement was not a testamentary substitute due, in part, to
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enforcement when son died),31 (4) failure to obtain comparables or
appraisals to determine the buy-sell agreement’s formula price,
see Bommer Revocable Trust v. Commissioner, supra; Lauder II, (5)
failure to seek professional advice in selecting the formula
price, see Bommer Revocable Trust v. Commissioner, supra; Lauder
II, (6) lack of provision in buy-sell requiring periodic review
of a stated fixed price, see Bommer Revocable Trust v.
Commissioner, supra, (7) exclusion of significant assets from the
formula price, see Lauder II (finding that omission of all
intangible assets from book value formula suggested testamentary
purpose), and (8) acceptance of below market payment terms for
purchase of decedent’s interest, see Bommer Revocable Trust v.
Commissioner, supra.
2. Adequacy of Consideration Test
Before determining whether the formula price in a buy-sell
agreement represented full and adequate consideration in money or
money’s worth, courts were required to decide, as a preliminary
matter, when and how the adequacy of consideration test would be
applied. For example, would the adequacy of consideration be
tested when the buy-sell agreement was adopted or when the buy-
sell restrictions were invoked at the decedent-stockholder’s
death? In addition, the term “adequate and full consideration”,
31
But see Bommer Revocable Trust v. Commissioner, T.C. Memo.
1997-380 (disagreeing with the taxpayer’s contention that record
of prior enforcement requires that buy-sell agreement be
respected for estate tax purposes).
- 75 -
which was not defined in section 20.2031-2(h), Estate Tax Regs.,
required interpretation.
In general, courts evaluated the adequacy of consideration
as of the date the buy-sell agreement was executed, rather than
at the date for valuing property to be included in the decedent-
shareholder’s gross estate. See St. Louis County Bank v. United
States, 674 F.2d at 1210; Lauder II; Estate of Bischoff v.
Commissioner, 69 T.C. at 41 n.9; Bensel v. Commissioner, 36
B.T.A. at 253. However, in exceptional circumstances, courts
examined the adequacy of consideration and conduct of parties
after the buy-sell agreement date if intervening events within
the parties’ control caused a wide disparity between the buy-sell
agreement’s formula price and fair market value. See St. Louis
County Bank v. United States, 674 F.2d at 1211; Estate of Rudolph
v. United States, 93-1 USTC par. 60,130, at 88449-88450, 71 AFTR
2d 93-2169, at 93-2176-93-2177 (S.D. Ind. 1993). In St. Louis
County Bank, supra at 1209, the intervening event (conversion
from moving, storage, and delivery business to real estate rental
business) “had a significant, adverse impact” on the stock’s
value as computed under the buy-sell agreement’s formula price
(computed as 10 times average annual net earnings per share for 5
preceding years).32
32
The moving business generated substantial yearly income
(high in 1968 of $1,061.15 per share; low in 1970 of $597 per
share), as defined under the stock purchase agreement’s formula.
(continued...)
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In Estate of Reynolds v. Commissioner, 55 T.C. at 194, we
considered whether the ultimate disparity between unrestricted
market price per share and the formula price could have been
predicted by the parties at the time they executed a voting trust
agreement. In that case, we found that the restrictive
provisions of the voting trust agreement were not determinative
of estate or gift tax value and were at most a factor to be
considered in valuing the voting trust certificates.33 See id.
at 191. The decedents’ family entered into the voting trust
agreement to maintain the family’s controlling interest in the
Kansas City Life Insurance Co., a publicly traded company. See
id. at 174-175. At the voting trust agreement date in 1946, the
unrestricted, over-the-counter market price of the underlying
stock was 2-1/2 times the voting trust formula price (25 times
the average annual cash dividend paid on a share of common stock
of the company over the preceding 3-year period). See id. at
32
(...continued)
However, while engaged in the rental real estate business, the
company’s stock value under the formula went down to $0 per share
from 1971 to 1975. See St. Louis County Bank v. United States,
674 F.2d 1207, 1209 (8th Cir. 1982).
33
The restrictive provisions were held not to fix estate and
gift tax values because (1) the voting trust certificates could
have been freely given or bequeathed without triggering the
restrictive provisions and (2) this Court considered inapplicable
the approach of the Court of Appeals for the Second Circuit in
the Wilson-Lomb line of cases because of the lack of regard for
the “retention value” of the voting trust certificates. See
Estate of Reynolds v. Commissioner, 55 T.C. 172, 188-192 (1970);
see infra p. 148 regarding gift tax valuation implications of
retention value.
- 77 -
193-194. By 1962 (year of death), the ratio of unrestricted
market price to voting trust formula price had become 10 to 1.
See id. at 194. The Commissioner argued that the restrictive
provisions should be disregarded in valuing the shares because
the voting trust agreement in Reynolds represented a device and
was not a bona fide business arrangement under section 20.2031-
2(h), Estate Tax Regs. See id. However, we found that there
were bona fide business reasons for the Reynolds voting trust
agreement, and that “the large discrepancy between market price
per unrestricted share and formula price per unit was not the
result of any cleverly devised plan to lower the testamentary
value of [decedents’] * * * investments in the company”. Id. at
194-195. Therefore, the voting trust agreement was factored into
the determination of fair market value, rather than being
completely disregarded.
To apply the adequacy of consideration test, courts were
required to determine the meaning of the phrase “adequate and
full consideration in money or money’s worth” used in section
20.2031-2(h), Estate Tax Regs. In Estate of Bischoff v.
Commissioner, 69 T.C. at 41 n.9, we concluded that consideration
was adequate because the formula price to be paid for a
partnership interest represented the fair market value of
partnership assets. In Dorn v. United States, 828 F.2d at 181,
the Court of Appeals for the Third Circuit observed that
“Although few cases have relied on Treasury Regulation
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§20.2031(h) [sic] for support, those which do discuss it support
the position that the option price affects the value of the gross
estate only if the option was granted at arm’s length.” In
Bensel v. Commissioner, 36 B.T.A. at 253-254, the adequacy of
consideration test was met when the agreement was entered into
because “the price agreed upon between the father and son was not
too low. That is, it was not lower than the price at which
persons with adverse interests dealing at arm’s length might have
been expected to have agreed.” Similarly, in Estate of Carpenter
v. Commissioner, T.C. Memo. 1992-653, we held that a book value
price was reasonable (i.e., adequate and full) because it was the
result of arm’s-length negotiations conducted at the time the
buy-sell agreement was created.
An instructive articulation of the adequacy of consideration
test was presented in Lauder II, 64 T.C.M. 1643, 1660, 1992
T.C.M. (RIA) par. 92,736, at 92-3733 through 92-3734, in which we
stated:
Notably, the phrase “adequate and full considera-
tion” is not specifically defined in section 20.2031-
2(h), Estate Tax Regs. In defining the phrase, we
begin with the proposition that a formula price may
reflect adequate and full consideration notwithstanding
that the price falls below fair market value. See,
e.g., Estate of Reynolds v. Commissioner, 55 T.C. 172,
194 (1970). In this light, the phrase is best
interpreted as requiring a price that is not lower than
that which would be agreed upon by persons with adverse
interests dealing at arm’s length. Bensel v.
Commissioner, supra. Under this standard, the formula
price generally must bear a reasonable relationship to
the unrestricted fair market value of the stock in
question.
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In summary, to satisfy the adequacy of consideration test,
given the greater scrutiny applied to intrafamily agreements
restricting transfers of closely held businesses interests, the
formula price under the buy-sell agreement must be comparable to
what would result from arm’s-length dealings between adverse
parties, and it must bear a reasonable relationship to the
unrestricted fair market value of the interest in question.
4. Statutory Changes
In 1990, Congress enacted the Chapter 14 special valuation
rules. See secs. 2701-2704 (Chapter 14); Omnibus Budget
Reconciliation Act of 1990 (OBRA), Pub. L. 101-508, sec.
11602(a), 104 Stat. 1388-491, 1388-500 (1990). These rules were
enacted to replace the complex, overly broad estate freeze rules
of recently enacted section 2036(c)34 with targeted rules that
were designed to assure more accurate valuation of property
subject to transfer taxes. See S. 3209, 101st Cong. 2d Sess.
(1990), 136 Cong. Rec. 30538.
Chapter 14 includes section 2703, which codifies rules
regarding the impact of restrictions (options, agreements, rights
to acquire or use property at less than fair market value, or
limitations on sale or use of property) on valuation for estate
and gift tax purposes.35 See sec. 2703. New section 2703
34
See Omnibus Budget Reconciliation Act of 1987, Pub. L.
100-203, sec. 10402, 101 Stat. 1330-431.
35
SEC. 2703. CERTAIN RIGHTS AND RESTRICTIONS DISREGARDED.
(continued...)
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applied to agreements, options, rights, or restrictions entered
into, granted, or substantially modified after October 8, 1990.36
See OBRA sec. 11602(e)(1)(A)(ii), 104 Stat. 1388-500.
The Senate bill (S. 3209) explained that the rules requiring
options, rights, or restrictions (1) to be bona fide business
arrangements and (2) not to be devices to transfer property to
members of the decedent’s family for less than full and adequate
consideration in money or money’s worth, see secs. 2703(b)(1) and
35
(...continued)
(a) General Rule.--For purposes of this subtitle, the
value of any property shall be determined without regard
to--
(1) any option, agreement, or other right to
acquire or use the property at a price less than the
fair market value of the property (without regard to
such option, agreement, or right), or
(2) any restriction on the right to sell or use
such property.
(b) Exceptions.--Subsection (a) shall not apply to any
option, agreement, right, or restriction which meets each of
the following requirements:
(1) It is a bona fide business arrangement.
(2) It is not a device to transfer such property
to members of the decedent’s family for less than full
and adequate consideration in money or money’s worth.
(3) Its terms are comparable to similar
arrangements entered into by persons in an arms’ length
transaction.
36
We summarize sec. 2703 to complete our analysis of the
evolution of legal standards on the ability of buy-sell
agreements to control estate tax value. However, the parties
have stipulated that the provisions of sec. 2703 do not apply to
the cases at hand. See supra note 23.
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(2), were similar to those contained in section 20.2031-2(h),
Estate Tax Regs. See S. 3209, supra at 30540-30541. S. 3209
also emphasized that the business arrangement and device
requirements were independent tests. See id. Further, S. 3209
explained that OBRA added a third requirement, that the terms of
the option, agreement, right, or restriction must be comparable
to similar arrangements entered into by persons in an arm’s-
length transaction. See id. According to S. 3209, this
requirement was not found in prior law. See id.
II. Do 1971 and 1973 Gift Tax Cases Have Preclusive Effect?
A. Petitioners’ Collateral Estoppel Argument
Petitioners argue that under the doctrine of collateral
estoppel, or issue preclusion, we are bound by certain
determinations of the U.S. District Court for the District of
Wyoming in the 1971 and 1973 gift tax cases. In petitioners’
view, the District Court found, as to True Oil and Belle Fourche,
that (1) their buy-sell agreements were bona fide business
arrangements and (2) book value of the transferred interests
equaled fair market value as of the agreement dates.37
37
Petitioners explain that the District Court explicitly
determined that book value equaled fair market value for the two
companies, describing this as an “ultimate” fact in the 1971 and
1973 gift tax cases and an “evidentiary” fact in the cases at
hand. In contrast, petitioners contend that the District Court
implicitly held that the buy-sell agreements were bona fide
business arrangements, because the District Court took the
agreements into account in determining fair market value of the
True Oil and Belle Fourche transferred interests. Petitioners
(continued...)
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Petitioners assert that the requirements for applying
collateral estoppel articulated in Peck v. Commissioner, 90 T.C.
162, 166-167 (1988), affd.
904 F.2d 525 (9th Cir. 1990), have
been met; therefore, respondent is precluded from relitigating
those two issues. We disagree. Moreover, petitioners
acknowledge that respondent is not estopped from arguing that the
True companies’ buy-sell agreements were testamentary devices
that were not controlling for estate tax purposes. We agree.
B. Legal Standards for Applying Collateral Estoppel
The doctrine of collateral estoppel provides that, once an
issue of fact or law is “actually and necessarily determined by a
court of competent jurisdiction, that determination is conclusive
in subsequent suits based on a different cause of action
involving a party to the prior litigation.” Montana v. United
States, 440 U.S. 147, 153 (1979) (quoting Parklane Hosiery Co. v.
Shore,
439 U.S. 322, 326 n.5 (1979)). Collateral estoppel is a
judicial doctrine designed to protect parties from unnecessary
and redundant litigation, to conserve judicial resources, and to
37
(...continued)
characterize this as an “evidentiary” fact in the 1971 and 1973
gift tax cases and an “ultimate” fact in the cases at hand. An
evidentiary fact is a fact that is necessary for or leads to the
determination of an ultimate fact. See Black’s Law Dictionary
611 (7th ed. 1999). An ultimate fact is a fact essential to the
claim or the defense. See id. at 612. In Meier v. Commissioner,
91 T.C. 273, 283-286 (1988), the Tax Court regarded the
distinction between ultimate and evidentiary facts as irrelevant
in applying collateral estoppel. See infra pp. 84-85.
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foster certainty in and reliance on judicial action. See Monahan
v. Commissioner, 109 T.C. 235, 240 (1997). This Court, in Peck
v. Commissioner, supra at 166-167, prescribed the following five
conditions that must be satisfied before applying collateral
estoppel to a current factual dispute (the Peck requirements):
(1) The issue in the second suit must be identical
in all respects with the one decided in the first suit.
(2) There must be a final judgment rendered by a
court of competent jurisdiction.
(3) Collateral estoppel may be invoked against
parties and their privies to the prior judgment.
(4) The parties must actually have litigated the
issues and the resolution of these issues must have
been essential to the prior decision.
(5) The controlling facts and applicable legal
rules must remain unchanged from those in the prior
litigation. [Citations omitted.]38
Collateral estoppel may be used in connection with matters
of law, matters of fact, and mixed matters of law and fact. See
Meier v. Commissioner, 91 T.C. 273, 283 (1988). Moreover, its
focus is on the identity of issues, not the identity of legal
proceedings, so that it may apply to issues of fact or law
previously litigated even though the claims differ. See Bertoli
v. Commissioner,
103 T.C. 501, 508 (1994)(citing Meier v.
Commissioner, 91 T.C. at 286). Collateral estoppel cannot apply
38
The Court of Appeals for the Tenth Circuit used a similar
test to determine whether collateral estoppel applied. See Klein
v. Commissioner, 880 F.2d 260, 262-263 (10th Cir. 1989).
- 84 -
if the party against whom it is asserted did not have a full and
fair opportunity to litigate the issue in the earlier proceeding.
See Meier v. Commissioner, 91 T.C. at 286 (citing Allen v.
McCurry, 449 U.S. 90 (1980)). To determine whether the issue to
be precluded in case 2 was identical to an essential issue
actually litigated in case 1 (Peck requirements 1 and 4), early
cases disagreed over whether the facts found in case 1 had to be
ultimate facts or instead, included both ultimate and evidentiary
facts. See Meier v. Commissioner, 91 T.C. at 284 (citing The
Evergreens v. Nunan,
141 F.2d 927, 928-929 (2d Cir. 1944)
(Evergreens)). In Amos v. Commissioner,
43 T.C. 50 (1964), affd.
360 F.2d 358 (4th Cir. 1965), this Court adopted the Evergreens
“ultimate facts” test, which limited the use of collateral
estoppel to ultimate facts found in the second case. However,
more recent cases and commentators have criticized the Evergreens
approach and its limitation of collateral estoppel to ultimate
facts. In Meier v. Commissioner, supra at 284-286, we abandoned
the Evergreens approach and adopted the rationale of Comment j,
Restatement, Judgments 2d, section 27 (1982), which focuses not
on whether the facts to be precluded from being relitigated were
evidentiary or ultimate, but on whether the parties recognized
the issue as important and necessary to the first judgment.39
39
The Restatement reads as follows:
(continued...)
- 85 -
C. Collateral Estoppel Impact of 1971 and 1973 Gift Tax
Cases
We now evaluate the 1971 and 1973 gift tax cases and the
cases at hand, in light of the Peck requirements, to determine
whether we are precluded from deciding whether True Oil’s and
Belle Fourche’s (1) buy-sell agreements were bona fide business
39
(...continued)
Determinations essential to the judgment. It is
sometimes stated that even when a determination is a
necessary step in the formulation of a decision and
judgment, the determination will not be conclusive
between the parties if it relates only to a “mediate
datum” or “evidentiary fact” rather than to an
“ultimate fact” or issue of law. It has also been
stated than [sic] even a determination of “ultimate
fact” will not be conclusive in a later action if it
constitutes only an “evidentiary fact” or “mediate
datum” in that action. Such a formulation is
occasionally used to support a refusal to apply the
rule of issue preclusion when the refusal could more
appropriately be based on the lack of similarity
between the issues in the two proceedings. If applied
more broadly, the formulation causes great difficulty,
and is at odds with the rationale on which the rule of
issue preclusion is based. The line between ultimate
and evidentiary facts is often impossible to draw.
Moreover, even if a fact is categorized as evidentiary,
great effort may have been expended by both parties in
seeking to persuade the adjudicator of its existence or
nonexistence and it may well have been regarded as the
key issue in the dispute. In these circumstances the
determination of the issue should be conclusive whether
or not other links in the chain had to be forged before
the question of liability could be determined in the
first or second action.
The appropriate question, then, is whether the
issue was actually recognized by the parties as
important and by the trier as necessary to the first
judgment. If so, the determination is conclusive
between the parties in a subsequent action * * *.
[Restatement, Judgments 2d, sec. 27 (1982).]
- 86 -
arrangements and (2) book values equaled their fair market values
on the agreement dates.
We preface the inquiry by noting that petitioners properly
raised the collateral estoppel issue in their petition. See Rule
39. The jurisdictional competency of the District Court in the
1971 and 1973 gift tax cases has not been questioned. Judgments
were entered, and the Government did not appeal. The parties to
the cases at hand were also parties to the 1971 and 1973 gift tax
cases (i.e., both petitioners and respondent were parties or
privies in the earlier gift tax cases and were bound by those
decisions).40 In sum, conditions (2) and (3) of the Peck
requirements are satisfied.
1. Bona Fide Business Arrangement Issue
Petitioners argue that we are precluded from deciding
whether the True Oil and Belle Fourche buy-sell agreements
represented bona fide business arrangements under section
20.2031-2(h), Estate Tax Regs., because the District Court
implicitly made this determination in the 1971 and 1973 gift tax
cases. We disagree with petitioners, because the issue was not
40
Specifically, the taxpayers in the 1971 and 1973 gift tax
cases were: Dave True, Jean True, Tamma Hatten, Hank True,
Diemer True, and David L. True. Petitioners in the cases at hand
are: Dave True’s estate (considered his privy) and Jean True.
The fact that the True children are not parties, in their own
right, to the cases at hand does not cause the remaining parties
to fail Peck requirement 3. See Peck v. Commissioner, 90 T.C.
162, 166-167 (1988), affd.
904 F.2d 525 (9th Cir. 1990).
- 87 -
actually litigated and decided in the 1971 and 1973 gift tax
cases and was not essential to those decisions (flunking Peck
requirement 4). Therefore, we proceed independently to determine
whether the True companies’ buy-sell agreements were entered into
for bona fide business reasons. See discussion infra pp. 99-101.
2. Whether Book Value Equaled Fair Market
Value as of Agreement Date Issue
The District Court’s findings that tax book value equaled
fair market value for the True Oil and Belle Fourche interests
transferred as of the buy-sell agreement dates in 1971 and 1973
also do not have preclusive effect in the cases before us. This
is because the issues in these cases (the fair market value of
the interests in question many years later) are not identical to,
and were not actually litigated in or essential to the District
Court’s decisions in the 1971 and 1973 gift tax cases.
In the 1971 and 1973 gift tax cases, the District Court
determined the fair market values (as of the agreement dates) of
transferred interests in Belle Fourche and True Oil, explicitly
taking into account the depressive effect that the buy-sell
agreements had on value. In those cases, the District Court
independently determined that fair market value equaled book
value at the agreement dates without finding that the buy-sell
agreements controlled transfer tax value under a Lauder II type
- 88 -
of analysis.41 Without a finding that the agreements were
testamentary devices, the District Court was free to consider the
buy-sell restrictions along with other relevant factors in
determining fair market value. See Rev. Rul. 59-60, 1959-1 C.B.
at 244.
In the cases at hand, we also must determine, as part of our
evidentiary findings, fair market value on the agreement dates to
help us decide whether the True companies’ buy-sell agreements
were testamentary devices. However, in so doing, we would not
take into account any depressive effect that the buy-sell
agreements might have had on value; to do otherwise would be to
indulge in circular reasoning that would assume the answer at the
outset of the inquiry. Therefore, the facts we must find in the
cases at hand (fair market value at agreement dates without
considering impact of buy-sell restrictions on value) were not
required to be found by the District Court in the 1971 and 1973
gift tax cases, leaving the matter open to our examination in the
cases at hand.
We analyze the differences between a formula price under a
buy-sell agreement and fair market value on the agreement date to
41
The District Court’s approach was similar to that employed
in Estate of Hall v. Commissioner, 92 T.C. 312 (1989), where we
did not decide whether the price determined under an adjusted
book value formula price was dispositive for estate tax purposes.
Instead we held, after reviewing the expert reports, that the
actual date of death fair market value of the shares did not
exceed the formula price. See discussion infra pp. 141-144.
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help expose any lack of arm’s-length dealings or presence of
testamentary intent. See Estate of Bischoff v. Commissioner, 69
T.C. at 41 n.9; Bensel v. Commissioner, 36 B.T.A. at 253; Lauder
II. If the buy-sell agreement is found to be a testamentary
device, it is to be disregarded for purposes of determining
estate and gift tax value. See discussion infra p. 153.
Accordingly, it would be incorrect to account for a buy-sell
agreement’s effect on value in deriving an evidentiary fact (fair
market value at agreement date) that will be used to decide
whether the agreement should have an effect on value at a later
date.
In Estate of Bischoff v. Commissioner, supra at 35-36, 41
n.9., we compared the buy-sell formula price to the fair market
value of the underlying partnership assets on the date they were
transferred to the partnership (which was close to the agreement
date), and found consideration to be adequate and the buy-sell
agreement price to be equal to fair market value. We did not
consider any depressive effect that the buy-sell agreement might
have had on underlying asset values at the agreement date.
In Lauder II, we analyzed various experts’ valuations,
finding the comparative valuation approach that emphasized
price/earnings ratios of industry competitors to be the most
reliable basis for valuing the decedent’s stock at the buy-sell
agreement dates. We then allowed a discount for lack of
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liquidity in computing fair market value; however, we did not
attribute the lack of liquidity to the buy-sell agreements. See
id.
In summary, the 1971 and 1973 gift tax cases determined fair
market value of the True Oil and Belle Fourche transferred
interests at the dates of agreement by taking into account the
depressive effect the buy-sell agreements had on value. The
District Court in those cases did not analyze whether the buy-
sell agreements served as substitutes for testamentary
dispositions and therefore was allowed to consider their effect
on value. This issue is not the same as the one in the cases
before us, as we are required to disregard the buy-sell
agreements in determining value at the relevant dates in order to
make our determination of whether the True family buy-sell
agreements were substitutes for testamentary devices. Therefore,
we are not bound by the District Court’s determinations that tax
book value equaled fair market value for the True Oil and Belle
Fourche interests transferred as of the buy-sell agreement dates.
III. Do True Family Buy-Sell Agreements Control Estate Tax
Values?
We now apply the Lauder II test to the True family buy-sell
agreements to determine whether the agreements control Federal
estate tax value. Because most of the buy-sell agreements at
issue in these cases were modeled on the True Oil partnership
agreement or the Belle Fourche stockholders’ restrictive
- 91 -
agreement, we focus attention on the facts surrounding the
creation and implementation of those agreements.
Petitioners assert that the True family buy-sell agreements
satisfy all four prongs of the Lauder II test, while respondent
contends that they flunk two of the four prongs.
A. Was the Offering Price Fixed and Determinable Under the
Agreements?
The parties agree that the formula price set forth in the
True family buy-sell agreements (tax basis book value) was both
fixed and determinable.42 Thus, the first prong of the Lauder II
test is satisfied.
B. Were Agreements Binding During Life and at Death?
Petitioners divide this test into two components: the
agreements must be enforceable under State law and must bind the
transferors both during life and at death. The True family buy-
sell agreements must satisfy both of these components to fulfill
the second prong of the Lauder II test. See Lomb v. Sugden, 82
F.2d 166, 167 (2d Cir. 1936); Wilson v. Bowers,
57 F.2d 682, 683
(2d Cir. 1932); Estate of Salt v. Commissioner,
17 T.C. 92, 99-
100 (1951); Lauder II.
First, respondent argues that the True companies’ buy-sell
agreements were not enforceable under Wyoming law. We disagree.
42
However, respondent challenges the propriety of using tax
basis book value as a measure of fair market value.
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Restrictions on transfers of corporate stock are valid and
enforceable if authorized by statute. See Wyo. Stat. Ann. sec.
17-16-627(b) (Michie 1999). Authorized restrictions include
those that (1) serve a reasonable purpose and (2) are not against
public policy. See Wyo. Stat. Ann. sec. 17-16-627(c)(iii)
(Michie 1999); Hunter Ranch Inc. v. Hunter, 153 F.3d 727 (10th
Cir. 1998), 1998 W.L. 380556 (unpublished opinion). Respondent
equates this requirement with the business purpose and
nontestamentary disposition prongs of the Lauder II test (i.e.,
transfer restrictions must fulfill a business purpose and must
not contravene public policy by serving as substitutes for
testamentary dispositions). However, respondent provides no
authority for his interpretation of the Wyoming statute, and it
is not self-evident that a Wyoming court would consider transfer
restrictions that served both business and testamentary purposes
to violate public policy. In fact, the District Court in the
1971 and 1973 gift tax cases treated the Belle Fourche and True
Oil buy-sell agreements as enforceable by factoring the transfer
restrictions into the computation of fair market value.
Under the Wyoming Uniform Partnership Act (WUPA),
partnership agreements govern relations among partners and
between partners and the partnership. As such, the WUPA provides
only default rules if the partnership agreement is silent. See
Wyo. Stat. Ann. sec. 17-21-103(a) (Michie 1999). However,
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certain rights cannot be varied by the partnership agreement.
See id. at sec. 17-21-103(b). Such non-variable rights do not
include the right to impose transfer restrictions on partnership
interests. See id.
Respondent further argues that the buy-sell agreements
should be set aside as unconscionable contracts of adhesion.
Respondent points to Tamma Hatten’s lack of legal representation
when she acquired interests in the True companies and entered
into the buy-sell agreements and withdrew from the True
companies, her lack of control over the buy-sell agreement terms,
and her inferior bargaining position to support his
unconscionability argument. A “contract of adhesion” is a
“standard-form contract prepared by one party, to be signed by
the party in a weaker position, usu. a consumer, who has little
choice about the terms.” Black’s Law Dictionary 318-319 (7th ed.
1999). Under Wyoming law, unconscionability is tested at the
time of the agreement and “is considered as a form of fraud
recognized in equity, but such fraud should be ‘apparent from the
intrinsic nature and subject of the bargain itself; such as no
man in his senses and not under delusion would make on the one
hand, and no honest and fair man would accept on the other’”. In
re Estate of Frederick, 599 P.2d 550, 556 (Wyo. 1979). We do not
believe that conditions present at the inception of the True
companies buy-sell agreements would meet these definitions. The
- 94 -
buy-sell agreements were not boilerplate documents and, in all
likelihood, the weaker parties (the True children, according to
respondent) would benefit the most from the non-arm’s-length
terms. The fact that Tamma Hatten may ultimately have suffered
financial detriment because she withdrew from the True companies
at the time she did has no bearing on whether the agreements were
unconscionable at inception or would be so regarded as of the
times they were given effect in 1993 and 1994. Accordingly, we
conclude that the True family buy-sell agreements were
enforceable under Wyoming law.
Second, respondent asserts that the buy-sell agreements,
although binding by their explicit terms, were often modified and
were not always followed by the parties, suggesting that they did
not actually bind the parties during life. On the contrary, we
find that the amendments to and waivers of the buy-sell
provisions were formally documented and were consistent with the
terms and general intent of the agreements (i.e., to maintain
family ownership). For example, waivers to allow non pro rata
purchases of interests by True family members, exchanges of stock
incident to a merger, and sales of stock by the Toolpushers’
Employees’ Trust back to the company were normal responses to
business exigencies. Similarly, amendments allowing transfers to
owners’ revocable living trusts, clarifying the mechanics of the
buy-sell provisions, and introducing the active participation
- 95 -
requirement were all in keeping with the general purpose of
maintaining control of the True companies among family members
who were active in the businesses. Moreover, the invocation of
the buy-sell provisions when Tamma Hatten withdrew from the True
companies is persuasive evidence that the parties treated the
agreements as binding. See Estate of Bischoff v. Commissioner,
69 T.C. at 42 n.10. Accordingly, the waivers and amendments do
not jeopardize the binding nature of the buy-sell agreements.
See Lauder II.
Third, respondent suggests that the corporate buy-sell
agreements (except the White Stallion agreement) are not binding
because Dave True had substantial power, as controlling
shareholder, to alter their terms during his lifetime.
Petitioners counter that Dave True did not have the ability
unilaterally to alter the agreements by virtue of his majority
ownership of the corporations. They argue that control of the
corporation is irrelevant because the buy-sell agreements were
agreements among the shareholders that could not be amended or
terminated without the shareholders’ unanimous consent.
Respondent and petitioners cited no cases to support their
positions on this matter. For the reasons stated below, we agree
with petitioners.
In Bommer Revocable Trust v. Commissioner, T.C. Memo. 1997-
380, we found that a buy-sell agreement was not binding on the
- 96 -
decedent during his lifetime because it explicitly gave the
decedent unilateral power to alter or amend its terms, and the
natural objects of the decedent’s bounty were the other
shareholders. In the cases at hand, we agree with petitioners
that Dave True could not unilaterally terminate the agreements
because, by their terms, the buy-sell agreements would not
terminate until the death of the last surviving shareholder.
However, contrary to petitioners’ assertions, we note that each
corporation was listed as a party to its own amended and restated
buy-sell agreement dated August 11, 1984.
Notwithstanding this inconsistency, we believe that Dave
True’s controlling ownership did not give him unilateral
authority to alter or amend the corporate buy-sell agreements so
that they would be considered non-binding. First, the agreement
in Bommer explicitly conferred on the decedent the unilateral
power to amend. See id. This is not true in the cases at hand.
Second, it appears that the primary parties to the instant
agreements were the shareholders and that the corporation was
included only to ensure that the stock certificates were marked
with transfer restrictions. Therefore, contrary to respondent’s
assertions, we conclude that Dave True’s majority ownership of
the True corporations did not confer on him the unilateral
authority to alter or amend the buy-sell agreements, which would
- 97 -
have been sufficient to render the agreements non-binding for
estate tax purposes.
However, we note that the White Stallion buy-sell agreement
allowed a different pricing formula for certain types of lifetime
transfers, and thereby did not equally bind transferors during
life and after death. Specifically, under the “Buy and Sell
Agreement” provision, if a stockholder were to die, become
legally disabled, or desire to sell all or part of his stock, the
remaining members of his group would be obligated to purchase the
stock on a pro rata basis for a price equal to book value at the
end of the preceding fiscal year, less dividends paid within 2-
1/2 months of such fiscal yearend. The transferring stockholder,
his heirs, trustees, etc., reciprocally would be obligated to
sell to those group members. Alternatively, under the “First
Right of Refusal” provision, if all the shareholders of one group
(selling group) wanted to transfer all their interests by
lifetime sale to a third party who was unaffiliated with the
other shareholder group (nonselling group), they could do so at
any price. But, the selling group would be required first to
offer the nonselling group the opportunity to purchase the stock
on the same terms and conditions as any bona fide third party
offer received by the selling group. Thus, a lifetime sale of
all the selling group’s stock could generate a higher price than
would a transfer at death under the book value formula price.
- 98 -
Section 20.2031-2(h), Estate Tax Regs., states: “Little
weight will be accorded a price contained in an option or
contract under which the decedent is free to dispose of the
underlying securities at any price he chooses during his
lifetime.” Similarly, in Estate of Weil v. Commissioner, 22 T.C.
1267, 1274 (1954), we explained:
where the agreement made by the decedent and the
prospective purchaser of his property fixed the price
to be received therefor by his estate at the time of
his death, but carried no restriction on the decedent’s
right to dispose of his property at the best price he
could get during his lifetime, the property owned by
decedent at the time of his death would be included as
a part of his estate at its then fair market value.
[Citations omitted; see also United States v. Land, 303
F.2d 170, 173 (5th Cir. 1962); Baltimore Natl. Bank v.
United States, 136 F. Supp at 654.]
In the cases at hand, a complete, lifetime buy-out of one
family group’s interests in White Stallion could be achieved at
the highest price the market would bear, while a transfer at
death (or during life by less than all group members) would be
limited to a book value purchase price. This runs afoul of the
Lauder II requirements.
Because the buy-sell agreements for the True companies other
than White Stallion were enforceable under State law and were
binding on the transferors both during life and at death, we find
that the second prong of the Lauder II test is satisfied as to
those companies. However, the White Stallion buy-sell agreement
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fails to satisfy the second prong of the Lauder II test because
it was not equally binding during life and at death.
C. Were Agreements Entered Into for Bona Fide Business
Reasons?
The buy-sell agreements in these cases were adopted and
maintained to ensure continued family ownership and control of
the True Companies. Dave True’s experiences of owning and
operating businesses with outsiders (and then having to buy them
out) motivated him to use buy-sell provisions (even when Jean
True was his only co-owner) to restrict a related owner’s ability
to sell outside the family. As previously stated, courts
consistently have recognized the goal of maintaining exclusive
family control over a business to be a bona fide business
purpose. See supra p. 71.
By maintaining family control and ownership, Dave True was
able to continue his policy of channeling profits from the True
companies into True Oil to fund the costs of searching for
additional reserves through exploratory drilling. In addition,
the buy-sell agreements were used to secure active participation
from owners of the True family businesses, because Dave True
feared that passive owners would not share his long-term vision
for the success and perpetuation of the True companies. Under
the buy-sell agreements, an owner who with his or her spouse
ceased to devote all or a substantial part of his or her time to
the business would be required to sell his or her interest in the
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business. Thus, the buy-sell agreements enforced the active
ownership requirements that played a central role in Dave True’s
business philosophy. In this regard, courts have found that
using buy-sell agreements to assure continuity of company
management policies or to retain key employees are bona fide
business purposes that satisfy this prong of the Lauder II test.
See supra pp. 71-72.
The parties generally agree that the True family buy-sell
agreements were entered into for bona fide business reasons.43
Thus, for the reasons stated above, we find that the third prong
(business purpose prong) of the Lauder II test is satisfied.
43
However, respondent disagrees with petitioners’ suggestion
that a finding of business purpose could preclude a finding of
testamentary intent. Petitioners cite dicta in St. Louis County
Bank v. United States, 674 F.2d 1207, 1210 (8th Cir. 1982), which
stated that the “fact of a valid business purpose could, in some
circumstances, completely negate the alleged existence of a tax-
avoidance testamentary device as a matter of law”. Petitioners’
brief states: “In this case, the business purposes for the
agreements are sufficient to establish that the agreements are
bona fide business arrangements. Petitioners do not rely solely
on those business purposes, however, to show that the agreements
are bona fide business arrangements.”
We agree with respondent that established case law and
regulatory authority require that the bona fide business purpose
and nontestamentary disposition prongs of the Lauder II test must
be satisfied independently. However, we acknowledge that in some
instances, the presence of a business purpose (e.g., a desire to
vest control of a company in an employee who is not related to
the testator by blood or marriage) may indicate that testamentary
motives are absent. This is not the situation in the cases at
hand. Alternatively, if the business purpose is to keep control
within the family, it is fully consistent with a testamentary
objective. In such a case, the presence of a business purpose
does not negate the testamentary purposes.
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D. Were Agreements Substitutes for Testamentary
Dispositions?
We now consider whether the True companies’ buy-sell
agreements were adopted for the purpose of achieving testamentary
objectives. As previously stated, greater scrutiny applies to
intrafamily agreements restricting stock transfers in closely
held businesses. This analysis requires us to apply the
appropriate common law tests (along with other relevant factors)
to the particular facts of the cases at hand. No one test or
factor is determinative; rather, we must consider all relevant
factors to decide whether the buy-sell agreements were used as
substitutes for testamentary dispositions.
1. Testamentary Purpose Test
Respondent argues that the True companies’ buy-sell
agreements were not the result of arm’s-length dealings and were
designed to serve testamentary purposes. After evaluating the
following factors, we agree with respondent that Dave True had
testamentary objectives (conflated with the legitimate business
reasons mentioned above) for adopting and maintaining the True
family buy-sell agreements.
a. Decedent’s Health When He Entered Into
Agreements
Dave True was in good health when he entered into the first
buy-sell agreements (Belle Fourche, True Oil, True Drilling) with
his children in 1971 and 1973. However, by the time he made the
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1993 transfers in issue, Dave True had a history of back problems
and a chronic pulmonary insufficiency that required him to be on
oxygen full time.
Courts have found that a decedent’s ill health at the time
he entered into a restrictive agreement indicated that he had
testamentary purposes for doing so. See, e.g., St. Louis County
Bank v. United States, 674 F. 2d at 1210; Lauder I; Estate of
Slocum v. United States, 256 F. Supp. at 755. Therefore, Dave
True’s good health in 1971 and 1973 does not lead to any
inference of testamentary motive for his entry into those
agreements. The subsequent decline in Dave True’s health has no
direct bearing on the likelihood of testamentary purpose when the
agreements were originally entered into.
b. No Negotiation of Buy-Sell Agreement Terms
Petitioners have provided little evidence to show that the
parties negotiated the terms of the buy-sell agreements.
Although the True children in their testimony consistently
characterized communications with their father regarding the buy-
sell agreements as discussions, rather than as negotiations,
there is no evidence that any changes were made to the buy-sell
agreements as a result of those discussions. The True children
did not receive independent legal or accounting advice when they
entered into the agreements, nor did they know who drafted them.
Further, certain facts suggest that the buy-sell agreement terms
were determined unilaterally by Dave True, based on his strong
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beliefs concerning how his family should own and operate their
businesses, beliefs that he ingrained in his children so that
they readily consented to any ownership conditions proposed by
their father.
Dave True’s control over his children’s interests in the
True companies indicates that he had absolute discretion to set
the buy-sell agreement terms. Before the True children had
reached majority, Dave True transferred gifts of cash and minor
interests in the True companies to the children’s guardianship
accounts, which he managed for their benefit. The children were
unaware of how or when they acquired those early interests in the
True companies. When the True children were in their early 20's
and 30's, Dave True transferred to them (either by gift or sale)
interests in three principal True companies, Belle Fourche, True
Drilling, and True Oil. The True children’s purchases of their
interests in Belle Fourche were financed with cash gifts from
their parents over the years and with earnings distributions from
other True companies. They did not know why, in connection with
their stock purchase, they also had to lend money to Belle
Fourche. Although the True children (except Tamma Hatten)
received gifts from Dave and Jean True every year but one between
1955 and 1993, they never received cash in hand. Instead,
amounts were transferred (under Dave True’s direction) to
accounts that were accumulated for the children’s benefit,
monitored by the True companies’ bookkeepers, used to purchase
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interests in the True companies, and lent to relatives and the
family businesses.
These facts indicate that Dave True exerted significant
control over the True children’s investments in the True
companies. He determined the extent of their ownership, the
timing of their acquisitions, and the methods of payment for the
children’s debt and equity interests. We conclude that Dave
True’s control over the means of conveying ownership to the
children also allowed him unilaterally to determine the terms of
the buy-sell agreements.
The specific terms of the buy-sell agreements also reflected
Dave True’s dominance over their creation. For instance, key
provisions restricting transfers to outsiders and setting the
transfer price at book value were included in the earliest buy-
sell agreements between Dave and Jean True. Similar versions of
those same provisions were incorporated into all subsequent buy-
sell agreements with the True children. Moreover, Dave True’s
imposition of the active participation requirements was actuated
by his strong personal bias against passive ownership. While the
True children may have understood and even agreed with their
father’s reasons for imposing these requirements, it is clear
that he had unfettered ability to do so, which he exercised,
without the need for negotiations.
It also follows from the events surrounding the sale of
Tamma Hatten’s interests in the True companies that there was a
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lack of negotiations among the parties. Tamma Hatten did not
seek separate legal or other professional counsel in connection
with the sale. Instead, she relied on Dave True and his advisers
to determine the sales price under the buy-sell agreements and to
structure the methods of payment. Accordingly, Dave True’s
advisers drafted an agreement outlining the terms of sale and set
up an escrow account for Tamma Hatten to receive roughly half of
the sales proceeds. The escrow arrangement, which departed from
the requirements of the buy-sell agreements, was meant to reserve
assets to pay Tamma’s share of contingent liabilities and to
provide a management vehicle for her investments. Finally, Tamma
Hatten was required (effectively) to pay the other owners in
order to sell her interests in certain profitable companies that
had negative book values at the buy-sell valuation date.
As previously discussed, Tamma Hatten, once she gave notice
that she and her husband would no longer be active participants,
was bound to sell her interests in the True companies pursuant to
the terms of the buy-sell agreements. However, it is likely that
an unrelated party in similar circumstances would have hired
separate counsel to interpret the buy-sell agreement terms,
review the sales agreements, and question the reasonableness of
being required to pay (i.e., take an offset against sales
proceeds) to sell interests in profitable companies. In
addition, an unrelated seller would want to hire her own
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investment manager, rather than agree to an escrow arrangement
that was not required under the buy-sell agreements.
In other cases involving related party buy-sell agreements,
we focused on the existence and extent of meaningful negotiations
between the parties to determine whether the agreements were
designed to serve testamentary purposes. See Bensel v.
Commissioner, 36 B.T.A. at 253 (finding no testamentary purpose
due to evidence of extensive and hostile negotiations); Bommer
Revocable Trust v. Commissioner, T.C. Memo. 1997-380 (finding no
bona fide negotiations among related parties because family’s
attorney represented all parties to the buy-sell); Lauder II
(finding that no negotiations and unilateral determination of
formula price by decedent’s son evidenced testamentary
purpose).44 Petitioners argue that proving family members sought
44
In Lauder II, supra, 64 T.C.M. 1643, 1658-1659 n.20,
1992 T.C.M. (RIA) par. 92,736, at 92-3732 n.20, and accompanying
text, we observed:
the record is devoid of any persuasive evidence that
the Lauders negotiated with respect to the formula
price. To the contrary, the record indicates that
Leonard [decedent’s son] unilaterally decided upon the
formula price. Ronald [decedent’s son] could not
remember who decided upon the formula and only recalled
that Leonard had explained the formula to him. Estee
[decedent’s wife] had no specific recollection of
either of the agreements. Given these circumstances,
it appears that the parties never intended to negotiate
the matter, fully recognizing that an artificially low
price would provide estate tax benefits for all.* * *
20
Presumably, if decedent and Estee were pursuing an
(continued...)
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independent advice regarding buy-sell terms is not essential to
showing that an agreement is a bona fide business arrangement and
not a testamentary device. We agree that such a showing is not
crucial to proving petitioners’ case. As previously stated, the
presence or absence of any particular factor is not dispositive
on the question of testamentary intent. However, lack of
independent representation among related parties to a buy-sell
agreement reasonably suggests less than arm’s-length dealings.
See Lauder II.
c. Enforcement of Buy-Sell Agreement Provisions
Courts have found the lack of enforcement of buy-sell
provisions at the death or withdrawal of a party to evidence a
testamentary purpose for the buy-sell arrangement. See, e.g.,
St. Louis County Bank v. United States, 674 F. 2d at 1211.
However, the record in the cases at hand indicates that the True
family generally complied with the terms of the buy-sell
agreements, or executed formal waivers when circumstances made it
44
(...continued)
identical agreement with unrelated parties in the place
of Leonard and Ronald, they would have been motivated,
by virtue of their advanced age, to negotiate a formula
ensuring as high a price as possible for their shares
balanced against their desire to maintain continuity of
management and control.
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appropriate for them to deviate from those terms.45 Thus, this
factor does not apply to the True companies’ buy-sell agreements.
Petitioners cite our opinion in Estate of Bischoff v.
Commissioner, 69 T.C. 32 (1977), for the proposition that
enforcement of a buy-sell agreement against the estate of a son
who predeceased his parents was strong evidence that the
agreement was a bona fide business arrangement and not a device.
Petitioners assert that Tamma Hatten’s sale to her parents and
brothers under the buy-sell agreements should be viewed as
equally strong evidence of Dave True’s lack of testamentary
purpose.
Petitioners misconstrue the facts of Estate of Bischoff v.
Commissioner, supra, and our comment in that case. In Estate of
Bischoff v. Commissioner, supra at 33-36, the partner-parties to
the buy-sell agreement included Bruno Bischoff, who died in 1967;
Bertha, his wife, who died in 1969; Herbert, their son, who died
in 1973; and Frank Brunckhorst, Bertha’s brother, who died in
1972. Thus, Herbert did not predecease his parents. Moreover,
our comment addressed the Commissioner’s assertion that the
Bischoff partnership agreement could have been amended to
circumvent the restrictive buy-sell provisions, so that those
provisions should have been ignored for purposes of determining
45
But see supra pp. 105-106 regarding escrow set up for the
Tamma Hatten sale that departed from requirements of buy-sell
agreements.
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value. See id. at 42 n.10. We disagreed and noted that the buy-
sell provisions had been adhered to following the deaths of Bruno
and Bertha Bischoff, Frank Brunckhorst, and “more importantly,
following the death of decedent’s son, Herbert.” Id. Thus, the
comment concerned whether the buy-sell agreement was enforceable
during life and at death, see supra p. 91, or whether decedent
had the ability to alter its terms at any time, see Bommer
Revocable Trust v. Commissioner, supra (explaining and
distinguishing Bischoff based on Bommer decedent’s unilateral
ability to amend buy-sell agreement). We did not say that an
agreement would be respected for estate tax purposes in all
circumstances as long as the parties adhered to its terms. See
id.
d. Failure To Seek Significant
Professional Advice in Selecting
Formula Price
Dave True consulted Mr. Harris, the family’s accountant and
longtime financial adviser, about using a tax book value purchase
price formula under the buy-sell agreements. Dave True’s
expressed purposes for using book value were (1) to avoid the
need for appraisals and (2) to provide an easily determinable
price in order to prevent future conflicts within the family.
When consulted, Mr. Harris indicated that he did not object to
using a book value purchase price in the case of True Oil;
however, in general, he believed that book value would not be
representative of fair market value in the case of a stand-alone,
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oil and gas exploration company. In his opinion, book value
would not reflect fair market value because the current value of
proven oil and gas reserves would not be accounted for on the
company’s books. However, in True Oil’s situation, revenues
generated through production extracted from those reserves, and
revenues from other True companies, were being plowed back into
True Oil. He believed that the constant expenditure of True
Oil’s (and other True companies’) resources to fund new and often
unsuccessful exploratory drilling absorbed the unbooked value of
the oil and gas reserves over time. Mr. Harris reasoned that on
a going-concern basis, True Oil’s book value closely approximated
fair market value at the date of the gifts. He indicated that
this would not be the case if True Oil were being valued on a
liquidating basis.
Mr. Harris’s expertise was in accounting, and he was well
acquainted with the True companies’ operations. The record
indicates that Mr. Harris was the only professional with whom
Dave True consulted in selecting the book value formula price.
However, Mr. Harris stated that he did not have a detailed
understanding of valuation methodologies, as he had no academic
or practical experience in the valuation area. On Mr. Harris’s
recommendation, Dave True obtained the B. Allen report, which
appraised True Oil’s reserves, before transferring 8-percent
interests to the True children. However, Mr. Harris indicated
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that he only reviewed the B. Allen report in connection with
subsequent litigation, not at the time of the gifts.
We reject any notion that Mr. Harris was qualified to opine
on the reasonableness of using the tax book value formula in the
True family buy-sell agreements. Mr. Harris was closely
associated with the True family; his objectivity was
questionable. More importantly, he had no technical training or
practical experience in valuing closely held businesses. The
record shows no technical basis (in the form of comparables,
valuation studies, projections) for Mr. Harris’s assertion that
tax book value represented the price at which property would
change hands between unrelated parties. In Lauder II, we were
troubled by the fact that the decedent’s son settled on a book
value formula after having consulted with only a close family
financial adviser. Similarly, in Bommer Revocable Trust v.
Commissioner, T.C. Memo. 1997-380, we found it significant that
the decedent consulted only with his attorney, who spent 1 day
calculating the buy-sell agreement’s fixed transfer price. On
the basis of the record evidence, we find that Dave True’s
discussions with Mr. Harris were insufficient to assess
objectively and accurately the reasonableness of using a tax book
value formula price for the True companies’ buy-sell agreements.
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e. Failure To Obtain or Rely on Appraisals
in Selecting Formula Price
Dave True obtained an appraisal (the B. Allen report) of
True Oil’s oil and gas reserves contemporaneously with the 1973
gifts to his children. Mr. Harris had suggested the appraisal
because he expected the tax book value gift valuation to be
challenged by the IRS. Petitioners provided no evidence of
contemporaneous appraisals of any of the other True companies.
The B. Allen report found that, as of August 1, 1973, the fair
market value of True Oil’s oil and gas properties was $9,941,000.
SRC later used this information to prepare its forensic appraisal
of True Oil in connection with the 1973 gift tax case. SRC
determined that the freely traded value of an 8-percent interest
in True Oil (as of August 1, 1973) would have been $535,000, as
compared with the tax book value of $54,653. The results of the
B. Allen report were discussed at family meetings, but there is
no clear evidence that the children reviewed the report in detail
before signing the True Oil buy-sell agreement.
Petitioners suggest that the logical inferences to be drawn
from the procurement of the B. Allen report were that: (1) Dave
True wanted to assure that his children had sufficient knowledge
of True Oil’s asset values so that their consent to the book
value price was informed, and (2) he obtained the report to help
determine whether to use a tax book value formula price in True
Oil’s buy-sell agreement. While these may have been secondary
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considerations, we find that the B. Allen report was obtained
primarily in anticipation of litigation and was not relied on by
the parties to arrive at the buy-sell agreement’s formula price.
First, because Dave True only obtained a contemporaneous
appraisal of True Oil’s assets, it is clear that the parties did
not rely on appraisals before adopting the other True companies’
buy-sell agreements. Second, as illustrated in the SRC report
(which was not available, however, at the time of the gift), the
appraised value of the reserves showed a significant disparity
between tax book value ($54,653) and fair market value ($535,000)
of an 8-percent interest in the assets of True Oil. Even without
the benefit of the SRC report, petitioners should have assumed
that almost $10,000,000 of unbooked asset value would increase
the market price of an interest in the partnership. There is no
evidence in the record of any attempt to reconcile this
difference, except for Mr. Harris’s rationalization that the
unbooked reserve value would be consumed over time to fund oil
and gas exploration. Third, petitioners have failed to show that
the True children reviewed the report in detail before executing
the True Oil buy-sell agreement, or that it made any difference
in the terms of the agreement or their entry into it.
Our impression is that Dave True was predisposed toward
using a tax book value formula because he had used it before in
his buy-sell agreements with Jean True, and because he saw it as
a relatively quick and easy way to determine price. He presented
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the idea to Mr. Harris, who “did not object” to the use of tax
book value in the special case of the True companies. Dave True
then obtained the B. Allen report to fulfill his due diligence
requirements, given the perceived threat of gift tax litigation.
Even petitioners qualified their assertion that Dave True relied
on the B. Allen report to assess whether to use a tax book value
formula by stating on brief: “but, in reality, Dave True likely
relied primarily on his own knowledge of the value of True Oil.”
We have often found that failure to obtain comparables or
appraisals to determine a buy-sell agreement’s formula price
indicates testamentary intent. See, e.g., Bommer Revocable Trust
v. Commissioner, supra; Lauder II; cf. Estate of Hall v.
Commissioner, 92 T.C. 312 (1989)(holding that the buy-sell price
reflected fair market value, due in part to the efforts expended
by the corporation to test the reasonableness of the adjusted
book value formula). Moreover, cases in which the lack of
outside appraisals did not evidence a testamentary intent
involved buy-sell agreements between persons that were not the
natural objects of the decedent’s bounty. See, e.g., Estate of
Bischoff v. Commissioner, 69 T.C. at 42 n.10.; Bensel v.
Commissioner, 36 B.T.A. at 252-254.
f. Exclusion of Significant Assets From
Formula Price
In Lauder II, we questioned the propriety of expressly
excluding the value of all intangible assets from the book value
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formula, because we thought that much of the company’s value was
attributable to goodwill. Similarly, we question the
reasonableness of omitting the value of proven oil and gas
reserves from True Oil’s buy-sell pricing formula, given that
those reserves represent the focus of the business and its most
valuable asset. Dave True’s stated reasons for using book value
were to avoid the need for appraisals and to provide an easily
determinable price in order to prevent future conflicts within
the family. However, as we stated in Lauder II, supra: “while
we appreciate that an adjusted book value formula may provide a
simple and inexpensive means for evaluating shares in a company,
we cannot passively accept such a formula where, as here, it
appears to have been adopted in order to minimize or mask the
true value of the stock in question.” Lauder II, T.C. Memo.
1992-736, 64 T.C.M. 1643, 1659, 1992 T.C.M. (RIA) par.
92,736, at 92-3732 (citing Estate of Trammell v. Commissioner,
18
T.C. 662 (1952)).
g. No Periodic Review of Formula Price
The True companies’ buy-sell agreements did not provide a
mechanism for periodic review or adjustment to the tax book value
formula. Over the years, the buy-sell agreements were amended on
several occasions. The 1984 amendments, which affected all buy-
sell agreements and related to Tamma Hatten’s withdrawal, made
only minor changes to the tax book value formula price
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computation. Since then, the tax book value formula price has
not been altered.
We have found that buy-sell agreements were not testamentary
substitutes if, inter alia, the agreements contained provisions
for periodic review of the formula price. See Estate of
Carpenter v. Commissioner, T.C. Memo. 1992-653 (dealing with buy-
sell agreement among unrelated parties). We have also been
persuaded that agreements without periodic review provisions were
designed to serve testamentary purposes. See Bommer Revocable
Trust v. Commissioner, T.C. Memo. 1997-380, 74 T.C.M. 346,
355, 1997 T.C.M. (RIA) par. 97,380, at 97-2424 (“We find it
unrealistic to assume that the decedent, as the majority
shareholder, would have negotiated a fixed price for the
agreements if he had been bargaining with unrelated parties”).
Under the circumstances of the cases at hand, we believe that
unrelated parties dealing at arm’s length would have included a
provision requiring periodic revaluation, or would have at least
considered amending the tax book value formula price, for two
reasons.
First, Mr. Harris opined, at the time of the agreement, that
a tax book value pricing formula would be appropriate for True
Oil only because of its history of expending the value of proven
oil and gas reserves to discover new ones. If this were not the
case, tax book value would not be a reliable indicator of value
because the reserves’ value would be omitted. Thus, we would
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expect that unrelated parties dealing at arm’s length would have
included a provision requiring periodic redetermination of the
pricing formula to allow for the future possibility that the
value of new reserves might outstrip the costs of finding and
developing them.
Second, when Tamma Hatten withdrew from and sold her
interests in the True companies pursuant to the buy-sell
agreements, it was clear that tax book value did not correspond
to the intrinsic value of some of the companies. For instance,
Eighty-Eight Oil, which was referred to as a “cash cow”, had
negative tax book value that required Tamma Hatten to offset the
sales proceeds to which she was entitled in order to sell her
interests. We would expect that unrelated parties dealing at
arm’s length would have re-evaluated the tax book value formula
price in light of these anomalous results, especially if the
agreements already had to be amended to reflect Tamma Hatten’s
withdrawal.
Petitioners argue that the lack of a periodic revaluation
provision is legally irrelevant because unanimous agreement was
required to amend the True companies’ buy-sell agreements.
Presumably, this means that the parties could always agree to
amend the formula price even absent a specific provision granting
revaluation authority. This argument ignores whether it was
reasonable for the True family not to reconsider the tax book
value pricing formula, given the actual and potential changes in
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circumstances mentioned above. Petitioners counter that they did
not amend the formula when they amended the agreements for other
reasons because they believed that the agreements produced a fair
and reasonable price. On the contrary, we believe that
petitioners did not alter the formula price because the sons
would benefit (taxwise and pricewise) from leaving in place a
formula transfer price that was as low as possible.
h. Business Arrangements With True Children
Fulfilled Dave True’s Testamentary Intent
Dave True’s business arrangements with his children
fulfilled his testamentary intent, as evidenced by his will and
ancillary estate planning documents. At his death, Dave True’s
estate plan provided equally for his children, except Tamma
Hatten. Dave and Jean True amended their estate planning
documents to delete any specific provisions for Tamma Hatten and
her family after her withdrawal from the family businesses. The
advancement language in Dave True’s appointment document
explained that Tamma Hatten’s “potential inheritance” had been
fully satisfied when his daughter severed her financial ties with
the True companies.
Since the 1970's, each of the True sons has managed one or
more of the True companies. Hank True assumed responsibility for
the oil and gas marketing, pipeline, and environmental cleanup
businesses; Diemer True managed the trucking and tool supply
companies; and David L. True ran the ranching and drilling
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operations. Tamma Hatten worked only briefly for the True
companies and not in a management capacity, and her husband never
had more than a subordinate role in management of any of the True
companies. However, the True children (including Tamma Hatten
before her withdrawal) always owned equal percentage interests in
each True company, regardless of the degrees of skill and effort
required to manage the various businesses.
These facts suggest that Dave True’s testamentary objectives
were fulfilled, in large part, through lifetime transfers to his
children of interests in the True companies. The buy-sell
agreements ensured that those testamentary objectives were met by
restricting transfers outside the family. The equality of the
percentage interests, in spite of the different management
responsibilities borne by each child, indicates that the
transfers were based on family relationships, provided the
minimal threshold participation requirement continued to be
satisfied.
The True sons are now the only individual parties to most of
the True companies’ buy-sell agreements. Under the existing
agreements, a predeceasing brother’s interest would be sold to
his surviving brothers at tax book value, and would not pass to
his heirs. This assumes that the predeceasing brother had no
heirs who actively participated in the family business. The True
sons have discussed this “problem” with Mr. Harris and have
decided not to make any changes to the existing buy-sell
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agreements until the current estate and gift tax litigation is
concluded.
We believe that the current buy-sell structure poses a
problem only if the True sons consider tax book value not to
fairly represent market value. Otherwise, it should not be a
problem that their heirs, who did not actively participate in the
True companies, might receive cash equal to the value of the True
sons’ business interests, as determined under the buy-sell
agreements. The True sons were the natural objects of Dave
True’s bounty; they are not the natural objects of each other’s
bounty; their own children and grandchildren are the natural
objects of their respective bounties. These facts lead us to
infer that Dave True used the business arrangements with his
children to fulfill his own testamentary objectives.
2. Adequacy of Consideration Test
The adequacy of consideration paid and received pursuant to
a buy-sell agreement is generally measured at the date the
agreement is executed. See supra p. 75. However, courts have
also evaluated the adequacy of consideration and conduct of
parties after the agreement date when intervening events within
the parties’ control caused a wide disparity between the formula
price and fair market value. The standard for determining
adequacy of consideration requires the formula price (1) to be
comparable to what persons with adverse interests dealing at
arm’s length would accept and (2) to bear a reasonable
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relationship to the unrestricted fair market value of the
interest in question. See Lauder II. Again, these standards
must be applied with the heightened scrutiny imposed on
intrafamily agreements restricting transfers of closely held
businesses. See Hoffman v. Commissioner, 2 T.C. at 1178-1179.
Petitioners argue that the book value formula price used in
the True companies’ buy-sell agreements reflected adequate and
full consideration as required in section 20.2031-2(h), Estate
Tax Regs., and as interpreted by relevant case law. For the
reasons stated below, we disagree.
a. Petitioners’ Brodrick v. Gore/Golsen Argument
Petitioners argue that the proper standard for determining
whether consideration was adequate and full can be found in
Brodrick v. Gore, 224 F.2d 892 (10th Cir. 1955). They contend
that the Court of Appeals for the Tenth Circuit held in Brodrick
v. Gore that, as a matter of law, an agreement containing legally
binding and mutual obligations among family members to sell and
purchase partnership interests at book value constitutes adequate
and full consideration, absent a showing of bad faith. See supra
pp. 65-66. Petitioners further argue that, under Golsen v.
Commissioner,
54 T.C. 742, 756 (1970), affd.
445 F.2d 985 (10th
Cir. 1971), we must follow Brodrick v. Gore because the cases at
hand are appealable to the Court of Appeals for the Tenth
Circuit.
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Respondent counters that petitioners mischaracterize the
Brodrick v. Gore holding. According to respondent, Brodrick v.
Gore did not hold that mutual buy-sell agreements are always
binding and efficacious for estate tax valuation purposes as a
matter of law. Instead, the Court of Appeals for the Tenth
Circuit held that the Government’s failure to allege that the
State court proceeding was collusive or otherwise invalid was
fatal to the Government’s case. We agree with respondent’s
interpretation of Brodrick v. Gore.
Golsen v. Commissioner, 54 T.C. at 757, established the rule
that this Court will “follow a Court of Appeals decision which is
squarely in point where appeal from our decision lies to that
Court of Appeals” (the Golsen rule). We later clarified the
reach of the Golsen rule by emphasizing that it should be
construed narrowly and applied only if “a reversal would appear
inevitable, due to the clearly established position of the Court
of Appeals to which an appeal would lie”. Lardas v.
Commissioner, 99 T.C. 490, 494-495 (1992). This is because “our
obligation as a national court does not require a futile and
wasteful insistence on our view.” Id. In the cases at hand, an
appeal would lie to the Court of Appeals for the Tenth Circuit.
Therefore, under the Golsen rule, we are bound to follow the
clearly established positions of that Court. We conclude,
however, that petitioners’ formulation of the holding in Brodrick
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v. Gore, supra, overstates the position of the Tenth Circuit
Court of Appeals.
First, we note the peculiar procedural posture of Brodrick
v. Gore. It was decided on motion for summary judgment and
relied on a prior, unappealed determination by a State court.
See Brodrick v. Gore, 224 F.2d at 894-896. Accordingly, because
there was no genuine issue as to any pleaded, material fact,
decision was rendered as a matter of law. See Fed. R. Civ. P.
56(c). Second, Brodrick v. Gore was decided before section
20.2031-2(h), Estate Tax Regs., which set out the bona fide
business arrangement and not a testamentary device requirements,
had been promulgated.46 Third, the Court of Appeals for the
Tenth Circuit has not revisited this question since the issuance
of section 20.2031-2(h), Estate Tax Regs. We therefore conclude
that Brodrick v. Gore is not “squarely in point” with the cases
at hand and that its holding is not dispositive under the Golsen
rule.
The taxpayers won in Brodrick v. Gore because (1) they
showed that the agreement was equally binding on the estate and
surviving partners, based on the facts found in the probate
proceeding, and (2) the Government had failed to plead that the
partnership agreement was tainted by bad faith or that the
46
Brodrick v. Gore, 224 F.2d 892 (10th Cir. 1955), was
decided July 22, 1955, and sec. 20.2031-2(h), Estate Tax Regs.,
was promulgated June 23, 1958. See id.; sec. 20.2031-2(h),
Estate Tax Regs.
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probate court proceeding was collusive or nonadversarial. Since
the issuance of the section 20.2031-2(h), Estate Tax Regs., in
1958, courts have focused on whether a buy-sell agreement was a
bona fide business arrangement and/or a testamentary device. See
supra p. 70. For instance, in Lauder II, T.C. Memo. 1992-736, 64
T.C.M. 1643, 1659, 1992 T.C.M. (RIA) par. 92,736, at 92-
3733, we stated:
the assumption that the formula price reflects a fair
price is not warranted where * * * the shareholders are
all members of the same immediate family and the
circumstances show that testamentary considerations
influenced the decision to enter into the agreement.
In such cases, it cannot be said that the mere
mutuality of covenants and promises is sufficient to
satisfy the taxpayer’s burden of establishing that the
agreement is not a testamentary device. Rather, it is
incumbent on the estate to demonstrate that the
agreement establishes a fair price for the stock. * * *
Here, the True family buy-sell agreements and the transfers
in issue all arose after the issuance of section 20.2031-2(h),
Estate Tax Regs. Respondent essentially has pleaded the
equivalent of bad faith (i.e., that the buy-sell agreements were
substitutes for testamentary dispositions). Thus, different
procedural settings and the intervening regulations prevent us
from being constrained, under the Golsen rule, by the decision of
the Court of Appeals for the Tenth Circuit in Brodrick v. Gore.
b. Petitioners’ Assertion That Respondent
Impermissibly Applied Section 2703
Retroactively
Petitioners argue on brief: “Prior to the enactment of
section 2703, no court had ever required a taxpayer to
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demonstrate that the buy-sell agreement was comparable to similar
arm’s-length arrangements between unrelated parties” (arm’s-
length requirement) (emphasis added). They support this
statement by citing the legislative history of section 2703,
which states that the arm’s-length requirement of section
2703(b)(3) was not present in prior law. See supra p. 81.
According to petitioners, the heightened scrutiny that respondent
has applied to the True companies’ intrafamily buy-sell
agreements amounts to a presumption of testamentary intent that
could be rebutted only by meeting the arm’s-length requirement.
Petitioners characterize this as an impermissible, retroactive
application of section 2703.
Respondent counters that petitioners misconceive the import
of section 2703. To respondent, “the effect of section
2703(b)(3) was to elevate the arm’s-length nature of the terms of
the agreement from a factor to consider in determining
[testamentary] intent to an absolute requirement.” Thus,
respondent insists that the arm’s-length requirement was present
before the enactment of section 2703, citing cases that antedated
section 2703 and applied section 20.2031-2(h), Estate Tax Regs.
We agree with respondent.
As already shown, courts often have considered whether buy-
sell agreements were comparable to arm’s-length arrangements
between unrelated parties in cases that both predated and
postdated issuance of section 20.2031-2(h), Estate Tax Regs., and
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in cases that preceded the enactment of section 2703. See, e.g.,
Dorn v. United States, 828 F.2d 177 (3d Cir. 1987); Estate of
Littick v. Commissioner,
31 T.C. 181 (1958); Bensel v.
Commissioner,
36 B.T.A. 246 (1937); Lauder II; Estate of
Carpenter v. Commissioner, T.C. Memo. 1992-653. Thus, although
this requirement was not explicitly set out in section 20.2031-
2(h), Estate Tax Regs. (as noted in the legislative history of
section 2703), the arm’s-length requirement has always been a
factor used by courts to decide whether a buy-sell agreement’s
price was determinative of value for estate tax purposes.
Further, we do not believe that the heightened scrutiny
applied to intrafamily buy-sell agreements essentially creates a
presumption of testamentary purpose that can only be rebutted by
a showing that the agreement satisfied the arm’s-length
requirement. As we have stated many times, no one factor is
dispositive, and all circumstances must be evaluated to determine
whether a buy-sell agreement is intended to serve as a substitute
for a testamentary disposition.
Even if we were to treat the arm’s-length requirement as a
“super factor” in our analysis, an impermissible, retroactive
application of section 2703 would not result. The arm’s-length
requirement played the same role in pre-section 2703 case law.
After surveying the cases that apply (either implicitly or
explicitly) the section 20.2031-2(h), Estate Tax Regs.,
requirement that a buy-sell agreement cannot be a testamentary
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device, we see that certain patterns emerge. The cases in which
the test was satisfied (i.e., no testamentary device found), and
the buy-sell agreement’s price was held to determine fair market
value, involved buy-sell agreements that (1) were between
unrelated parties or related parties who were not the natural
objects of the decedent’s bounty and (2) were either implicitly
or expressly found to be done on an arm’s-length basis.47 Thus,
case law preceding the enactment of section 2703 shows that
courts were more likely to find that a buy-sell agreement’s price
determined estate tax value under section 20.2031-2(h), Estate
Tax Regs., if the agreement was comparable to that which would be
47
Cases involving intrafamily buy-sell agreements that were
held not to determine estate tax value include: Dorn v. United
States, 828 F.2d 177 (3d Cir. 1987); St. Louis County Bank v.
United States,
674 F.2d 1207 (8th Cir. 1982); Estate of Reynolds
v. Commissioner,
55 T.C. 172 (1970); Hoffman v. Commissioner,
2
T.C. 1160 (1943); Bommer Revocable Trust v. Commissioner, T.C.
Memo. 1997-380; Lauder II; Slocum v. United States, 256 F. Supp
753 (S.D.N.Y. 1966). But see Estate of Rudolph v. United States,
93-1 USTC par. 60,130, 71 AFTR 2d 93-2169 (S.D. Ind. 1993).
Cases involving buy-sell agreements that (1) were between
unrelated parties or parties that were not the natural objects of
decedent’s bounty, (2) were implicitly or explicitly found to
have been transacted on an arm’s-length basis, and (3) were held
to determine estate tax value include: Estate of Bischoff v.
Commissioner,
69 T.C. 32 (1977) (brother and sister not
considered natural objects of each other’s bounty; implicitly
arm’s length); Estate of Littick v, Commissioner,
31 T.C. 181
(1958)(three of five parties to agreement were brothers;
explicitly arm’s length); Bensel v. Commissioner,
36 B.T.A. 246
(1937), affd.
100 F.2d 639 (3d Cir. 1938) (son was not natural
object of decedent’s bounty due to hostile relationship;
explicitly arm’s length); Estate of Carpenter v. Commissioner,
T.C. Memo. 1992-653 (unrelated parties to agreement; explicitly
arm’s length); Estate of Seltzer v. Commissioner, T.C. Memo.
1985-519 (only two of five parties to agreement were related;
implicitly arm’s length).
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derived (or actually was derived) from arm’s-length dealings
between adverse parties.
c. Did Tax Book Value Pricing Formula Represent
Adequate and Full Consideration?
Petitioners make various arguments to support their
contention that the tax book value pricing formula used in the
True family buy-sell agreements represented adequate and full
consideration under section 20.2031-2(h), Estate Tax Regs., and
the Lauder II test. They contend that tax book value was
adequate and full consideration because (1) it equaled fair
market value at the dates of agreement for True Oil and Belle
Fourche; (2) book value was a common pricing formula among
related and unrelated parties at the dates of agreement; (3) the
parties testified that they thought the price was realistic when
they entered into the agreements; (4) there were bona fide
business reasons for using a tax book value formula price; and
(5) book value was not required to bear a predictable
relationship to the fair market value of underlying assets,
inasmuch as the True family had no plans to liquidate the True
companies.
First, petitioners observe that no court has required a
taxpayer to prove that a buy-sell agreement’s formula price
represented fair market value at either the date of agreement or
at the time of the transfers at issue. Moreover, petitioners
cite St. Louis County Bank v. United States, supra, for the
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proposition that adequacy of the formula price is only one factor
to consider in evaluating whether a buy-sell agreement is bona
fide and not a device. They further contend that, under Estate
of Bischoff v. Commissioner, 69 T.C. 32 (1977), if the formula
price equaled fair market value at the agreement date, it was
strong evidence of a fair or realistic buy-sell agreement price.
Thus, petitioners argue that tax book value was a fair price
because tax book value equaled fair market value at the dates of
agreement for the True Oil and Belle Fourche interests
transferred to the True children (as determined by the 1971 and
1973 gift tax cases).
We disagree with petitioners’ contention. As previously
discussed, see supra pp. 85-90, we are not bound by the District
Court’s determinations in the 1971 and 1973 gift tax cases that
the tax book value of interests in True Oil and Belle Fourche
equaled fair market value at the agreement dates. As a result,
we are free to determine independently the fair market value of
True Oil and Belle Fourche transferred interests at those dates,
without taking into account the depressive effect of the buy-sell
agreements. To do this, we refer to the valuation information
provided in the SRC appraisals.
In the True Oil and Belle Fourche appraisals, which were
prepared for litigation, SRC ostensibly used recognized valuation
methods to derive a “freely traded value” for the transferred
interests as of the agreement dates. The freely traded value for
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Belle Fourche stock was $120 per share (or $57,120 per each 1-
percent interest sold) on August 2, 1971. The freely traded
value for each 8-percent partnership interest in True Oil was
$535,000 on August 1, 1973.
SRC then examined average marketability discounts of
comparable companies to determine the appropriate discount from
freely traded value. In the Belle Fourche appraisal, the average
marketability discount for investment companies48 subject to
investment letter restrictions ranged from 15 to over 50 percent,
with an average discount of 33 percent. In the True Oil
appraisal, which was performed 2 years later, the average
marketability discount was within the same range, with an average
discount of 34 percent.
SRC ultimately disregarded the average marketability
discount information and opined that the buy-sell restrictions in
the True Oil and Belle Fourche agreements absolutely precluded
sales in the public market. As a result, SRC limited fair market
value to the buy-sell formula prices, which amounted to discounts
of 90 percent and 68 percent, respectively, from the freely
traded value of the True Oil and Belle Fourche transferred
interests. SRC effectively treated the buy-sell agreements as if
they controlled Federal gift tax value; rather than solely as
48
Described as public companies that as a policy invested in
stock subject to investment letter restrictions. Investment
letter restrictions prevented the holder from selling shares to
the public for a fixed period of time (generally 2 to 3 years).
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factors to be considered with other relevant factors in
determining fair market value, as required under Rev. Rul. 59-60,
1959-1 C.B. 237.
As previously discussed, the proper approach to determining
fair market value at the agreement date is to disregard the
depressive effect of the buy-sell agreement on value.
Accordingly, we do not follow SRC’s methodology, which
essentially treated the buy-sell agreements’ formula prices as
dispositive. Instead, we apply the average marketability
discounts for comparable companies to the freely traded values
determined by SRC to compute fair market value at the agreement
dates. For Belle Fourche, fair market value of a 1-percent
interest on August 2, 1971, was $38,270 (or $80.40 per share),49
whereas tax book value on that date was $18,416 (or $38.69 per
share). For True Oil, fair market value of an 8-percent
partnership interest on August 1, 1973, was $353,100,50 whereas
tax book value on that date was $54,653. We therefore conclude
that tax book value did not equal fair market value of the
transferred interests in Belle Fourche and True Oil as of the
buy-sell agreement dates.
49
Freely traded value of $120 per share multiplied by 476
shares transferred, the product of which is then discounted by 33
percent (average marketability discount averted to by SRC).
50
Freely traded value of $535,000 discounted by 34 percent
(average marketability discount averted to by SRC).
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Second, petitioners assert that book value was the most
common formula pricing provision in agreements between related
and unrelated parties when the True family adopted the buy-sell
agreements at issue in these cases. Petitioners cite Estate of
Anderson v. Commissioner, 8 T.C. 706, 720 (1947), Estate of
Carpenter v. Commissioner, T.C. Memo. 1992-653, Brodrick v. Gore,
224 F.2d at 897, Estate of Hall v. Commissioner,
92 T.C. 312
(1989), Estate of Bischoff v. Commissioner, 69 T.C. at 34-36, and
Luce v. United States,
4 Cl. Ct. 212, 222-223 (1983), to support
their position.
We acknowledge that these are cases in which courts have
equated book value to fair market value. These cases involved
transfers subject to buy-sell agreements between related parties,
Brodrick v. Gore, supra; Estate of Bischoff v. Commissioner,
supra, between unrelated parties, Estate of Carpenter v.
Commissioner, supra; Estate of Anderson v. Commissioner; supra,
and between related and unrelated parties, Estate of Hall v.
Commissioner, supra, and transfers not subject to buy-sell
agreements at all, Luce v. United States, supra. However, this
information is not helpful in determining whether the True
companies’ tax book value pricing formula is comparable to a
formula derived from arm’s-length dealings between adverse
parties. The Lauder II test requires scrutiny of the facts of
each case. On brief, respondent distinguished most of
petitioners’ cited cases from the cases at hand on their facts,
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procedural settings, or standards of law applied. Indeed, we
have found no decided cases in which a tax book value buy-sell
agreement formula determined fair market value.51 Moreover,
there are contrary cases holding book value to be an unreliable
basis from which to determine a stock’s fair market value. See,
e.g., Estate of Andrews v. Commissioner, 79 T.C. 938, 948 n.16
(1982); Biaggi v. Commissioner, T.C. Memo. 2000-48 (income tax
case), affd. without published opinion __ F.3d __ (2d Cir. April
20, 2001); Estate of Ford v. Commissioner, T.C. Memo. 1993-580,
affd.
53 F.3d 924 (8th Cir. 1995); Brown v. Commissioner, T.C.
Memo. 1966-92; Estate of Cookson v. Commissioner, T.C. Memo.
1965-319. Thus, petitioners do not persuade us that the True
family’s use of a tax book value pricing formula in their buy-
sell agreements was comparable to what unrelated parties would
use in similar circumstances.
Third, petitioners rely on Estate of Carpenter v.
Commissioner, T.C. Memo. 1992-653, to claim that tax book value
was a fair and realistic price because the True family testified
that they considered it to be so. However, that case involved
arm’s-length negotiations among unrelated parties to transfer
interests at book value, whereas the True companies’ buy-sell
51
Again, we note that in the 1971 and 1973 gift tax cases,
the District Court held that tax book value equaled fair market
value, taking into account the depressive effect of the buy-sell
agreements. However, the District Court did not hold that the
tax book value formula price determined gift tax value. See
discussion supra pp. 85-90.
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agreements were among family members and there was no convincing
evidence of arm’s-length dealing. Moreover, the record shows
that Dave True exerted significant control over his children’s
investments in the True companies. Although the True children
may have agreed to the formula price provisions and other
restrictions imposed by Dave True, that does not prove, under the
circumstances, that those restrictions would be considered
reasonable from an arm’s-length perspective.
Fourth, petitioners argue that valid business reasons,
rather than testamentary designs, motivated the True family’s
decision to use a tax book value pricing formula. They explain
that the formula had to be (1) understandable to the parties, (2)
predictable, and (3) easily determinable to avoid future
conflicts and to accommodate the short timeframe (6 months from
date of withdrawal) within which tax book value had to be
computed and payments had to be made under the agreements. While
there might have been valid business reasons for choosing a tax
book value formula price, we note that legitimate business
purposes are often mixed with testamentary objectives in the
family context. See Lauder II. Thus, petitioners’ argument does
not dispose of the testamentary device and adequacy of
consideration issue.
Fifth, petitioners contend that tax book value was not
required to bear a predictable relationship to fair market value
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of the underlying assets because the True family had no plans to
liquidate the True companies. Petitioners argue on brief:
book value likely would not have represented the fair
market value of * * * [True Oil’s and Belle Fourche’s]
assets upon liquidation. If the price under a buy-sell
agreement * * * [were] the fair market value of the
business in liquidation, then one of the primary
purposes of a buy-sell agreement would be undermined.
Since the primary business purpose of a buy-sell
agreement is continuation of the business by its
current owners, the agreed price likely will not equate
to the value of the business in liquidation. * * *
At the same time, they argue that because True Oil’s and Belle
Fourche’s tax book values equaled fair market values at the
agreement dates, this is strong evidence that tax book value was
a fair price.
To the contrary, respondent argues (citing St. Louis County
Bank v. United States, supra) that the reasonableness of the
formula price should be analyzed both at the date of agreement
and at later dates to determine whether the agreement was a
testamentary substitute. If the buy-sell agreement’s formula
could be expected to minimize the transfer price, this would
indicate an intent to transfer the interest for less than
adequate and full consideration. We agree.
As we stated in Lauder II, adequate and full consideration
requires a formula price (1) to be comparable to that which would
be negotiated by persons with adverse interests dealing at arm’s
length and (2) to bear a reasonable relationship to the
unrestricted fair market value of the interest in question.
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Under item (2), we must consider whether disparities (at the
interest owner’s death) between the fair market value of
unrestricted interests and the buy-sell agreement’s formula price
could have been predicted by the parties at the time the
agreements were executed. See Estate of Reynolds v.
Commissioner, 55 T.C. at 194.
Certain facts indicate that the True companies’ tax book
value formula price was lower than the formula price that would
have been negotiated by unrelated parties dealing at arm’s
length. For instance, petitioners concede that tax book value
does not reflect the fair market value of underlying assets.
They justify this disparity by saying that value should not be
determined on a company-by-company, liquidating basis, but
instead on an aggregate, going concern basis. Thus, petitioners
contend that the value of True Oil’s proven oil and gas reserves
was properly omitted from the tax book value pricing formula
because the reserves essentially were purchased with earnings
from the other True companies and their value likely would be
dissipated in the unsuccessful search for replacement reserves.
We find it unreasonable to assume that Dave True, in a comparable
situation with unrelated parties, would have agreed to a formula
price that assumed that the value of True Oil’s reserves would be
expended indefinitely on dry holes resulting from unsuccessful
efforts to locate additional reserves.
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Moreover, the True family sometimes chose not to use tax
book value pricing formulas in their dealings with unrelated
parties. Petitioners highlight the fact that unrelated
stockholders sold their stock in Belle Fourche to Dave and Jean
True (not pursuant to buy-sell agreements) at a book value price.
However, we note that one unrelated shareholder sold stock, which
amounted to 24 percent of the stock initially issued by the
corporation, for more than book value; in addition, the book
value used in buying out unrelated shareholders of Belle Fourche
was GAAP book value rather than tax book value. See supra p. 23.
Also, the White Stallion buy-sell agreement, which included
parties that would not be considered natural objects of Dave
True’s bounty (Dave True’s brother and his family), was the only
buy-sell agreement that departed from a pure tax book value
pricing formula (see “First Right of Refusal” provision described
supra p. 49). Similarly, the Toolpushers Employees’ Trust was
specifically exempted from Toolpushers’ buy-sell agreement, thus
allowing the Employees’ Trust to sell its shares back to the
company for more than book value. In an analogous situation, the
True Oil employee profit-sharing plan’s contribution formula
required intangible drilling costs (IDC’s), which were deducted
for tax book purposes, to be added back to determine annual
profits for the purpose of determining the employer’s
contribution obligations.
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The True family’s use of tax book value formula pricing for
companies that engage in ranching and exploratory drilling for
oil and gas further suggests an intention to transfer interests
for less than adequate and full consideration. Congress has
granted various tax incentives to the oil and gas industry, which
include the current write-off of IDC’s and the deduction of cost
or percentage depletion, whichever is higher. Those incentives
reduce book value for tax purposes, sometimes creating anomalous
results such as True Oil’s negative book value at the time of
Tamma Hatten’s sale. Some of the incentives create only short-
term timing differences between books reported on tax versus
financial accounting bases (e.g., accelerated depreciation),
while others create long-term or permanent differences (compare
current deduction of IDC’s to full cost method of accounting for
exploration costs).
Additionally, tax incentives granted to the farming and
ranching industries also create distortions between tax book
value and underlying fair market value. Because True Ranches
deducted (when paid) feed and other costs incurred to raise
livestock, none of those costs were capitalized as basis.
Therefore, raised livestock had no book value on True Ranches’
tax basis books.
These facts suggest that the True family should have known,
at the time the buy-sell agreements were executed, that tax book
value would probably not bear a reasonable relationship to
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(indeed be substantially less than) unrestricted fair market
value.
Respondent also argues that the ranchland exchange
transactions among True Oil, True Ranches, and Smokey Oil,
discussed supra pp. 55-59, reflected petitioners’ attempts
artificially to reduce tax book value through aggressive tax
planning (i.e., petitioners were “double-dipping”). Respondent
suggests that even if these transactions were efficacious income
tax planning techniques--which the Court of Appeals for the Tenth
Circuit held they were not--their effect was to minimize or
eliminate tax book value of certain assets so that Dave True
could transfer interests in the affected True companies for less
than adequate and full consideration. We agree.
Courts have evaluated conduct after the agreement date when
intervening events within the parties’ control caused a wide
disparity between the buy-sell agreement’s formula price and fair
market value. See St. Louis County Bank v. United States, 674 F.
2d at 1211; Estate of Rudolph v. United States, 93-1 USTC par.
60,130, at 88449-88450, 71 AFTR 2d 93-2169, at 93-2176 through
93-2177 (S.D. Ind. 1993). Here, the ranchland exchange
transactions were clearly within the True family’s control. In
addition, because of those transactions, True Ranches received
ranchland properties with substantial fair market value and a
zero tax book value, while the high basis assets received by
Smokey Oil could be expected to be written down for tax purposes.
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Thus, petitioners could have predicted that the ranchland
exchange transactions would create a disparity in which actual
fair market value would exceed the tax book value formula price
under the True Ranches buy-sell agreement.52
3. True Family Buy-Sell Agreements Were Substitutes
for Testamentary Dispositions
To summarize, we have found facts indicating that the buy-
sell agreements at issue in these cases (1) were not the result
of arm’s-length dealings and served Dave True’s testamentary
purposes and (2) included a tax book value formula price that was
not comparable to a price that would be negotiated by adverse
parties dealing at arm’s length and would not, over time, be
expected to bear a reasonable relationship to the unrestricted
fair market value of the ownership interests in the True
companies. In Lauder II, certain facts regarding how the
agreement was entered into allowed us to infer that the buy-sell
agreements served testamentary purposes. We then went on to
52
The Trues argued that evidence of legitimate business
purposes for the ranchland exchange transactions should render
the step transaction doctrine inapplicable. They advanced an
analogous argument in the cases at hand. The Court of Appeals
for the Tenth Circuit acknowledged the evidence of business
purposes, but held that such evidence was not dispositive and
that the step transaction doctrine should still apply. See True
v. United States, 190 F.3d 1165, 1176-1177 (10th Cir. 1999). We
also note the following observation of the Court of Appeals for
the Tenth Circuit: “None of the individual steps in the
ranchland [exchange] transaction is the type of business activity
we would expect to see in a bona fide, arm’s length business deal
between unrelated parties”. True v. United States, 190 F.3d at
1179.
- 141 -
determine whether consideration was full and adequate, to resolve
whether the formula price was binding for estate tax purposes.
See id. After considering all the circumstances, and
particularly the arbitrary manner in which the formula price was
selected, we concluded that the agreements were adopted for the
principal purpose of achieving testamentary objectives and were
not binding for estate tax purposes. See id.
Similarly, in the cases at hand we have weighed all material
facts and conclude that the True companies’ buy-sell agreements
were substitutes for testamentary dispositions. Therefore, the
fourth prong (nontestamentary disposition prong) of the Lauder II
test has not been satisfied.
E. Conclusion: True Family Buy-Sell Agreements Do Not
Determine Estate Tax Values
The True family buy-sell agreements do not satisfy the
Lauder II test, because they are substitutes for testamentary
dispositions. As a result, under section 2031 and the related
regulations, the tax book value buy-sell agreement price does not
control estate tax values of interests in the True companies at
issue in the estate tax case.
Petitioners cite Estate of Hall v. Commissioner, 92 T.C. 312
(1989), in support of their position that the buy-sell agreement
price should control estate tax value. In Estate of Hall, the
estate of Joyce C. Hall, the founder of Hallmark Cards, Inc.,
reported the value of his Hallmark shares for estate tax purposes
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at “adjusted book value”, as determined under various buy-sell
and option agreements. We did not decide whether the price
determined under the adjusted book value formula in those
agreements was dispositive for estate tax valuation purposes;
instead, we held, after careful review of the experts’ reports,
that the actual date of death fair market value of the shares did
not exceed the price determined under the adjusted book value
formula, as reported on the estate tax return. In so doing, we
did two things: (1) We found no evidence to support respondent’s
intimations that the agreements “were merely estate planning
devices [that served] no bona fide business purpose”; and (2) we
concluded that “the transfer restrictions * * * and the prices
set in the buy-sell and option agreements” could not be ignored
in arriving at value because, among other things, “there [was] no
persuasive evidence to support a finding that the restrictions,
or the offers to sell set forth in the agreements, were not
susceptible of enforcement or would not be enforced by persons
entitled to purchase under them.” Estate of Hall v.
Commissioner, supra at 334-335.
The differences between the cases at hand and Estate of Hall
are significant and substantial. In these cases we have found
the buy-sell agreements to be testamentary devices,
notwithstanding that they also served valid business purposes.
As a result, the depressing effect on value that the buy-sell
agreements may have had in these cases is to be ignored, rather
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than taken into account and given some effect, as in Estate of
Hall. See infra p. 153.
An important factor that supports our conclusion in these
cases and distinguishes Estate of Hall is the profound difference
between the tax book value formula in the True family buy-sell
agreements and the adjusted book value formula in Estate of Hall.
Book value in the cases at hand is income tax basis book value,
which gives effect to the income tax subsidies for the oil and
gas and cattle industries, and accelerated depreciation, which
have the effect of substantially reducing book value as compared
with book value determined under generally accepted accounting
principles. “Adjusted book value” in Estate of Hall was book
value using financial statements prepared in accordance with
generally accepted accounting principles, adjusted to reflect the
value of intangibles arising from above-average earnings. In
contrast, the tax basis book value formula in the True family
buy-sell agreements ignores all intangibles, which, Lauder II
indicated, suggests that an unadjusted book value formula has a
testamentary purpose. It ignores the current “discovery value”
of proven reserves, which would increase the price that a well-
informed buyer would be willing to pay. It even ignores historic
actually paid for costs, such as drilling costs and exploration
expenditures attributable to proven reserves, and feed expense
and other costs of homeraised calves that would enter into cost
of goods on hand under generally accepted accounting principles,
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as well as the basis reductions associated with accelerated
depreciation for income tax purposes.
Petitioners’ opening brief says: “Under the facts in this
case, there is no reason to believe that any buyer of an interest
in the True companies would pay more than the book value price of
such interest”, preceded by a quote from Estate of Hall v.
Commissioner, 92 T.C. at 337, that “there was [not] even a remote
possibility that any investor, including a permitted transferee,
would purchase Hallmark shares at a price higher than adjusted
book value.” This is just not true in the cases at hand. There
were instances of sales of higher than book value for profit
sharing purposes and by unrelated parties. In any event, even
if, as could have been expected, all of the sales in the
transactions at issue between family members were at tax basis
book value in accordance with the provision in the buy-sell
agreements, there is no reason to believe, if the buy-sell
agreements are disregarded, as they must be as a result of our
testamentary device finding, that a hypothetical buyer would not
have been willing to pay higher prices than the tax basis book
values at which the subject interests changed hands between
members of the True family.
IV. Do True Family Buy-Sell Agreements Control Gift Tax Values?
We now consider whether the buy-sell agreements at issue in
these cases determine gift tax values for lifetime transfers of
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interests in the True companies made by Dave and Jean True in
1993 and 1994, respectively.
A. Framework for Analyzing Gift Tax Valuation Issues
Federal gift tax is imposed on transfers of property by gift
by any individual during a calendar year. See sec. 2501(a)(1).
The gift is measured by the value of property passing from the
donor and not by the resulting enrichment of the donee. See sec.
25.2511-2(a), Gift Tax Regs. The value of property transferred
at the date of gift is considered to be the amount of the gift.
See sec. 2512(a); sec. 25.2512-1, Gift Tax Regs.
The value of property for gift tax purposes is determined in
the same manner as for estate tax purposes, see supra p. 60, by
applying the hypothetical willing buyer and seller standard. See
Estate of Reynolds v. Commissioner, 55 T.C. at 187-188
(explaining that the estate and gift tax regulations provide
identical definitions of value); compare sec. 25.2512-1, Gift Tax
Regs., with sec. 20.2031-1(b), Estate Tax Regs. Identical
factors are used for gift and estate tax purposes to determine
fair market value of a closely held business for which there is
no public market or recent arm’s-length sale. See Ward v.
Commissioner, 87 T.C. 78, 101 (1986); secs. 25.2512-2(a),
25.2512-2(f), 25.2512-3, Gift Tax Regs.
Transfers that are subject to Federal gift tax include
sales, exchanges, and other dispositions of property for
consideration. See sec. 2512(b). If property is transferred for
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less than adequate and full consideration, the amount by which
the value (as defined above) of property exchanged exceeds the
value of consideration received is deemed to be a gift. See sec.
2512(b); Commissioner v. Wemyss, 324 U.S. 303, 306-307 (1945)
(“The section taxing as gifts transfers that are not made for
‘adequate and full (money) consideration’ aims to reach those
transfers which are withdrawn from the donor’s estate.”); sec.
25.2512-8, Gift Tax Regs. However, a sale, exchange, or other
transfer of property made in the ordinary course of business,
meaning a transaction that is bona fide, at arm’s length, and
free from any donative intent, will be considered as made for
adequate and full consideration. See Commissioner v. Wemyss, 324
U.S. at 306-307; sec. 25.2512-8, Gift Tax Regs. As previously
stated in the estate tax context, transactions within a family
group are subject to special scrutiny, such that there is a
presumption that intrafamily transfers are gifts. See Harwood v.
Commissioner,
82 T.C. 239, 259 (1984)(citing Estate of Reynolds
v. Commissioner, 55 T.C. at 201), affd. without published opinion
786 F.2d 1174 (9th Cir. 1986).
B. Buy-Sell Agreements Do Not Determine Value for Gift Tax
Purposes
It is well settled that restrictive agreements, such as the
buy-sell agreements at issue in the cases at hand, generally do
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not control value for Federal gift tax purposes.53 At most, a
buy-sell agreement may be a factor to consider in determining
gift tax value. See Ward v. Commissioner, 87 T.C. at 105;
Harwood v. Commissioner, 82 T.C. at 260; Berzon v. Commissioner,
63 T.C. 601, 613 (1975), affd.
534 F.2d 528 (2d Cir. 1976);
Estate of Reynolds v. Commissioner, 55 T.C. at 189; Rev. Rul. 59-
60, 1959-1 C.B. 237. Many reasons have been advanced by this
Court and others for the disparate treatment accorded buy-sell
agreements for gift tax versus estate tax purposes.
In estate tax cases, the purchasing individuals or entities
have immediately exercisable, valid, and irrevocable rights to
purchase the decedent’s interest from the estate as of the
valuation date. The critical event (death) that subjects the
stock to the purchase right has occurred, and it is clear that
the seller-estate can receive no more than the formula price.
See Spitzer v. Commissioner, 153 F.2d 967, 970-971 (8th Cir.
53
See Spitzer v. Commissioner, 153 F.2d 967, 971 (8th Cir.
1946); Krauss v. United States,
140 F.2d 510, 511 (5th Cir.
1944); Commissioner v. McCann,
146 F.2d 385, 386 (2d Cir. 1944),
revg.
2 T.C. 702 (1943); Ward v. Commissioner,
87 T.C. 78, 105
(1986); Harwood v. Commissioner,
82 T.C. 239, 260 (1984), affd.
without published opinion
786 F.2d 1174 (9th Cir. 1986); Berzon
v. Commissioner,
63 T.C. 601, 612-613 (1975), affd.
534 F.2d 528
(2d Cir. 1976); Estate of Reynolds v. Commissioner,
55 T.C. 172,
189-190 (1970); James v. Commissioner,
3 T.C. 1260, 1264 (1944),
affd. per curiam
148 F.2d 236 (2d Cir. 1945); Moore v.
Commissioner,
3 T.C. 1205, 1211 (1944); Rev. Rul. 59-60, 1959-1
C.B. 237; Hood et al., Closely Held Corporations in Business and
Estate Planning, Vol. II, sec. 9.13.2, p. 151-152 (1982); Bittker
& Lokken, 5 Federal Taxation of Income, Estates & Gifts, par.
135.3.10 at 135-57 through 135-59 (2d ed. 1993).
- 148 -
1946). However, in gift tax cases, the transferring stockholder
or partner (putative donor) is under no immediate obligation to
sell. See Commissioner v. McCann, 146 F.2d 385, 386 (2d Cir.
1944), revg.
2 T.C. 702 (1943); James v. Commissioner,
3 T.C.
1260, 1264 (1944). Instead, he merely agrees to offer his
interest to the other owners on stated terms if and when he
decides to sell or transfer his interest. Thus, the obligation
to sell has not matured in the gift tax cases and therefore
cannot set a ceiling on transfer tax value.
Resale value is not the only factor to consider in
determining fair market value for gift tax purposes. Until the
transferor actually disposes of his interest, he is entitled to
all the rights and privileges of ownership (e.g., rights to
receive dividends and to decide when to dispose of his interest).
See Harwood v. Commissioner, 82 T.C. at 261; Estate of Reynolds
v. Commissioner, 55 T.C. at 190; Baltimore Natl. Bank v. United
States, 136 F. Supp. 642, 654 (D. Md. 1955). Thus, courts found
that gift tax fair market value should include this “retention
value”, which the buy-sell agreement price does not adequately
capture.
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C. Application of Gift Tax Rules to Lifetime Transfers by
Dave and Jean True
1. True Family Buy-Sell Agreements Do Not Control Gift
Tax Values
The weight of authority establishes that the True family
buy-sell agreements do not fix values for Federal gift tax
purposes. However, petitioners contend that identical standards
should apply to determine whether buy-sell agreements control
values for both estate and gift tax purposes. We disagree, for
the reasons stated below.
First, petitioners argue that “fair market value” has the
same meaning for estate tax and gift tax purposes; therefore, the
standard for determining whether a buy-sell agreement controls
fair market value should be the same under both regimes.
Although petitioners’ argument has superficial appeal, it does
not reflect the development of the law in this area.
Second, petitioners attempt to distinguish the cases at hand
from the many cases in which restrictive agreements were found
not to determine gift tax value. Petitioners suggest that in
those cases, courts emphasized that the event giving rise to an
obligation to sell had not occurred as of the date of gift (i.e.,
gift transfers of stock or partnership interests did not trigger
option or first-offer provisions). As a result, it was not
certain whether or when the buy-sell provisions would be
triggered. Petitioners contrast this with the treatment of
transfers at death, stating that courts allowed buy-sell
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agreements to determine estate tax value because death gave rise
to the obligation to sell. Petitioners argue that the events
giving rise to the obligation to sell under the True buy-sell
agreements were Dave and Jean True’s decisions to sell their
respective interests in 1993 and 1994; therefore, their lifetime
transfers made subject to the buy-sell agreement restrictions
should be treated under the same standard as transfers at death
and not by the standard applied to gift transfers that do not
trigger the buy-sell provisions. We disagree.
Petitioners’ analysis strikes us as mechanical and
unreflective of the law’s development in this area. In Harwood
v. Commissioner, 82 T.C. at 260, we said: “Restrictive
provisions in a partnership agreement which limit the amount
received from the partnership by a withdrawing partner or the
estate of a deceased partner to the book value of his partnership
interest are not binding upon respondent for gift tax purposes.”
The fact that the operation of the buy-sell agreements was
triggered by Dave and Jean True’s decisions to sell their
interests in the True companies does not substantively
distinguish these cases from those in which the transferor was
not required first to offer his interest to others before making
a gift to his family. In either situation, the transferor has
retained the right to choose when and if a disposition would
occur. In the meantime, the transferor is entitled to receive
dividends or partnership distributions, and to enjoy the other
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benefits associated with his or her investment. The estate
executor has no such discretion at the decedent-stockholder’s or
decedent-partner’s death.
In any event, the same buy-sell agreements are at issue for
both estate and gift tax purposes, and we have found them to be
substitutes for testamentary dispositions under Lauder II and
section 20.2031-2(h), Estate Tax Regs. Therefore the True family
buy-sell agreements at issue in the cases at hand do not control
values for gift tax purposes.
2. Lifetime Transfers by Dave and Jean True Were Not
in Ordinary Course of Business
As previously discussed, sales or exchanges for less than
adequate and full consideration constitute gifts. See sec.
2512(b); Commissioner v. Wemyss, 324 U.S. 303 (1945); sec.
25.2512-8, Gift Tax Regs. However, a sale made in the ordinary
course of business (bona fide, at arm’s length, and free from
donative intent) is considered to have been made for adequate and
full consideration. See Commissioner v. Wemyss, 324 U.S. at 306-
307; sec. 25.2512-8, Gift Tax Regs.
Dave and Jean True’s sales of interests in the True
companies were not made in the ordinary course of business. In
1993, Dave True sold partial interests in the various True
companies that were partnerships to ensure that, on his death,
his estate would secure the benefits of pre-Chapter 14 rules
regarding the determinative nature of buy-sell agreements for
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estate tax valuation purposes. Likewise, Jean True’s sales to
her sons in 1994, shortly after her husband’s death, fulfilled
the couple’s overall testamentary plan to pass the family
businesses to their sons. These motivations for the sales were
not devoid of testamentary (or donative) intent. In addition, we
have already discussed at length how the creation and continued
enforcement of the True companies’ book value buy-sell agreements
lacked indicia of arm’s-length dealing. See supra pp. 101-144;
Harwood v. Commissioner, 82 T.C. at 258 (“We do not believe that
a transfer by a mother to her sons of her interest in the family
partnership, structured totally by the family accountant, with no
arm’s-length bargaining, can be characterized as a transaction in
the ordinary course of business.”).
Petitioners erroneously argue that section 2512(b) does not
apply to the lifetime sales by Dave and Jean True; therefore,
they provide no evidence and only conclusory statements to
support their conclusion that the sales were made in the ordinary
course of business.
In conclusion, because the buy-sell agreements do not
establish gift tax fair market value, we must independently
determine value and compare that value to consideration paid in
the 1993 and 1994 lifetime transfers to decide whether interests
in the True companies were transferred for less than adequate and
full consideration. Any excess of the value of interests
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transferred over the value of consideration received will
constitute gifts under section 2512(b).
V. Impact of Noncontrolling Buy-Sell Agreements on Estate and
Gift Tax Valuations
Having held that the True companies’ buy-sell agreements do
not control fair market value for either estate tax or gift tax
purposes, we must decide whether noncontrolling buy-sell
agreements are factors to consider in valuing the subject
interests under sections 2031 and 2512.
For estate tax purposes, section 20.2031-2(h), Estate Tax
Regs., explicitly states that a buy-sell agreement price will be
disregarded in determining the value of securities unless it is
found that the agreement represents a bona fide business
arrangement and not a device to pass the decedent’s shares to the
natural objects of his bounty for less than adequate and full
consideration. Therefore, only if the agreement is both a bona
fide business arrangement and not a testamentary device would its
price have an effect on estate tax value. See Lauder II.
We applied this principle in Estate of Lauder v.
Commissioner, T.C. Memo. 1994-527, 68 T.C.M. 985, 998-999,
1994 T.C.M. (RIA) par. 94,527, at 94-2741 (Lauder III), in which
we stated:
We agree with respondent that, in light of our
holding in * * * [Lauder II], it would be anomalous if
particular portions of the shareholder agreement are
now deemed relevant to the question of the fair market
value of decedent’s stock. At the risk of belaboring
the point, our responsibility is to determine the fair
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market value of decedent’s stock on the date of his
death. In our prior opinion, we resolved that the
formula price was intended to serve a testamentary
purpose, and thus would not be respected for Federal
estate tax purposes. It is worth noting at this point
that we have not had the opportunity to address the
validity of each and every aspect of the shareholder
agreement. Nonetheless, we repeat the observation made
earlier in these proceedings that there is no evidence
in the record that the Lauders engaged in arm’s-length
negotiations with respect to any aspect of the
shareholder agreement. Absent proof on that point, we
presume that all aspects of the agreement, particularly
those tending to depress the value of the stock, are
tainted with the same testamentary objectives rendering
the formula price invalid. [Fn. ref. omitted.]
In light of our holding in * * * [Lauder II] we
hold that the specific provisions of the shareholder
agreement are not relevant to the question of the fair
market value of decedent’s stock on the valuation date.
Simply put, the willing buyer/willing seller analysis
that we undertake in this case would be distorted if
elements of such testamentary origin are injected into
the determination.
Although we did not hold the buy-sell agreement in Lauder
III invalid per se, the only evidentiary weight we accorded it
was to recognize that it demonstrated the Lauders’ commitment to
maintaining family control over the business. That fact, among
others, justified the use of a lack of a marketability discount
in the valuation analysis. See Estate of Godley v. Commissioner,
T.C. Memo. 2000-242 (disregarding option provision in valuing
partnership interests because it served as substitute for
testamentary disposition).
In the cases at hand, we hold for similar reasons that the
restrictive provisions of the buy-sell agreements (including but
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not limited to the formula price) are to be disregarded in
determining fair market value for estate tax purposes.
Rev. Rul. 59-60, 1959-1 C.B. 237, which provides valuation
guidance for both estate and gift tax purposes, states that a
buy-sell agreement is a factor to consider with other relevant
factors in determining fair market value. It further provides
that it is always necessary to determine whether the agreement
represents a bona fide business arrangement or is a testamentary
device. See id. We take these statements, together with Lauder
III and its interpretation of section 20.2031-2(h), Estate Tax
Regs., to mean that the same rule should apply to disregard
noncontrolling buy-sell agreements for gift tax and estate tax
valuation purposes. Cf. Estate of Reynolds v. Commissioner, 55
T.C. at 194 (holding that voting trust agreement preemption
provisions should not be disregarded in consolidated gift and
estate tax cases because the agreement was not a testamentary
device).
Issue 2. If True Family Buy-Sell Agreements Do Not Control
Values, What Are Estate and Gift Tax Values of Subject Interests?
FINDINGS OF FACT
After respondent’s concessions, the transferred interests
whose values remain in dispute are: True Oil, Eighty-Eight Oil,
and True Ranches, to be valued as of January 1, 1993, June 4,
1994, and June 30, 1994; Belle Fourche and Black Hills Trucking,
to be valued as of June 4, 1994, and June 30, 1994; and White
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Stallion, to be valued as of June 4, 1994 (disputed companies).
See Appendix schedules 1-3. The parties have stipulated that the
fair market values of the assets owned by the disputed companies,
except White Stallion, were the same on June 30, 1994, as they
were on June 4, 1994.
Financial information for the disputed companies was
compiled and analyzed in the expert reports, which derived the
data from the companies’ Federal partnership and S corporation
income tax returns for tax years 1988 through 1994. The disputed
companies maintained tax basis books and records for management
purposes and did not have financial statements that had been
audited or otherwise reviewed by certified public accountants.
See supra pp. 12-22 for historical background of disputed
companies.
I. True Oil
True Oil’s proved oil reserves equaled 5,297,528 barrels
(bbl) as of August 1, 1973, and 7,389,000 bbl as of June 4, 1994.
Proved gas reserves were 8,551,994 thousands of cubic feet (Mcf)
as of August 1, 1973, and 9,075,000 Mcf as of June 4, 1994. The
parties have stipulated that the total fair market value of all
oil and gas properties and related facilities owned by True Oil
was $39,650,000 as of January 1, 1993, and $34,200,000 as of June
4, 1994. In addition, respondent agreed not to dispute
petitioners’ position that True Oil’s reserves were 8.9 million
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barrels of oil-equivalent (boe)54 on January 1, 1993, and on June
4, 1994.
During the period 1988 through 1993, True Oil’s revenues
declined from a high of $25.8 million in 1990 to a low of $17.6
million in 1993. In addition, operating margins declined from
44.2 percent of revenues in 1990 to 35.8 percent of revenues in
1993. These declines can be attributed to increased competition
within the industry and to True Oil’s unsuccessful attempts to
find new reserves. True Oil spent over $300 million on
intangible drilling costs from 1972 through 1998; approximately
58 percent of those costs related to nonproductive wells.
True Oil’s ordinary income also declined from a high of
approximately $12.2 million in 1990 to a loss of $4.7 million in
1993. For the period 1988 through 1993, True Oil sustained net
losses only in 1992 and 1993. In those 2 years, True Oil
deducted extraordinary exploration costs of approximately $23
million on an unsuccessful venture in Honduras.
For the 6 months ending June 30, 1994, True Oil’s revenues
decreased sharply from approximately $11.3 million (for 6 months
ending June 30, 1993) to $7.5 million. Likewise, net income was
lower than for the same 6-month period in 1993.
54
Barrels of oil-equivalent takes into account both oil and
gas reserves. Gas is converted to boe units either based on a
heating ratio (usually 6,000 cubic feet of gas to a barrel of
oil) or on a current price ratio (about 9,000 to 1 in the 1993-94
period).
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True Oil’s fixed assets increased from $28.4 million in 1988
to $36.6 million in 1993. Total assets decreased from a high in
1991 of approximately $41.4 million to $18.4 million in 1993.
Current liabilities increased from $7.8 million in 1990 to $8.1
million in 1993. True Oil carried no funded debt during the
period being examined, so that current liabilities represented
total liabilities.
During the period 1988 through 1994, withdrawals from
partners’ capital exceeded contributions by approximately $26.8
million. However, in the last 4 of those years (1991 to 1994),
total contributions exceeded distributions by almost $2.5
million.
General partnership interests in True Oil have never been
traded in public markets.
II. Belle Fourche
Belle Fourche’s primary asset is a network of pipelines it
uses to gather and transport crude oil. At the valuation dates,
Belle Fourche had approximately 1,740 miles of gathering line and
870 miles of main line. Crude oil was collected into the
gathering line system from the production point (e.g., wellhead
or stock tank) and eventually reached a main line for
distribution to the market via oil storage facilities or
transportation to other pipelines.
Throughput is the standard measure for pipeline operations
that describes the amount of fluid transported through the system
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in a given period of time. During the period 1979 through 1993,
Belle Fourche’s throughput ranged from approximately 26 to 36
million barrels per year;55 the highest volume was in 1993 (36.2
million barrels), while the lowest volume was in 1988 (26.2
million barrels). Since 1990, the company’s throughput has
steadily increased.
Belle Fourche earned revenue from its pipeline system by
charging tariffs for transportation, delivery, and testing of
crude oil. Amounts charged by Belle Fourche were regulated by
Federal and State agencies.
During the period 1988 through 1993, revenues increased at a
compounded annual growth rate of 11 percent, from a low of $10.5
million in 1988 to a high of $17.5 million in 1993. Belle
Fourche was profitable from 1988 to 1993, generating the highest
pre-tax income of $8.2 million in 1990 and the lowest of $3.7
million in 1993 (As an S corporation, Belle Fourche is not
required to pay corporate level income taxes.). However, pre-tax
income margins have declined from a high of 61 percent in 1990 to
a low of 21 percent in 1993. This trend is attributable to a
55
Petitioners’ experts’ reports stated that Belle Fourche’s
historical average throughput was 25,000 barrels per day.
Annualizing that figure would result in average throughput of
just over 9 million barrels per year. The parties did not
address this discrepancy at trial or on brief. We find the 26 to
36 million barrels per year average to be more reliable because
it was derived from respondent’s expert’s analysis of filings
with regulatory agencies.
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decline in production, which was expected to continue as of the
valuation dates.
For the 6 months ending June 30, 1994, Belle Fourche’s
revenues declined from approximately $8.8 million (for 6 months
ending June 30, 1993) to $7.3 million. Likewise, net income was
lower than for the same 6-month period in 1993.
Belle Fourche’s fixed assets increased steadily from $57.6
million in 1988 to $78.6 million in 1993. In 1992, Belle Fourche
paid approximately $16 million to purchase a smaller crude oil
common carrier system (the Thunderbird pipeline) located near its
preexisting pipelines.
During the period 1988 through 1993, Belle Fourche carried
long-term debt to shareholders, which rose most sharply from 1991
($1.3 million) to 1992 ($18 million). Shareholder debt was
$17,115,350 as of December 31, 1993. However, the corporation
repaid $1.2 million of the debt in May 1994, resulting in
shareholder debt of $15,915,350 on May 31, 1994, and June 30,
1994. Interest on shareholder debt was calculated based on the
greater of a Colorado bank’s prime rate or the short-term
applicable Federal rate. The interest rate for 1994 ranged from
6 to 6.75 percent.
During the period 1988 through 1993, Belle Fourche
distributed total cash or other property worth over $36 million
to its shareholders, with average total distributions of over $5
million annually. On average, these distributions exceeded the
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shareholders’ tax obligations on their distributive shares of
taxable income.
Belle Fourche stock has never been traded in public markets.
III. Eighty-Eight Oil
On brief, respondent adopted Mr. Kimball’s marketable
minority value for Eighty-Eight Oil of $25,174,683 as of
January 1, 1993; Mr. Lax’s marketable minority value was $40
million as of June 3, 1994.
During the period 1988 through 1993, Eighty-Eight Oil’s
revenues increased from $191.7 million in 1988 to $558.6 million
in 1992, then decreased to $466.7 million in 1993. Operating
margins varied over the analyzed period from 2 percent of
revenues in 1988 to .8 percent in 1993.
Eighty-Eight Oil generally was profitable from 1988 to 1993,
generating the highest ordinary income of $4.1 million in 1992
and the lowest of $623,000 in 1988; however, the company
sustained a $7 million loss in 1991. During the period, Eighty-
Eight Oil annually deducted, in arriving at ordinary income, an
average of $1.2 million in total guaranteed payments to partners.
For the 6 months ending June 30, 1994, Eighty-Eight Oil’s
revenues declined from $242 million (for 6 months ending June 30,
1993) to $161 million. However, Eighty-Eight Oil so managed its
expenses that ordinary income increased as compared with the same
6-month period in 1993.
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Eighty-Eight Oil’s fixed assets increased from $714,000 in
1988 to approximately $13 million in 1993, as the company
acquired buildings, equipment, and land. Current assets
increased from $20.6 million in 1988 to approximately $46 million
in 1993, which is attributable to an increase in cash, cash
equivalents, and prepaid crude oil purchases. At the end of 1992
and 1993, current assets (i.e., cash, cash equivalents, accounts
receivable, inventories, prepaid crude oil purchases) constituted
more than 85 percent of Eighty-Eight Oil’s total assets. Total
current liabilities decreased from $35.4 million in 1989 to $16.8
million in 1993. A large reduction in current liabilities
occurred between 1988 and 1989 after the company paid off $30.9
million in debt. Eighty-Eight Oil carried no funded long-term
debt during the period being examined, so that current
liabilities represented total liabilities.
Eighty-Eight Oil’s financial ratios improved over the
analyzed period and were strong relative to the median oil
industry ratios. Between 1988 and 1993, the company’s current
ratio increased from .3 to 2.7, as compared with the industry
average of 1.3 in 1993. Eighty-Eight Oil’s working capital
increased significantly from $8.5 million in 1989 to $29.3
million in 1993. The company’s accounts receivable turnover
ratio improved from 19.2 in 1990 to 24.5 in 1993, which is
substantially above the industry average of 6.5. Thus, during
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the analyzed period, Eighty-Eight Oil increasingly became more
liquid than the industry.
During the period 1988 through 1994, overall partners’
capital contributions exceeded withdrawals by approximately $60
million. However, in the most recent of those years (1993 and
1994) total withdrawals exceeded contributions by over $36
million. Under the partnership agreement, additional capital
contributions were to be made in the same percentages as the
profit and loss sharing ratios. However, the partners’ capital
account balances were often not in proportion to their profit and
loss sharing ratios. For example, Dave True’s capital account
balance at the end of 1992 was $7,046,509, while total partners’
capital was $43,590,998. This gave Dave True a 16.17-percent
interest in total partners’ capital, as compared with his yearend
profit and loss sharing ratio of 68.47 percent, according to the
partnership agreement dated August 11, 1984, and the 1992
schedule K-1. Petitioners explained that disproportionate
capital accounts were unique to Eighty-Eight Oil, which operated
as a bank that held excess cash for the True family, and did not
reflect the operations of the other True family partnerships.
The day before selling part of his interest in Eighty-Eight
Oil to his sons as of January 1, 1993, Dave True contributed over
$6 million to partners’ capital. In accordance with the
partnership agreement, he then sold 24.84 percent of his Eighty-
Eight Oil partnership interest to his sons based on the book
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value of his capital account as of the close of business on
December 31, 1992, or $7,046,509. Thus, he sold 24.84 percent
out of his 68.47-percent interest in profits, losses, and capital
for $2,556,379. The consideration paid by the True sons for an
aggregate 24.84-percent interest in Eighty-Eight Oil represented
5.86 percent of total partners’ capital as of December 31, 1992.
As a result of the sales, the True sons’ profit and loss sharing
ratios each increased by 8.28 percent, for a total increase of
24.84 percent.56 If Dave True had not made the $6 million
capital contribution to Eighty-Eight Oil on December 31, 1992,
the price he would have been entitled to receive for the 24.84-
percent partnership interest would have been less than $400,000.
General partnership interests in Eighty-Eight Oil have never
been traded in public markets.
IV. Black Hills Trucking
Respondent has adopted the final Lax report’s controlling
equity value (using the net asset value method) of $10,933,730 as
of June 3, 1994.
Black Hills Trucking engaged in interstate transport of
oilfield and drilling equipment, specializing in on-road and off-
road hauling of heavy equipment. From 1988 to 1994, Black Hills
Trucking conducted 75 percent of its business with unrelated
56
Because of the state of the record, we were unable to
perform a similar analysis of partners’ capital account balances
in connection with the June 4 and June 30, 1994, transfers.
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companies. Black Hills Trucking’s assets fell into three
categories: Power equipment, trailer equipment, and
miscellaneous and office equipment. Power equipment included
trucks, tractors, cranes, forklifts, heavy construction
equipment, and small vehicles; trailer equipment included
flatbed, float, lowboy, tanker and dump trailers, and accessory
trailers such as jeeps, boosters, dollies, light trailers, a
barbeque pit, and other towed equipment; miscellaneous and office
equipment included computers, maintenance and shop equipment, and
furniture. The ages of the various types of equipment ranged
from 1 to 40 years.
During the period 1989 through 1993, revenues increased
slightly from $15.1 million to $16.8 million. Black Hills
Trucking suffered losses over the analyzed period that ranged
from a high of $6.1 million in 1990 to a low of $178,000 in 1992.
On average, the company annually deducted approximately $2.1
million of depreciation expense in computing its losses.
For the 6 months ending June 30, 1994, revenues increased
from $9.086 million (for 6 months ending June 30, 1993) to $9.436
million. Net losses for the period decreased from $2.628 million
in 1993 to $220,680 in 1994. However, management indicated that
the company’s outlook was bleak due to excess supply and
insufficient demand in the trucking industry.
Total net fixed assets (tax basis) drastically declined over
the period from $8.9 million in 1989 to $3.1 million in 1993 due
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to the company’s selloff of buildings and equipment. Total
assets decreased over the period from $13.2 million in 1989 to
$6.7 million in 1993.
During the period 1989 through 1993, Black Hills Trucking
carried long-term shareholder debt that ranged from a high of
$13.9 million in 1990 to a low of $855,000 in 1992. Shareholder
debt was roughly $2.8 million at the end of 1993.
During the period 1988 through 1994, Black Hills Trucking
distributed cash or other property to its shareholders only in
1989, in the amount of $213,000. On the other hand,
shareholders’ contributions to paid-in or capital surplus
increased during the analyzed period, spiking from $1.4 million
in 1990 to $16.7 million in 1991.
The stock of Black Hills Trucking has never been traded in
public markets.
V. True Ranches
Respondent adopts the entity values derived by Mr. Kimball
under the net asset value method. Accordingly, the parties agree
that the controlling equity value of True Ranches was
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$41,003,00057 as of January 1, 1993, and $45,297,509 as of June
30, 1994.
During the period 1989 through 1993, revenues fluctuated
from a low of $23.3 million in 1991 to a high of $31.3 million in
1992. Ordinary income also fluctuated from a high of $2.1
million in 1992 to a loss of $3.6 million in 1991. The company
incurred losses in 2 out of the 5 years being examined.
For the 6 months ending June 30, 1994, revenues decreased
from $12.7 million (for 6 months ending June 30, 1993) to $9.3
million. Net losses for the period increased from $842,179 in
1993 to $1.9 million in 1994.
True Ranches had no current liabilities during the analyzed
period. However, net working capital steadily declined from
roughly $7 million in 1990 to $4.8 million in 1993.
During the period 1988 through 1994, partners’ capital
contributions exceeded withdrawals by approximately $64.4
million.
Partnership interests in True Ranches have never been traded
in public markets.
57
Originally, the Kimball report computed True Ranches’ net
asset value to be $40,863,000 as of Jan. 1, 1993; however,
Mr. Kimball later revised his estimate to $41,003,000, based on
clarifying data received from the ranch property appraisers. On
brief, respondent agreed with Mr. Kimball’s original value as of
Jan. 1, 1993. We assume that respondent also adopts Mr.
Kimball’s revised value.
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VI. White Stallion
Respondent adopts the final Lax report’s controlling equity
value (using the net asset value method) of $1,139,080 as of
June 3, 1994.
White Stallion operates a dude ranch near Tucson, Arizona,
consisting of 250 acres of land and improvements. During the
period 1989 through 1992, revenues increased from $677,224 in
1989 to $1,042,260 in 1992. The compounded annual growth rate
for the period was approximately 15 percent. Revenues for 1993
showed no substantial percentage growth. Ordinary income
increased during the period from $2,771 in 1989 to $166,922 in
1993.
During the period 1988 through 1993, the company carried
long-term shareholder debt that ranged from roughly $46,000
(early years) to $92,000 (ending balance in 1993).
During the period 1988 through 1994, White Stallion made no
distributions of cash or other property to its shareholders. On
the other hand, shareholders’ contributions to paid-in or capital
surplus slightly increased during the analyzed period.
White Stallion stock has never been traded in public
markets.
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OPINION
I. Expert Opinions
As is customary in valuation cases, the parties rely
primarily on expert opinion evidence to support their contrary
valuation positions. We evaluate the opinions of experts in
light of their demonstrated qualifications and all other evidence
in the record. See Anderson v. Commissioner, 250 F.2d 242 (5th
Cir. 1957), affg. in part and remanding in part on another ground
T.C. Memo. 1956-178; Parker v. Commissioner,
86 T.C. 547, 561
(1986). We have broad discretion to evaluate “‘the overall
cogency of each expert’s analysis.’” Sammons v. Commissioner,
838 F.2d 330, 334 (9th Cir. 1988)(quoting Ebben v. Commissioner,
783 F.2d 906, 909 (9th Cir. 1986), affg. in part and revg. in
part T.C. Memo. 1983-200), affg. in part and revg. in part on
another ground T.C. Memo. 1986-318. Although expert testimony
usually helps the Court determine values, sometimes it does not,
particularly when the expert is merely an advocate for the
position argued by one of the parties. See, e.g., Estate of
Halas v. Commissioner,
94 T.C. 570, 577 (1990); Laureys v.
Commissioner,
92 T.C. 101, 129 (1989).
We are not bound by the formulas and opinions proffered by
an expert witness and will accept or reject expert testimony in
the exercise of sound judgment. See Helvering v. National
Grocery Co., 304 U.S. 282, 295 (1938); Anderson v. Commissioner,
250 F.2d at 249; Estate of Newhouse v. Commissioner, 94 T.C. at
- 170 -
217; Estate of Hall v. Commissioner, 92 T.C. at 338. We have
rejected expert opinion based on conclusions that are unexplained
or contrary to the evidence. See Knight v. Commissioner, 115
T.C. 506 (2000); Rose v. Commissioner,
88 T.C. 386, 401 (1987),
affd.
868 F.2d 851 (6th Cir. 1989); Compaq Computer Corp. v.
Commissioner, T.C. Memo. 1999-220.
Where necessary, we may reach a determination of value based
on our own examination of the evidence in the record. See Lukens
v. Commissioner, 945 F.2d 92, 96 (5th Cir. 1991)(citing Silverman
v. Commissioner,
538 F.2d 927, 933 (2d Cir. 1976), affg. T.C.
Memo. 1974-285); Ames v. Commissioner, T.C. Memo. 1990-87, affd.
without published opinion
937 F.2d 616 (10th Cir. 1991). Where
experts offer divergent estimates of fair market value, we decide
what weight to give those estimates by examining the factors they
used in arriving at their conclusions. See Casey v.
Commissioner,
38 T.C. 357, 381 (1962). We have broad discretion
in selecting valuation methods, see Estate of O’Connell v.
Commissioner,
640 F.2d 249, 251 (9th Cir. 1981), affg. on this
issue and revg. in part T.C. Memo. 1978-191, and in determining
the weight to be given the facts in reaching our conclusions,
inasmuch as “finding market value is, after all, something for
judgment, experience, and reason”, Colonial Fabrics, Inc. v.
Commissioner,
202 F.2d 105, 107 (2d Cir. 1953), affg. a
Memorandum Opinion of this Court. While we may accept the
opinion of an expert in its entirety, see Buffalo Tool & Die Mfg.
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Co. v. Commissioner, 74 T.C. 441, 452 (1980), we may be selective
in the use of any part of such opinion, or reject the opinion in
its entirety, see Parker v. Commissioner, supra at 561. Finally,
because valuation necessarily results in an approximation, the
figure we arrive at need not be directly attributable to specific
testimony if it is within the range of values that may properly
be arrived at from consideration of all the evidence. See
Silverman v. Commissioner, supra at 933; Alvary v. United States,
302 F.2d 790, 795 (2d Cir. 1962).
II. Experts and Their Credentials
A. Petitioners’ Expert, John H. Lax
Before filing the estate tax return, petitioners obtained an
appraisal (initial Lax report) of the estate’s corporate and
partnership interests in the True companies as of June 3, 1994,
from the Valuation Services Group of Arthur Andersen LLP (AA),
Houston, Texas. John H. Lax (Mr. Lax), a principal at AA,
participated in the evaluation of the True companies, assisted in
the preparation of the reports, and testified at trial on behalf
of petitioners. Mr. Lax specializes in financial analysis and
appraisal of business enterprises, individual securities, and
various intangible assets. He earned a Senior American Society
of Appraisers designation in 1975 and became a Certified
Management Accountant in 1976.
Petitioners provided a copy of the initial Lax report to the
IRS during the 1993 gift tax return audit, which overlapped with
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respondent’s audits of the estate tax return and Mrs. True’s 1994
gift tax return. In preparing the 1993 and 1994 gift tax notices
and the estate tax notice, respondent used most of the entity
values determined by Mr. Lax but entirely disallowed the claimed
discounts.
Subsequently, Mr. Lax submitted a revised expert witness
report (final Lax report) and testified at trial regarding the
value of the estate’s interests in the True companies as of June
3 and 4, 1994. The final Lax report differed from the initial
Lax report in several ways; most importantly, the final Lax
report repudiated certain marketability discounts found in the
initial Lax report because AA had decided, subsequent to issuance
of the initial Lax report, that market data did not justify
measurable marketability discounts in connection with controlling
interests.
B. Petitioners’ Expert, Curtis R. Kimball
After petitions had been filed in these cases, petitioners
engaged Willamette Management Associates (WMA) to appraise the
transferred interests in the True companies. Curtis R. Kimball
(Mr. Kimball), a principal of WMA and its national director for
estate and gift tax matters, participated in the evaluations,
assisted in the preparation of the resulting reports, and
testified at trial on behalf of petitioners. Mr. Kimball has
performed valuations of business entities and interests, analyzed
publicly traded and private securities, and appraised intangible
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assets and intellectual property. He is an Accredited Senior
Appraiser of the American Society of Appraisers and a Chartered
Financial Analyst of the Association for Investment Management
and Research. Mr. Kimball personally had appraised interests in
three closely held oil and gas companies before True Oil, and WMA
had appraised interests in three others. Also, WMA had appraised
interests in closely held pipeline and oil tool manufacturing
companies.
Mr. Kimball submitted two expert witness reports (Kimball
reports) and testified at trial regarding the values of interests
in the True companies as of January 1, 1993, June 4, 1994, and
June 30, 1994. He also prepared a rebuttal to respondent’s
expert reports.
Messrs. Lax and Kimball valued many of the same interests as
of the same dates but came to different conclusions regarding
value. Petitioners introduced both experts’ appraisals of value
into evidence and did not choose between them.
C. Petitioners’ Expert, Dr. Robert H. Caldwell
Dr. Robert H. Caldwell (Dr. Caldwell) is co-founder of The
Scotia Group, Inc., Dallas, Texas, which provides domestic and
international oil and gas advisory services. He has a Ph.D. in
geology and is a Certified Petroleum Geologist.
Dr. Caldwell prepared expert witness reports (Scotia
reports) for trial that computed the fair market value of True
Oil’s oil and gas properties as of January 1, 1993, and June 4,
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1994. Dr. Caldwell did not testify at trial because the parties
eventually stipulated the values of the oil and gas properties on
the basis of discussions between Dr. Caldwell and respondent’s
expert, Mr. Gustavson, supra p. 156-157.
D. Petitioners’ Expert, Michael S. Hall
Michael S. Hall (Mr. Hall) is president of Hall and Hall
Mortgage Corp., Denver, Colorado, which provides farm real estate
financing and appraisal services. He is a C.P.A., a Certified
General Appraiser in Colorado and Wyoming, and a qualified expert
witness in U.S. Bankruptcy Court. Mr. Hall prepared an expert
witness report (H&H report) that valued the land and improvements
of True Ranches as of January 1, 1993, and June 3, 1994; he also
testified at trial.
E. Respondent’s Expert, John B. Gustavson
Respondent’s only expert witness with respect to interests
in the disputed companies was John B. Gustavson (Mr. Gustavson),
of Gustavson Associates, Inc., Boulder, Colorado. Mr. Gustavson
is a minerals appraiser and a Certified Professional Geologist
who has valued over 100 oil and gas properties. He is not an
expert in business valuations.
Mr. Gustavson submitted an expert witness report (Gustavson
report) regarding the fair market values of oil and gas
properties and assets owned by True Oil and assets owned by Belle
Fourche as of January 1, 1993, and June 4, 1994. The Gustavson
report did not value 100 percent of the equity interests or the
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subject interests in True Oil and Belle Fourche. Mr. Gustavson
testified at trial regarding the fair market value of Belle
Fourche assets only, due to the parties’ agreement on the value
of True Oil’s oil and gas properties. In addition, Mr. Gustavson
prepared reports (Gustavson rebuttals) and testified in rebuttal
to the final Lax report and the Kimball reports.58 Mr.
Gustavson’s rebuttal testimony solely dealt with the valuations
of interests in True Oil and in Belle Fourche.
III. Preliminary Matters Regarding Valuation
A. Respondent’s Alleged Concessions Regarding Valuation
Discounts
In a telephone conference on January 8, 1999, the Court
asked the parties to submit schedules, before trial, setting
forth their positions on the fair market values of the interests
still in dispute. The parties responded by jointly submitting
schedules, attached to a cover letter dated January 14, 1999,
entitled “Comparison of Values of Transferred Interests”
determined as of January 1, 1993, June 4, 1994, and June 30, 1994
(Exhibit 262-P).
Exhibit 262-P contained information about each company under
the following headings: Return Value/Book Value, IRS Value per
58
Mr. Gustavson also prepared rebuttal reports to the Scotia
reports and the SRC appraisals. As a result of the parties’
agreement regarding the value of True Oil’s reserves, Mr.
Gustavson did not testify in rebuttal to the Scotia reports.
However, those rebuttal reports, as well as Dr. Caldwell’s
rebuttal to the Gustavson report, were admitted into evidence.
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Notice, AA Hypothetical Value, WMA Hypothetical Value, and
Current IRS Value. A footnote to the “Current IRS Value” column
in each schedule stated: “These values reflect respondent’s
agreement to allow combined minority interest and marketability
discounts of up to 40 percent.” For the most part, petitioners
prepared Exhibit 262-P and then furnished it to respondent for
his review and approval. However, respondent provided
petitioners with the “Current IRS Value” information and text for
the related footnote.
On February 16, 1999, the first day of trial, the parties
filed a stipulation of facts and a supplemental stipulation of
facts. The stipulations did not refer to “Current IRS Value[s]”
or the combined minority and marketability discounts mentioned in
Exhibit 262-P. However, the stipulations stated that respondent
was no longer asserting adjustments in the value of transferred
interests in certain companies, each of which had a “Current IRS
Value” that approximated its “Return Value/Book Value”.
Respondent’s trial memorandum, dated January 28, 1999,
stated:
In [his] notice of deficiency respondent allowed no
discounts to the underlying values of the transferred
interests. Respondent has indicated to petitioners that
minority and marketability discounts of up to 40% should
be applied in determining the fair market values of the
transferred interests.
In addition, “Current IRS Value[s]” differed from values reported
in the statutory notices because the “Current IRS Value[s]”
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incorporated Mr. Gustavson’s underlying asset values for Belle
Fourche and True Oil, rather than those of Mr. Lax, and reflected
approximately $16 million of debt owed by Belle Fourche that had
not been accounted for previously.
At trial, respondent’s counsel characterized as a
“concession” the position in Exhibit 262-P and the trial
memorandum that allowed minority and marketability discounts.
Both petitioners’ counsel and the Court indicated that they did
not understand exactly how “Current IRS Value[s]” were derived in
all cases. Respondent’s counsel stated that the combined
discounts were different for each company and that the exact
amounts would be fleshed out through further testimony59 and on
brief. Respondent’s counsel also stated that the combined
discounts were less than 40 percent in some cases and that
respondent never intended the 40-percent figure to serve as a
starting point for negotiation.
At trial’s end, respondent’s counsel asserted that “Current
IRS Value[s]” had been put forth as a settlement position only,
in an effort to resolve the case, and that respondent had not
conceded that petitioners were entitled to combined, across-the-
board discounts of no less than 40 percent as to all the disputed
companies. Petitioners’ counsel objected to respondent’s
59
However, respondent presented no additional testimony to
explain the derivation of the discounts included in the “Current
IRS Value[s]” figure or the amount of any discounts respondent
was proposing in lieu thereof.
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settlement position characterization, and the Court instructed
the parties to address the issue in their arguments on brief.
Petitioners argue that respondent’s concessions, presented
at and before trial, indicating combined minority and
marketability discounts of up to 40 percent to the True companies
still in dispute, constituted admissions--clear, deliberate, and
unequivocal statements regarding questions of fact. Claiming
they relied on these admissions in presenting their case,
petitioners argue that they would be prejudiced if respondent
were allowed to change his position to claim that combined
minority and marketability discounts are less than 40 percent of
the prediscount values of any of the subject interests. We
disagree.
Statements made by respondent’s counsel during trial were
not clear, deliberate, or unequivocal as to the level of
discounts that respondent was or might be conceding. It is clear
that respondent had abandoned the determinations of value in the
statutory notices and had acknowledged that some minority and
marketability discounts were appropriate. However, respondent’s
counsel indicated that “Current IRS Value[s]” represented
different levels of combined discounts that could not be computed
by simply applying a 40-percent discount to the entity values
determined in the statutory notices or otherwise modified by the
Gustavson reports. Before the end of trial, respondent’s counsel
explained that different discounts applied for each company,
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combined discounts were less than 40 percent in some cases, and
that a more detailed breakdown was pending. Indeed, the only
“Current IRS Value[s]” that incorporated combined discounts of 40
percent were for interests in Eighty-Eight Oil and Black Hills
Trucking. Thus, as of the end of trial, the discounts that
respondent was conceding remained unclear. This lack of clarity
is further evidenced by the failure of the parties to include
stipulations regarding combined discounts in the joint
stipulations introduced by the parties after they had submitted
Exhibit 262-P to the Court.
More importantly, we do not believe that petitioners relied
on respondent’s statements regarding “Current IRS Value[s]” and
combined discounts in presenting their case. In Ware v.
Commissioner, 92 T.C. 1267, 1268 (1989), affd.
906 F.2d 62 (2d
Cir. 1990), we said:
The rule that a party may not raise a new issue on
brief is not absolute. Rather, it is founded upon the
exercise of judicial discretion in determining whether
considerations of surprise and prejudice require that a
party be protected from having to face a belated
confrontation which precludes or limits that party’s
opportunity to present pertinent evidence. * * *
[Citations omitted; see also Estate of Andrews v.
Commissioner, 79 T.C. 938, 952 (1982).]
Petitioners obtained expert appraisals for the subject
interests in all disputed companies, and their experts testified
at trial in support of their findings on entity values and
discounts. Petitioners appear to have accepted respondent’s
concessions regarding companies with “Current IRS Value[s]” that
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roughly equal “Return Value/Book Value[s]”, but have continued to
litigate the values of the subject interests in other companies,
proposing combined discounts exceeding 40 percent in most cases.
Petitioners also presented rebuttal reports and expert testimony
addressing Mr. Gustavson’s criticisms of the Kimball and Lax
reports. Finally, petitioners devoted large portions of their
reply brief to rebutting respondent’s posttrial valuation
positions. All this indicates that petitioners continued to
marshal their evidence and arguments to support valuation
discounts greater than those reflected in the “Current IRS
Value[s]” figures. Petitioners have not persuaded us that they
would have presented their case any differently if respondent had
made no statements regarding “Current IRS Value[s]”.
Accordingly, we find that respondent’s disavowal or clarification
of his pretrial statements of “Current IRS Value[s]” did not
prejudice petitioners’ ability to present valuation evidence.
B. Role of Burdens and Presumptions in Cases at Hand
Petitioners have also argued that if respondent is allowed
to revert to the adjustments reflected in the deficiency notices,
respondent should have the burden of proof on any adjustment that
increased the value of a transferred interest to more than the
“Current IRS Value”. Moreover, petitioners contend that
respondent did not sustain such burden, because he did not offer
any expert testimony regarding the value of the subject
interests. We disagree.
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First, in all but two cases (Dave True’s date of death
interests in Black Hills Trucking and White Stallion), the values
of the subject interests advanced by respondent on brief were
lower than those determined in the deficiency notices.
Therefore, respondent is not reverting to the deficiency notice
values. Second, the mere fact that the position of one party is
not supported by expert testimony does not require that the other
party’s position, which is so supported, will prevail. See Tripp
v. Commissioner, 337 F.2d 432, 434-435 (7th Cir. 1964), affg.
T.C. Memo. 1963-244; Wyoming Inv. Co. v. Commissioner,
70 F.2d
191, 193 (10th Cir. 1934), remanding on other grounds a
Memorandum Opinion of the Board of Tax Appeals; Cupler v.
Commissioner,
64 T.C. 946, 955-956 (1975); Estate of Scanlan v.
Commissioner, T.C. Memo. 1996-331, affd. in an unpublished
opinion
116 F.3d 1476 (5th Cir. 1997); Brigham v. Commissioner,
T.C. Memo. 1992-413.
The presumption of correctness and the burden of proof have
no bearing on our decisions in the cases at hand. There is
sufficient evidence in the record to arrive at supportable
positions on entity values and appropriate discounts, bearing in
mind that opinions of value may legitimately differ within a
reasonable range. See Silverman v. Commissioner, supra at 933;
Alvary v. United States, 302 F.2d 790, 795 (2d Cir. 1962).
- 182 -
The peculiar circumstances of the cases at hand warrant our
inquiries into, and ultimate findings of, intermediate values for
the True companies that exceed tax book values but are less than
the values determined by respondent in the notices. As discussed
at length under issue 1 of this opinion, petitioners’ buy-sell
agreements requiring sales of interests in the True companies at
tax book value virtually assured unrealistically low entity
values for certain companies. This was due to the use of (1)
accelerated depreciation methods by capital intensive companies
and (2) enhanced write-offs of substantial asset costs and
capital expenditures of the ranching and oil and gas companies.
Thus, the method of accounting used to derive tax book values
provided a basis for our holding that the buy-sell agreements
were testamentary devices and for our hypothesis--without regard
to the presumption of correctness or the burden of proof in
sustaining or overturning the determinations in the notices--that
petitioners’ values did not accurately represent fair market
value and that higher values would be appropriate.
Accordingly, we have not relied on the presumption of
correctness or the burden of proof to decide the cases at hand.
We have based our findings of value on our own examination of
evidence in the record, including expert reports, published
studies, witness testimony, exhibits, and joint stipulations of
fact. See infra pp. 186-287; see also Burns v. Commissioner, 36
- 183 -
AFTR 2d 75-6235, 75-2 USTC par. 9774 (10th Cir. 1975), affg. T.C.
Memo. 1974-220.
C. Petitioners’ Aggregation and Offset Argument
The transferred interests whose values remained in dispute
at the date of trial are listed in the Appendix. The values of
transferred interests in the other companies (undisputed
companies) were not in controversy by the time of trial either
because (1) respondent had not adjusted their values in the
statutory notices or (2) the parties stipulated that respondent
would no longer assert an adjustment in connection with those
interests. Even so, petitioners submitted appraisal information
into evidence that valued some, but not all, of the undisputed
companies as of the valuation dates.
In a footnote to their opening brief, petitioners argue that
if the Court finds that the book value buy-sell price was not
controlling for estate and gift tax purposes, an offset should be
allowed in determining the overall value of the gross estate and
taxable gifts to the extent that the value of any interest
included in the gross estate or subject to gift tax is less than
book value. Petitioners reason that the estate tax is imposed on
the fair market value of the total taxable estate, and that the
gift tax is imposed on the fair market value of all taxable gifts
during the taxable period. Therefore, according to petitioners,
any overreported value should offset any underreported value in
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calculating the overall estate tax or gift tax liability. We
believe that petitioners’ argument oversimplifies the issue; we
do not agree that petitioners would be entitled to an offset for
estate tax or gift tax purposes for the reasons set forth below.
First, petitioners reported on the 1993 and 1994 gift tax
returns and on the estate tax return that the fair market value
of every subject interest was the book value, as determined under
each company’s buy-sell agreement, at which the subject interest
was sold. See supra pp. 51-55. Reported values are considered
to be an admission by petitioners, so that lower values cannot be
substituted without cogent proof that the reported values were
erroneous. See, e.g., Estate of Hall v. Commissioner, 92 T.C.
312, 337-338 (1989). Here, petitioners did not provide evidence
of value contrary to book value with regard to transferred
interests in True Geothermal Energy, True Mining, and True
Environmental Remediating LLC as of January 1, 1993, and Clareton
Oil, Donkey Creek Oil, Pumpkin Buttes Oil, Sunlight Oil, and Wind
River Oil as of June 4 and June 30, 1994. Therefore, the record
does not contain sufficient evidence to determine the aggregate
fair market value of all the transferred interests.
Second, with respect to the gift tax, we have found no
authority that would allow petitioners to offset sales of some
companies for allegedly excess consideration (i.e., buy-sell
formula price exceeded fair market value) against unrelated sales
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of other companies for inadequate consideration (i.e., fair
market value exceeded buy-sell formula price) to produce a lower
net deemed gift. Section 2512(b) provides:
SEC. 2512(b). Where property is transferred for less
than an adequate and full consideration in money or
money’s worth, then the amount by which the value of the
property exceeded the value of the consideration shall
be deemed a gift, and shall be included in computing the
amount of gifts made during the calendar year.
The language of the statute suggests that the gift amount is
reduced only by consideration received for the transferred
property that constitutes the gift. See Robinson v.
Commissioner, 75 T.C. 346, 351 (1980), affd.
675 F.2d 774 (5th
Cir. 1982). However, petitioners are in effect proposing that
sales of certain True companies for excessive consideration
served as consideration for sales of other True companies. The
facts do not support this proposition.
Each of the True companies was subject to a separate buy-
sell agreement. The parties could pick and choose which of the
companies they would sell and which they would retain. Each sale
was a separate, independent transaction. Accordingly, we see no
reason why consideration for the transfer of one interest should
serve as consideration for another separate transfer.
Third, with respect to estate tax, we are skeptical of
petitioners’ claim that book values exceeded fair market values
for interests in certain True companies owned by Dave True at his
death. We have said many times that a buy-sell agreement that
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constitutes a testamentary device will not fix estate and gift
tax value. More precisely, however, we would say that the buy-
sell formula price does not set a ceiling on value, but that it
does set a floor. The mandatory buy-sell provisions in the cases
at hand effectively gave the estate a put, which set a minimum
value for Dave True’s interests owned at death. Even assuming
that the buy-sell agreement does not set a floor on value, we
doubt that book value actually and substantially exceeded estate
tax fair market value. Petitioners generally base their claims
of overreported value on appraisal information provided in the
final Lax report. However, we often note in our analysis of the
disputed companies, infra, that the final Lax report’s valuation
conclusions were unsubstantiated and result-oriented.
Therefore, we find that there is insufficient evidence to
support lower fair market values for any of the undisputed
companies than those originally reported on the 1993 and 1994
gift and estate tax returns.
IV. Valuations of True Companies in Dispute
A. True Oil
1. Marketable Minority Interest Value
a. Kimball Reports
The Kimball reports determined the so-called hypothetical
fair market value of the subject interests in the disputed
companies by using generally accepted valuation procedures and by
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disregarding the book value buy-sell price, but otherwise taking
into account all other provisions of the buy-sell agreement. The
reports outlined four generally accepted approaches for valuing
closely held companies: (1) The guideline company method, (2)
the discounted cash-flow method, (3) the asset accumulation
method, and (4) the transaction method.
The guideline company method is a market-based valuation
approach that estimates the value of the subject company by
comparing it to similar public companies. First, a group of
comparable “guideline” companies is selected and analyzed; then
market multiples are derived and applied to the financial
fundamentals of the subject company. Financial fundamentals
include various measures of operating revenue, income, underlying
asset values, and unit volume of production. This method yields
the value of a marketable minority interest because value is
determined based on publicly marketable minority interests in
companies that have registered and traded securities.
The discounted cash-flow method is an income approach based
on the premise that the subject company’s market value is
measured by the present value of future economic income it
expects to realize for the benefit of its owners. This approach
analyzes the subject company’s revenue growth, expenses, and
capital structure, as well as the industry in which it operates.
The subject company’s future cash-flows are estimated, and the
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present value of those cash-flows is determined based on an
appropriate risk-adjusted rate of return.
The asset accumulation method is a cost approach that
estimates fair market value of the subject company based on the
assets and liabilities reflected on its balance sheet. The fair
market values of each company’s assets and liabilities are first
determined and accumulated; then the subject company’s total
equity is calculated by subtracting total liabilities from total
assets. A closely held business owner must have the ability to
liquidate the company to realize fully the value produced by this
method. Thus, the asset accumulation method yields the value of
a controlling interest, because a minority shareholder could not
force liquidation.
The transaction method, another market-based approach,
identifies and analyzes actual transactions (e.g., mergers and
acquisitions) of companies with operations similar to those of
the subject company. As with the guideline company method,
market multiples are derived from the comparable companies and
applied to the financial fundamentals of the subject company.
This method yields the value of a controlling interest because
mergers and acquisitions typically are accompanied by a complete
change of control.
After considering these valuation approaches, Mr. Kimball
concluded that a market-based approach, specifically the
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guideline company method, would be used most appropriately to
value the True Oil interests. Mr. Kimball rejected the
discounted cash-flow method because he believed it was too
difficult to forecast the future prices of oil and gas needed to
estimate future revenues and cash-flows. He also rejected the
transaction method because he found no data on transactions of
companies with operations similar to True Oil. Mr. Kimball did
not apply the asset accumulation approach; instead, he used the
stipulated physical volume of True Oil’s proved reserves,
measured in barrels of oil-equivalent, to derive the reserve
multiple used in the guideline company method.
Mr. Kimball first identified eight guideline companies from
the crude oil and natural gas industries, focusing on companies
generally in the same geographic area (Rocky Mountain territory)
as True Oil.
Mr. Kimball then focused his analysis on five market
multiples: Earnings before interest and taxes (EBIT); earnings
before depreciation, interest, and taxes (EBDIT); revenues;
tangible book value of invested capital (TBVIC); and reserves
(BOE). He calculated these multiples and True Oil’s financial
fundamentals over two time periods, the latest fiscal year and a
simple average of the preceding 5 fiscal years. Mr. Kimball
placed a weight of 20 percent on each earnings multiple (EBIT,
EBDIT, and revenues), 30 percent on the reserves multiple, and 10
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percent on the TBVIC multiple. Thus, earnings-based multiples
were weighed more heavily in aggregate.
Mr. Kimball selected low (rather than mean or average)
multiples of the guideline companies to apply against True Oil’s
financial fundamentals, because he found that True Oil had low or
negative growth relative to the guideline companies. He also
chose lower multiples because of the depressive effect of True
Oil’s buy-sell agreement terms (other than the book value price
term). Mr. Kimball did not adjust True Oil’s actual earnings
over the valuation period to reflect differences in accounting
for intangible drilling costs, saying that such adjustments would
not be made by a hypothetical buyer of a closely held business.60
Instead, he made qualitative adjustments to the market multiples
to reflect such differences. Mr. Kimball did not quantify the
effect of those adjustments on the market multiples.
Lastly, Mr. Kimball multiplied True Oil’s financial
fundamentals by the selected multiples derived from guideline
company data, and he ascribed different weights to each product.
Because True Oil had no long-term debt, the sum of these amounts
represented the market value of its equity.
60
As previously stated, True Oil deducted intangible
drilling costs in arriving at taxable income. In contrast,
public companies would be required to capitalize some of those
costs under either the successful efforts or full cost method of
accounting required by SEC rules or GAAP. See supra p. 23.
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Mr. Kimball concluded that fair market value of True Oil’s
total equity on a marketable minority basis was $37,253,000 on
January 1, 1993, and $34,623,000 on both June 4 and June 30,
1994.
b. Final Lax Report
The final Lax report calculated fair market value of
interests in the disputed companies without considering any
obligations or restrictions imposed by the book value buy-sell
agreement. Mr. Lax valued the subject interests as of June 3,
1994, the day before Dave True’s death. However, he opined that
the value remained unchanged on June 4, 1994.
The final Lax report employed two market-based valuation
approaches, the guideline company method and the reserves method,
to determine the value of True Oil.61 First, Mr. Lax used the
guideline company method to arrive at a marketable, minority
value of $24,500,000. He identified six publicly traded
companies that he considered to be comparable to True Oil; four
of those companies also were used by Mr. Kimball. Mr. Lax
applied EBDIT, EBIT, pretax earnings, and book value multiples to
True Oil’s financial results for the 12-month period ending
May 31, 1994. Unlike the Kimball reports, the final Lax report
did not provide detailed supporting schedules showing how Mr. Lax
61
Mr. Lax stated that he did not employ the income approach
for any of the True entities because, like Mr. Kimball, he
believed that it was too difficult to forecast the future prices
of oil and gas needed to estimate future revenues and cash-flows.
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calculated guideline company multiples and True Oil’s financial
fundamentals. In addition, the relative weight Mr. Lax placed on
each multiple and whether he adjusted the data for differences in
accounting methods are also unclear.
Second, Mr. Lax valued True Oil based on an estimated value
of its reserves on June 3, 1994. Mr. Lax adopted the conclusions
of the Scotia report that fair market value of True Oil
properties on the valuation date was $34,800,000, based on both a
discounted cash-flow and comparative sales approach. Mr. Lax
weighted this value at 80 percent because he believed that a
reserve analysis based on discounted cash-flows was the best
indication of value for an exploration and production company.
Next, Mr. Lax reviewed exploration and production industry
acquisitions in the Rocky Mountain region that occurred within 1
year of the valuation date to establish an implied range of
dollars per barrels of oil-equivalent, which he applied to the
Scotia report’s estimated reserve volume to arrive at a value of
$27,000,000. He weighted this value at 20 percent. Mr. Lax did
not update his conclusions after the parties agreed to the value
and volume of True Oil’s oil and gas properties.
After combining the weighted results of the two reserves
methods, Mr. Lax computed a marketable, controlling value for
True Oil of $33,200,000. He converted this to a marketable
minority value by applying a 25-percent minority discount,
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resulting in a reserves value of $24,900,000. The final Lax
report explained that AA relied on data from acquisition
transactions and real estate investment trusts (REIT’s) to
compute the minority discounts applied to the subject interests.
The report did not include either a description of the studies or
their findings.
Mr. Lax compared the two indications of value, $24,500,000
under the guideline company method and $24,900,000 under the
reserves method, and concluded that True Oil’s marketable
minority value was $24,820,000 on June 3, 1994.
c. Gustavson Report and Respondent’s Position
The Gustavson report valued major assets owned by True Oil
as of January 1, 1993, and June 4, 1994, which included producing
oil and gas properties, the Red Wing Creek gas plant, the Little
Knife gas plant, and the Grampian pipeline. Mr. Gustavson did
not value the company as a whole. He explained that industry
practice would treat the value of proved reserves as the most
important (if not the only) indicator of value for a small,
independent oil and gas producer such as True Oil.
Mr. Gustavson used the discounted cash-flow method (income
approach) to value producing properties, and he used the boe
method (market approach) to verify those values because he
considered the boe method to be the least reliable valuation
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approach. Mr. Gustavson also used an investment recovery method
to value plant and pipeline facilities.
The Gustavson report valued True Oil’s major assets at
$48,000,000 on January 1, 1993, and $33,700,000 on June 4, 1994.
Subsequently, Mr. Gustavson reconciled his valuation
methodologies with those of Dr. Caldwell62 to arrive at the True
Oil stipulated asset values of $39,650,000 as of January 1, 1993,
and $34,200,000 as of June 4, 1994. See supra p. 156. According
to respondent, the value of True Oil’s major assets represented
the 100-percent equity value of the company.
Because Mr. Gustavson is not an expert in business
valuations, he did not value the subject interests in any True
company. Instead, respondent argues on brief that the True Oil
interests transferred by Dave and Jean True to their sons as of
January 1, 1993 (Dave transferred an 8.28-percent interest to
each son), and June 30, 1994 (Jean transferred a 5.74-percent
interest to each son), were entitled to minority discounts of no
more than 10 percent.63 Respondent bases his conclusions on a
62
The Scotia reports also valued oil and gas properties
owned by True Oil as of Jan. 1, 1993, and June 4, 1994. Dr.
Caldwell primarily relied on the discounted cash-flow method to
value True Oil’s proved reserves and other facilities, and
applied the comparative sales method to test the reasonableness
of those results. The Scotia reports concluded that the fair
market value of True Oil’s major assets was $34,800,000 on both
valuation dates.
63
Petitioners interpreted respondent’s statements on brief
to mean that respondent was allowing combined minority and
(continued...)
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student note published near the time of the transactions at issue
in these cases, which found 10-percent discounts to be the
starting point for minority discounts that had been upheld by
courts. See DenHollander, Note, “Minority Interest Discounts and
the Effect of the Section 2704 Regulations”, 45 Tax Law. 877
(1992).
Respondent also argues that the 38.47-percent interest owned
by Dave True at his death is not entitled to a minority discount,
because it represents a significant ownership block that had
swing vote potential. Respondent argues, on the ground that Dave
True held the largest single block of voting rights in True Oil,
that his block could be combined with any other single block to
control the company, even though he did not own a stand-alone
controlling interest. Accordingly, respondent contends that no
minority discount should be allowed in valuing Dave True’s
interest in True Oil as of June 4, 1994.
In summary, respondent computed marketable minority values
for the True Oil interests transferred as of January 1, 1993, and
June 30, 1994, of $35,685,000 and $30,780,000, respectively.
63
(...continued)
marketability discounts of 20 percent for transfers of interests
in True Oil by Dave True and Jean True as of Jan. 1, 1993, and
June 30, 1994, respectively, and for the transfer of Jean True’s
interest in Belle Fourche as of June 30, 1994. We interpret
respondent’s statements to mean that separate minority and
marketability discounts of 10 percent each should apply.
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Respondent derived a marketable controlling value for the
interest valued as of Dave True’s death at $34,200,000.
d. Court’s Analysis
The positions of the parties and the Court’s determination
of the marketable minority values of True Oil’s total equity at
each of the valuation dates are summarized infra pp. 215-216.
In the cases at hand, we find that exclusive use by
petitioners’ experts of the guideline company method to calculate
True Oil’s marketable minority value is inappropriate. We
recognize that market-based approaches are helpful tools for
determining fair market value of unlisted stock. See sec.
20.2031-2(f), Estate Tax Regs; Rev. Rul. 59-60, sec. 3.03, 1959-1
C.B. at 238. However, in the case of an ongoing business, courts
generally will not restrict consideration to only one valuation
approach. See Hamm v. Commissioner, 325 F.2d 934, 941 (8th Cir.
1963), affg. T.C. Memo. 1961-347; Ward v. Commissioner,
87 T.C.
78, 102 (1986); Estate of Andrews v. Commissioner, 79 T.C. at
945; Portland Mfg. Co. v. Commissioner,
56 T.C. 58, 80 (1971),
affd. without published opinion (9th Cir. 1975); Trianon Hotel
Co. v. Commissioner,
30 T.C. 156, 181 (1958); Hooper v.
Commissioner,
41 B.T.A. 114, 129 (1940).
We find it unreasonable to assume that a hypothetical
willing buyer would rely entirely on public company multiples to
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compute the purchase price of a closely held, family business64
that derived all its value from its ability to discover and
exploit oil and gas reserves. See Zukin, Financial Valuation:
Businesses and Business Interests, par. 19.2[6] at 19-9, par.
19.2[8] at 19-13 (1990). If a company is primarily in the
business of selling its assets, then hypothetical buyers most
likely would be interested in the company’s net asset value. See
Ward v. Commissioner, 87 T.C. at 102 (citing Harwood v.
Commissioner, 82 T.C. 239, 265 (1984), affd. without published
opinion
786 F.2d 1174 (9th Cir. 1986)(concerning company engaged
in selling timber)); see also Estate of Jameson v. Commissioner,
T.C. Memo. 1999-43. True Oil’s proved oil and gas reserves are
its most significant asset and its sole source of revenue, so it
64
Dr. Shannon Pratt (founder of WMA) and his colleagues
articulated some of the fundamental differences between large and
small companies that would diminish the value of the guideline
company approach as follows:
Public companies are run by boards of directors
and professional managers. These executives make
operating decisions based on a different set of
corporate objectives than private companies typically
have. Private companies are more likely to have
relationships with family members, employees,
suppliers, customers, and the local community that have
developed over a long period of time. These
relationships can present the board and the management
of the private company with corporate objectives that
are different than a strict duty to maximize
shareholder value. As an additional example, in
private companies, the analyst is more likely to
observe a strategy that is designed to minimize income
taxes, compared with strategies of public companies.
[Pratt et al., Valuing Small Businesses and
Professional Practices 289 (3d ed. 1998).]
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is appropriate to use the net asset value method (or what Mr.
Kimball called the asset accumulation method), in conjunction
with the guideline company method, to determine the value of True
Oil. Accordingly, we treat the stipulated value of True Oil’s
major assets65 as the company’s net asset value.
Petitioners argue that the Kimball reports properly
accounted for the value of True Oil’s reserves by using the
reserves multiple in the guideline company analysis. We disagree
for two reasons. First, Mr. Kimball’s reserves multiple was
based on the stipulated physical volume of proved reserves
measured in barrels of oil-equivalent, known as the boe method;
however, the geological experts’ reports of both parties favored
the discounted cash-flow method to value True Oil’s proved
reserves and used the less reliable boe method only as a
reasonableness test. Second, Mr. Kimball weighted the reserves
multiple at only 30 percent, which we would consider low given
the nature of True Oil’s business.
Petitioners also contend that we should disregard altogether
the net asset value method in determining True Oil’s entity value
because the subject interests carried no liquidation rights so
that holders of such interests could not access the underlying
asset values. We disagree. Although the net asset value method
yields the value of a controlling interest, a minority discount
65
True Oil had no long-term debt on or around the valuation
dates, and current assets generally offset current liabilities.
- 199 -
would be applied to reflect the constraints imposed on minority
owners. Moreover, True Oil is primarily in the business of
selling its assets; thus, liquidation is not the only means by
which an owner would have access to the company’s net asset
value. Here it is likely that a hypothetical purchaser would
give substantial weight to True Oil’s underlying asset values
even though he would not have the ability immediately to realize
those values in their entirety by forcing liquidation. See
Estate of Andrews v. Commissioner, 79 T.C. at 945; Estate of Dunn
v. Commissioner, T.C. Memo. 2000-12.
Turning to the guideline company method, the Kimball reports
present a clear and adequately documented approach to determining
True Oil’s marketable minority value. However, we note a few
areas of concern. First, we could not trace any adjustments made
to either the guideline companies’ earnings multiples or True
Oil’s financial fundamentals to reflect the fact that intangible
drilling and dry hole costs were being accounted for differently.
This omission could lead to significant distortions in value
given True Oil’s substantial intangible drilling (including
nonproductive well) costs over the years. Second, Mr. Kimball’s
consistent choice of only the lowest guideline company multiples
suggests a lack of comparability between the selected companies
and True Oil. Third, the restrictive provisions (other than
price) of True Oil’s buy-sell agreement inappropriately
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influenced Mr. Kimball’s choice of multiples. As stated earlier,
restrictive provisions of buy-sell agreements that are deemed to
be testamentary devices should be disregarded in determining fair
market value for estate and gift tax purposes. See supra p. 153.
Adjustments for these errors would result in marketable minority
values higher than those derived by Mr. Kimball.
The final Lax report’s guideline company analysis was even
more questionable. It provided no data to support the
calculations of EBDIT, EBIT, pretax earnings, and book value for
either the comparable companies or True Oil. Further, Mr. Lax
did not explain the relative weight placed on each factor. The
Lax report also applied market multiples to only 1 year’s worth
of financial data. We believe that using a 5-year average of
True Oil’s financial fundamentals (as Mr. Kimball did) would have
provided more representative results. Without more data and
explanations, we cannot rely on the final Lax report’s valuation
conclusions using the guideline company method.
We need not discuss the strengths or weaknesses of Mr. Lax’s
reserves method because the parties stipulated the value of True
Oil’s reserves as of the relevant measurement dates.
Regarding the issue of minority discounts, this Court
recognizes that a minority interest in a company usually is worth
less than a proportionate share of the company’s total value, see
Ward v. Commissioner, 87 T.C. at 106; Estate of Andrews v.
- 201 -
Commissioner, 79 T.C. at 953, because a minority interest holder
lacks control over company policy, cannot direct payment of
dividends, and cannot compel a liquidation of company assets, see
Estate of Newhouse v. Commissioner, 94 T.C. at 249; Harwood v.
Commissioner, 82 T.C. at 267. Applicability of minority
discounts depends on the type of interest being appraised (i.e.,
degree of control the interest confers) and on any assumptions
regarding control that are implicit in the entity-level
valuation.
For estate tax purposes, the property being valued is the
interest decedent owned at death. See sec. 2031. We arrive at
this value by examining the degree of control inherent in the
decedent’s interest and not the control conveyed to the
decedent’s legatees. See Estate of Chenoweth v. Commissioner, 88
T.C. 1577 (1987). We determine whether a block of stock is a
minority interest without considering the identity and prior
holdings of the transferee, because the hypothetical willing
buyer-willing seller test is an objective test. See Estate of
Watts v. Commissioner,
823 F.2d 483, 486-487 (11th Cir. 1987),
affg. T.C. Memo. 1985-595; Estate of Bright v. United States,
658
F.2d 999, 1005-1006 (5th Cir. 1981).
We find the 25-percent minority discount applied in Mr.
Lax’s reserves method analysis to be unsubstantiated and
unreliable. The final Lax report vaguely described studies of
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acquisition transactions and REIT’s to support the chosen
discount, but it did not cite specific studies, describe the
studies’ assumptions and findings, or analyze the control
features of the True oil subject interests. We therefore
disregard the final Lax report’s proposed minority discount.
We also disagree with respondent’s argument that the 38.47-
percent interest Dave True owned at death would be combined with
any other single ownership block to control True Oil so that a
minority discount is unjustifiable. In determining whether a
minority discount applies, we do not assume that the hypothetical
buyer is a member of decedent’s family. See Propstra v. United
States, 680 F.2d 1248, 1251-1252 (9th Cir. 1982); Estate of Hall
v. Commissioner, supra; Minahan v. Commissioner,
88 T.C. 492, 499
(1987). Here, we assume that the buyer is an unrelated party,
but we are free to recognize Jean True and the True sons as the
other general partners as of Dave True’s death. See Estate of
Davis v. Commissioner,
110 T.C. 530, 559 (1998). Given these
assumptions, we find it unlikely that a member of Dave True’s
family would join forces with an unrelated purchaser to gain
voting control over True Oil. See id. In addition, the concept
of voting control does not apply to True Oil, a general
partnership that is jointly managed by all of its owners. Cf.
Estate of Winkler v. Commissioner, T.C. Memo. 1989-231
(distinguishing voting from nonvoting stock for valuation
- 203 -
purposes and denying minority discount to voting stock because of
swing vote potential).
A comparison of the marketable minority values for True Oil
proposed by Mr. Kimball and by respondent follows:
Kimball reports’
Respondent’s net
Valuation guideline company
asset value method
date method
January 1, 1993 $37,253,000 $35,685,000
June 4, 1994 $34,623,000 N/A
June 30, 1994 $34,623,000 $30,780,000
We have acknowledged the merits of both parties’ valuation
methods and believe that some combination of the two methods
would most accurately measure True Oil’s marketable minority
value. However, Mr. Kimball’s values would require adjustments
for our stated concerns, which are likely to result in higher
values. As it is, we need not compute Mr. Kimball’s adjusted
guideline company values because respondent’s marketable minority
values (shown above) are less than Mr. Kimball’s as of January 1,
1993, and June 30, 1994. Thus, we accept respondent’s marketable
minority values as of January 1, 1993, and June 30, 1994, and
treat them as concessions.
Respondent did not determine True Oil’s marketable minority
value as of June 30, 1994, because he treated Dave True as owning
a controlling interest at death. However, we treat Dave True’s
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38.47-percent interest in True Oil as a minority interest, and we
assume that True Oil’s marketable minority value on June 4, 1994,
was equal to its value on June 30, 1994 (i.e., $30,780,000).
2. Marketability Discounts
a. Kimball Reports
The Kimball reports discussed two types of empirical studies
that WMA relied on to quantify marketability discounts for
closely held companies. Those studies analyzed discounts on
sales of restricted shares of publicly traded companies
(restricted shares studies) and discounts on private transactions
that preceded public offerings (pre-IPO studies).
The restricted shares studies sought to isolate
marketability from all other value-affecting factors by analyzing
the price differential between freely traded stock of a public
company and stock that is otherwise identical except for certain
time period restrictions on trading in the open market. The
Kimball reports discussed the results of eight studies that
covered the years 1966 through 1988, and found average
marketability discounts ranging from approximately 26 to 45
percent.
The Kimball reports also discussed two pre-IPO studies that
used data from SEC registration statements to compare share
prices of companies before and after they had gone public. The
- 205 -
studies generally covered the years 1975 through 1995, and found
marketability discounts ranging from 40 to 63 percent.66
Next, the Kimball reports generally addressed aspects of all
the True companies’ partnership agreements and Wyoming’s general
partnership law that made the subject partnership interests less
liquid than publicly traded stock or limited partnership
interests. Mr. Kimball testified that he factored all the
partnership agreement provisions (other than the book value buy-
sell price) into his determination of marketability discounts.
First, the Kimball reports noted that transfer or assignment
of a partnership interest would not terminate the partnership, so
that a hypothetical buyer would have to litigate to force
liquidation of a True partnership.
Second, the Kimball reports stated that Wyoming law required
a buyer to obtain consent from the existing partners to be
admitted as a new partner; otherwise, the buyer would be treated
as a transferee with rights limited to receiving his or her pro
rata share of current and liquidating distributions. As a
result, the Kimball reports concluded that potential purchasers
would be discouraged from buying an interest in a True
partnership without the assurance of gaining such consent.
Third, the Kimball reports observed that the mandatory buy-
sell provisions would have a chilling effect on the market for
66
One of the studies specifically omitted natural resource
companies from the group of companies being examined.
- 206 -
interests in the True partnerships. The reports stated that
potential buyers would not want to spend time analyzing an offer
price if there were other buyers with prior purchase rights,
especially if those buyers were current owners and operators of
the business. Additionally, the universe of potential purchasers
would be reduced by (1) the requirement that all partners (or
their spouses) actively participate in the business and (2) the
prohibition against encumbering partnership interests (treated as
a sales event triggering mandatory buy-sell), because purchasers
would have difficulty obtaining financing without pledging the
subject interests.
Fourth, the Kimball reports suggested that potential
investors would hesitate to expose themselves to personal
liability as general partners given the environmental and
business risks associated with the oil and gas industry.
Fifth, the Kimball reports observed that none of the True
partnerships had made section 754 elections, so that a
hypothetical purchaser of the subject interests would recognize
built-in gain on sales by the partnerships of their assets. The
Kimball reports explained that this would adversely affect
marketability because a hypothetical purchaser could avoid such
built-in gain through an outright purchase of assets similar to
those owned by the partnership.
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Based on the foregoing, the Kimball reports concluded that
the subject interests in True Oil were not readily marketable and
applied 40-percent marketability discounts to the marketable
minority values as of January 1, 1993, June 4, 1994, and June 30,
1994.
b. Final Lax Report
The final Lax report contained only a brief justification
for the marketability discounts applied to minority interests in
True Oil. The report said that AA gathered data on discounts
that have been realized on private market sales of restricted or
illiquid ownership interests and also examined the cost of
creating a public market for closely held interests. However,
the underlying data from those studies was not included in the
report. The final Lax report concluded that a minority interest
in True Oil was relatively illiquid, because the company was
closely held and its interests were unregistered; therefore,
Mr. Lax applied a 45-percent marketability discount to the
marketable minority value calculated as of June 3, 1994.
c. Gustavson Report/Rebuttals and Respondent’s
Position
Respondent did not provide expert testimony regarding
marketability discounts for any True company; instead, the
Gustavson rebuttals criticized only the discounts applied in the
Kimball and final Lax reports.
- 208 -
Respondent characterizes the True Oil interests as being
marketable and therefore proposes a 10-percent discount for
interests being valued as of January 1, 1993, and June 30, 1994,
and no discount (due to swing vote potential) for the interest
being valued as of June 4, 1994.
d. Court’s Analysis
A discount for lack of marketability reflects the absence of
a ready market for interests in closely held businesses. See
Estate of Andrews v. Commissioner, 79 T.C. at 953. The benchmark
for marketability of minority interests is the active public
securities market, where a security holder can quickly and easily
sell a minority interest at a relatively low cost. The minority
owner of a closely held company does not have similar liquidity,
because the pool of potential purchasers is substantially smaller
and securities registration requirements impose substantial
delays and transaction costs.
To determine appropriate marketability discounts, this Court
has considered fundamental elements of value that investors use
to make investment decisions. Some of the factors include: (1)
The cost of a similar company’s stock; (2) an analysis of the
corporation’s financial statements; (3) the corporation’s
dividend-paying capacity and dividend payment history; (4) the
nature of the corporation, its history, its industry position,
and its economic outlook; (5) the corporation’s management; (6)
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the degree of control transferred with the block of stock to be
valued; (7) restrictions on transferability; (8) the period of
time for which an investor must hold the stock to realize a
sufficient return; (9) the corporation’s redemption policy; and
(10) the cost and likelihood of a public offering of the stock to
be valued. See Estate of Gilford v. Commissioner, 88 T.C. 38, 60
(1987); Northern Trust Co. v. Commissioner,
87 T.C. 349, 383-389
(1986), affd. sub nom. Citizens Bank & Trust Co. v. Commissioner,
839 F.2d 1249 (7th Cir. 1988); Mandelbaum v. Commissioner, T.C.
Memo. 1995-255, affd. without published opinion
91 F.3d 124 (3d
Cir. 1996).
The factors limiting marketability of True Oil general
partnership interests on the valuation dates included: (1) The
True family’s commitment to keep True Oil privately owned; (2)
the risk that a purchaser would not obtain unanimous consent to
be admitted as a partner; (3) True Oil’s declining revenues due
to increased competition and failure to find new reserves or to
increase production; (4) the subject interests’ lack of control;
(5) a purchasing partner’s exposure to joint and several
liability; and (6) the long holding period required to realize a
return.
Under Issue 1 of this opinion, we have held that the
restrictive provisions of the buy-sell agreements are to be
disregarded in determining fair market value for estate and gift
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tax purposes. See supra pp. 153-155. We concur with the
reasoning of Lauder III, which found that all aspects of the buy-
sell agreement, and particularly those tending to depress value,
were tainted by the same testamentary objectives that made the
formula price irrelevant for transfer tax purposes.
The Lauder III shareholders’ agreement was a stand-alone
document separate from the corporation’s governing instruments
(i.e., articles of incorporation, bylaws), much like the
Stockholders’ Restrictive Agreements of the True corporations.
Accordingly, we disregard the Belle Fourche, Black Hills
Trucking, and White Stallion buy-sell agreements entirely in
determining fair market value of the subject interests in those
companies. By contrast, the True partnerships incorporated buy-
sell restrictions among the governing provisions of the
partnership agreements. As a result, we disregard only the buy-
sell provisions67 of the True Oil, Eighty-Eight Oil, and True
Ranches partnership agreements in determining fair market value
of the subject interests in those companies. We consider the
buy-sell agreements only to recognize that their existence
demonstrates the True family’s commitment to maintain family
control over the True companies.
67
The buy-sell provisions in the True Oil, Eighty-Eight Oil,
and True Ranches partnership agreements are titled: Par. 17.
“Restriction on Partnership Interest”; Par. 18. “Sales Events”;
Par. 19. “Buy and Sell Agreement”; Par. 20. “Price”; Par. 21.
“Effective Date”, and Par. 25. “Binding on Heirs”.
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The Kimball reports determined the so-called hypothetical
fair market value of the subject interests by ignoring the book
value buy-sell price, but otherwise regarding all other
provisions of the buy-sell agreements. Mr. Kimball factored the
buy-sell agreement terms into his determination of both entity
values and marketability discounts. This is a major flaw in
methodology that reduces the reliability of the conclusions of
the Kimball reports.
While we ignore buy-sell restrictions for valuation purposes
if they are deemed to be testamentary devices, we do not ignore
State law transfer restrictions. In determining the value of an
asset for transfer tax purposes, State law determines what
property is transferred. See Morgan v. Commissioner, 309 U.S.
78, 80 (1940); Estate of Bright v. United States,
658 F.2d 999,
1001 (5th Cir. 1981); Estate of Nowell v. Commissioner, T.C.
Memo. 1999-15. Under the Wyoming Uniform Partnership Act (WUPA),
a person may become a partner only with the consent of all
partners. See Wyo. Stat. Ann. sec. 17-21-401(j) (Michie 1999).68
A partner’s only transferable interest in the partnership is his
or her interest in distributions. See Wyo. Stat. Ann. sec. 17-
21-502(a) (Michie 1999). The transfer, in whole or in part, of a
partner’s transferable interest does not entitle the transferee
68
All referenced sections of the Wyoming Uniform Partnership
Act (WUPA) were in effect at the time of the subject transfers in
1993 and 1994.
- 212 -
to participate in the management or conduct of partnership
business, to require access to information about partnership
transactions, or to inspect or copy the partnership books and
records. See Wyo. Stat. Ann. sec. 17-21-503(a) (Michie 1999). A
transferee of a partner’s transferable interest is entitled to
receive current or liquidating distributions to which the
transferor would otherwise be entitled. The transferor retains
the rights and duties of a partner other than an interest in the
distributions transferred. See Wyo. Stat. Ann. sec. 17-21-503(b)
and (c) (Michie 1999).
The denial of management rights to a transferee interest
would make it less marketable than a partnership interest. See
Adams v. United States, 218 F.3d 383 (5th Cir. 2000). A
hypothetical purchaser could not count on being admitted into
partnership with the close-knit True family and would factor any
uncertainty regarding his ownership rights and privileges into
his offering price. See Estate of Newhouse v. Commissioner,
supra at 230-233. Thus, we agree with the conclusion of the
Kimball reports that this is a value-depressing factor.
On the other hand, we are troubled by the lack of any clear
connection between the Kimball reports’ general discussion of
restricted stock and pre-IPO studies and the marketability
discounts applied to the True Oil subject interests. For
instance, there was no showing that the industries represented in
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the studies had risks and other attributes similar to the oil and
gas industry. In fact, one of the pre-IPO studies specifically
excluded natural resource companies from the companies being
examined.
In addition, Mr. Kimball did not explain how his analysis of
True Oil’s historical financial data, see supra pp. 156-158,
affected the marketability discounts. We believe his analysis,
by choosing comparison years that emphasized downward trends in
True Oil’s financial performance (e.g., extraordinary losses in
Honduras), painted a bleaker picture than is appropriate. On the
positive side, True Oil replaced and slightly increased its
proved reserves from 1973 to 1994 and did so without incurring
outside debt. Even allowing for this, we find that True Oil’s
substantial exploration expenditures, declining revenues, and
inability to make significant net distributions to partners would
adversely affect the marketability of an interest in the company.
We are dissatisfied completely with both Mr. Lax’s and
respondent’s treatment of marketability discounts. First,
neither provided empirical data for average discounts in the
market or an analysis of marketability factors particular to True
Oil. Second, the final Lax report applied higher marketability
discounts than the Kimball reports, even though the final Lax
report did not consider any value-depressing aspects of the True
Oil buy-sell agreement. Third, respondent’s marketability
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discounts are either unreasonably low (given the factors limiting
marketability discussed above) or nonexistent, due to
respondent’s incorrect assumptions regarding swing vote
potential.
Based on the record before us, we apply a 30-percent
marketability discount to the minority interests in True Oil
valued as of January 1, 1993, June 4, 1994, and June 30, 1994.
We derive this figure first by acknowledging that the subject
interests in True Oil are less marketable than actively traded
interests, for reasons previously stated. We then use Mr.
Kimball’s discount as a starting point. Mr. Kimball did not
explain clearly how he used market data to compute his
marketability discounts. It appears that he chose a 40-percent
discount to fall within the high range of discounts observed in
the restricted stock studies (26 to 45 percent). We believe that
the restricted stock studies provide more relevant data than the
pre-IPO studies, because True Oil interests are subject to State
law transfer restrictions and because True Oil is not comparable
to a company on the verge of going public. Finally, we reduce
the proposed 40-percent discount to 30 percent, because Mr.
Kimball improperly considered the True Oil buy-sell agreement in
developing his marketability discounts.
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3. Summary of Proposed Values and Court’s Determinations of Values of Interests
in True Oil
Value as of Book value Statutory Kimball Final Lax Respondent’s Court’s
January 1, 1993 reportd on notice value reports report position values
return
Entity Value
(Controlling Basis) N/A N/A N/A N/A $39,650,000 N/A
(3,965,000)
Less: Minority Discount N/A N/A N/A N/A 10% N/A
Marketable Minority
Value N/A N/A $37,253,000 N/A 35,685,000 $35,685,000
Less: Marketability (14,901,200) (3,568,500) (10,705,500)
Discount N/A N/A 40% N/A 10% 30%
Nonmarketable Minority
Value N/A N/A 22,351,800 N/A 32,116,500 24,979,500
Value of 24.84%
Interests (total)
Transferred to True Sons 5,226,006 13,940,210 5,552,187 N/A 7,977,739 6,204,908
Value as of
June 4, 1994
Entity Value
(Controlling Basis) N/A N/A N/A N/A 34,200,000 N/A
Less: Minority Discount N/A N/A N/A N/A N/A N/A
Marketable Minority
Value N/A N/A 34,623,000 24,820,000 N/A 30,780,000
Less: Marketability (13,849,200) (11,169,000) (9,234,000)
Discount N/A N/A 40% 45% N/A 30%
Nonmarketable Minority
Value N/A N/A 20,773,800 13,651,000 N/A 21,546,000
Value of 38.47% Interest
Owned at Dave True’s
Death 5,538,423 20,041,717 7,991,681 5,251,540 13,156,740 8,288,746
- 216 -
Value as of Book value Statutory Kimball Final Lax Respondent’s Court’s
June 30, 1994 reported on notice reports report position values
return value
Entity Value
(Controlling Basis) N/A N/A N/A N/A $34,200,000 N/A
Less: Minority (3,420,000)
Discount N/A N/A N/A N/A 10% N/A
Marketable Minority
Value N/A N/A $34,623,000 N/A 30,780,000 $30,780,000
Less: Marketability (13,849,200) (3,078,000) (9,234,000)
Discount N/A N/A 40% N/A 10% 30%
Nonmarketable Minority
Value N/A N/A 20,773,800 N/A 27,702,000 21,546,000
Value of 17.23%
Interests (total)
Transferred to True
Sons 2,528,315 8,976,312 3,579,326 N/A 4,773,055 3,712,376
- 217 -
B. Belle Fourche
1. Value of Total Equity on a Marketable Basis
a. Kimball Report
Mr. Kimball applied the guideline company method to value
the subject interests in Belle Fourche as of June 4 and June 30,
1994. He rejected the discounted cash-flow method, reasoning
that the cash-flow projections and discount rate determinations
required would be too difficult to compute and would not reflect
investors’ attitudes toward these types of companies.
First, Mr. Kimball identified four guideline companies from
the crude petroleum pipeline and refined petroleum pipeline
industries, which are similar but not identical to Belle
Fourche’s line of business. Mr. Kimball could not identify any
publicly traded companies that were engaged in crude oil
gathering.
Mr. Kimball then analyzed six market multiples: EBIT,
EBDIT, debt-free net income (DFNI), debt-free cash-flow (DFCF),
revenues, and TBVIC. As with True Oil, he used data from the
latest year and an average of the 5 preceding years to calculate
the multiples. Mr. Kimball weighted the EBDIT and DFCF multiples
at 30 percent each and the rest at 10 percent each. Mr. Kimball
explained that he chose low multiples to apply to Belle Fourche’s
financial fundamentals because the guideline companies were
larger and more successful than Belle Fourche.
- 218 -
After subtracting debt owed to shareholders of $17,115,350,
Mr. Kimball concluded that the fair market value of Belle
Fourche’s total equity on a marketable minority basis was
$13,654,361 on both June 4 and June 30, 1994.
Mr. Kimball calculated total equity on a minority basis even
though he was valuing a 68.47-percent interest as of June 4,
1994, because he found that the Belle Fourche buy-sell agreement
eliminated any premium for control that might otherwise have
attached to a block of stock representing voting control.
Relying on the opinion of a Wyoming attorney, Mr. Kimball
explained that a hypothetical purchaser (other than a current
stockholder) would not be recognized as a stockholder unless he
or she complied with the buy-sell agreement terms or gained
consent of the other stockholders. Mr. Kimball stated that a
hypothetical purchaser who was not recognized as a stockholder
would not have the right to vote, the right to distributions, or
any other rights against the company, unless he or she
successfully challenged enforcement of the buy-sell agreement in
court. For these reasons, Mr. Kimball concluded that a
hypothetical purchaser would not pay a premium for such
questionable control.
b. Initial and Final Lax Reports
The initial Lax report also used the guideline company
method and compared Belle Fourche’s financial results to those of
six pipeline companies (none of which operated gathering lines).
- 219 -
Mr. Lax applied EBDIT, EBIT, and pre-tax earnings (EBT) multiples
to Belle Fourche’s financial results for the 12-month period
ending May 31, 1994. The initial Lax report did not disclose the
selected guideline company multiples, Belle Fourche’s financial
fundamentals, or the weight assigned to each multiple to arrive
at total equity value.
The initial Lax report concluded that the fair market value
of Belle Fourche’s equity as of June 3, 1994, on a marketable
controlling basis, was $10 million, which included a 25-percent
control premium. According to the report, the premium was based
on the specific control features of the subject interest (e.g.,
control over the company’s distributions, assets, and management
decisions) and on public market acquisition transactions.
As described in more detail later, the initial Lax report
applied a 40-percent marketability discount to arrive at a
nonmarketable controlling value for the 68.47-percent interest of
$4,108,200 as of June 3, 1994.
Similarly, the final Lax report used the guideline company
method and the same public company comparisons as the initial Lax
report. However, Mr. Lax stated that he did not compute an
entity value for Belle Fourche in the final Lax report. Instead,
he purported to value the specific 68.47-percent interest without
first deriving the total equity value of Belle Fourche on either
a controlling or a noncontrolling basis.
- 220 -
Mr. Lax explained that even though a 68.47-percent interest
wielded voting control over Belle Fourche, a hypothetical buyer
would not pay a premium for the interest because of the
interrelatedness of the True companies. According to Mr. Lax,
Belle Fourche is part of a network of interdependent, family-
owned companies engaged in all aspects of the oil and gas
business. He emphasized that these companies shared management
and administrative resources and relied on each other for
success, so that it would be difficult for Belle Fourche to stand
alone profitably. He observed that as a pipeline company with no
dedicated reserves, Belle Fourche depended on True Oil, True
Drilling, and especially on Eighty-Eight Oil, as the shipper, to
ensure continued operation of its pipeline. Mr. Lax concluded
that a hypothetical buyer would not assign additional value to
voting control over Belle Fourche because the buyer could not
obtain similar control over the related True companies.
The valuation analysis of the final Lax report concluded:
Using the 12 months ended [May 31, 1994] EBDIT of
$9,000,000 and multiples of 2, 2.5 and 3.0 less the
interest bearing debt of $16,000,000; EBIT of
$4,057,000 and multiples of 4.5, 5.0 and 5.5 less the
debt of $16,000,000 and EBT of $2,975,000 and multiples
of 2, 2.5, 3, we concluded an equity value for the
68.47 percent [interest] of $4,100,000 as of June 3,
1994.
The information above represents all the financial data that
Mr. Lax provided to support his valuation conclusion.
As described infra, the final Lax report stated that no
marketability discount would apply to Dave True’s 68.47-percent
- 221 -
interest in Belle Fourche, contrary to the findings of the
initial Lax report.
c. Gustavson Report and Respondent’s Position
Mr. Gustavson applied the discounted cash-flow (DCF) method
to value pipeline assets owned by Belle Fourche as of June 4,
1994; he did not value the company as a whole. Under this
method, Mr. Gustavson multiplied projected future throughput by
estimated net revenue per barrel to develop annual net cash-
flows, which he then discounted to account for the time value of
money.
The Gustavson report projected discounted cash-flows for 15
years, assuming half a year’s throughput in years 1 and 16. He
estimated 1994 throughput based on one-half of actual 1993
throughput, or 18 million barrels. Mr. Gustavson incorporated an
annual decline rate for throughput (7 percent) that mirrored the
forecasted rate of decline in oil production for the State of
Wyoming. Mr. Gustavson noted that his analysis of local
production data yielded a 2-percent decline rate; however, he
chose the higher statewide rate to be more conservative. Mr.
Gustavson stated that he examined Belle Fourche’s throughput data
(derived from filings with regulatory agencies) going back 23
years, and that he found the flow to be fairly uniform.
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Mr. Gustavson estimated net revenue per barrel by dividing
Belle Fourche’s historical net revenue69 by its historical
throughput. He averaged the values for years 1990 through 1993
to derive an average net revenue per barrel of .24, and applied
this to projected throughput in year 1. Mr. Gustavson
established a 4-percent annual decline rate for net revenue per
barrel by consulting a survey conducted by the Society of
Petroleum Evaluation Engineers (SPEE). This assumed that
increasing operating costs would decrease the profit margin on
each barrel transported by the pipeline.
In his report, Mr. Gustavson applied a 14-percent discount
rate to the projected net cash-flows. He computed this rate by
taking 10 percent, the regulated maximum tariff over cost of
service that a pipeline operator was allowed to charge, and
adding 2 percent, for the risk that new competition might
undercut Belle Fourche’s prices, and another 2 percent, to
account for the risk that Belle Fourche’s throughput might drop
below the average decline rate. Mr. Gustavson cited industry
personnel as confirming that a 10- to 15-percent discount rate
was typically used to analyze cash-flows of a pipeline company.
Mr. Gustavson stated that he did not conduct site visits or
discuss his DCF projections with Belle Fourche’s management. He
69
Historical net revenue was composed of gross operating
revenue minus operating expenses, rent/lease payments, State and
local property taxes, other taxes, and interest expense.
- 223 -
explained that it was not necessary to interview management in
this case for a number of reasons: Cash-flow was not influenced
entirely by management; he assumed that management policies would
remain unchanged; the pipeline industry was highly regulated on a
Federal and State level; and public information was available
regarding how much oil could be expected to flow through a
pipeline.
Mr. Gustavson concluded that the fair market value of Belle
Fourche’s pipeline assets under the DCF method was $34.62 million
on June 4, 1994. Mr. Gustavson also briefly discussed the
comparable sales and cost approaches to verify his conclusions
under the DCF method.70
According to respondent, Mr. Gustavson’s gross asset value
of $34,600,000 (rounded) minus outstanding long-term debt of
$17,115,350 represented the company’s net asset value. Thus,
respondent derived a marketable controlling value for Belle
Fourche of $17,484,650 as of June 4 and June 30, 1994.
70
Under the comparable sales method, Mr. Gustavson examined
an unrelated purchase of a Canadian crude oil pipeline in July
1993. He used generally the same DCF analysis as he did for
Belle Fourche; however, he assumed that fair market value equaled
the purchase price and solved for net revenue per barrel of oil.
This resulted in a net revenue figure of .26 per barrel, which
closely approximated the .24 per barrel amount used for Belle
Fourche. Under the cost method, Mr. Gustavson reviewed appraisal
information prepared for tax assessment purposes by the Wyoming
Department of Revenue. For 1995, the Department of Revenue
valued Belle Fourche assets at $27,605,035, on a replacement cost
basis. Because this number was reasonably close to the DCF
method’s value, Mr. Gustavson stated that this validated his
conclusions.
- 224 -
Respondent allowed a 10-percent minority discount in
valuing the 17.23-percent interest transferred by Jean True as of
June 30, 1994. Therefore, respondent asserts that Belle
Fourche’s marketable minority value was $15,736,185 on that date.
d. Court’s Analysis
The positions of the parties and the Court’s determination
regarding the marketable value of Belle Fourche’s total equity at
each of the valuation dates are summarized infra p. 240.
As with True Oil, we find it inappropriate to use only the
guideline company method to value the subject interests in Belle
Fourche. We believe that a hypothetical buyer would consider the
company’s underlying asset value in negotiating a purchase price,
especially if purchasing a controlling interest. We therefore
consider both the guideline company and net asset value methods
to value the Belle Fourche interests at issue in these cases.
First, however, we address the strengths and weaknesses of the
experts’ reports.
We have serious reservations about Mr. Lax’s approach to
valuing Belle Fourche; thus, for the reasons stated below, we
reject the final Lax report’s valuation conclusions.
First, the final Lax report’s guideline company analysis
suffers from the same lack of substantiation as its True Oil
analysis. As the quoted material on page 220, supra, indicates,
Mr. Lax provided no data showing: (1) How he computed the
- 225 -
guideline company multiples or the Belle Fourche financial
fundamentals, (2) which of three multiples he applied to Belle
Fourche’s fundamentals, or (3) how he weighed each resulting
product. Without more information we cannot evaluate the
reliability of Mr. Lax’s results.
Second, the final Lax report calculated the equity value of
Dave True’s 68.47-percent interest in Belle Fourche on a fully
marketable noncontrolling basis without first valuing the company
as a whole. This significantly departed from the initial Lax
report’s guideline company approach, which first valued the
company on a marketable controlling basis, and then applied a 40-
percent marketability discount. Even though both reports used
the guideline company method, we believe the approaches were
substantially different and find it remarkable that both reports
arrived at the same ultimate value of roughly $4,100,000 for Dave
True’s interest. This suggests that the final Lax report was
result-oriented.
Third, while Mr. Lax conceded that Dave True’s 68.47-percent
interest had voting control over Belle Fourche, he averred that a
hypothetical buyer would not pay more for such voting control
because he could not control the related True companies that
Belle Fourche depended on for its business (e.g., True Oil, True
Drilling, and especially Eighty-Eight Oil). We disagree.
- 226 -
Hank True testified that during the period 1992 through
1994, Belle Fourche’s business primarily consisted of moving oil
for unrelated companies. Further, Mr. Gustavson observed that
Belle Fourche’s average annual throughput substantially exceeded
the quantities of oil actually produced by the True companies.
Therefore, we are not persuaded that the value of a controlling
interest in Belle Fourche would be diminished by its
interrelatedness with the True companies.
Turning to the Kimball report, we find various errors in the
computation of Belle Fourche’s financial fundamentals,
specifically EBDIT. According to respondent, Mr. Kimball
computed EBDIT by taking ordinary income reported on page 1 of
Form 1120S (line 21) and by adding back interest expense (line
13) and depreciation (line 14c). However, line 14c did not
account for depreciation that was included in the computation of
cost of goods sold, reported on Schedule A. Respondent argues
that total depreciation reported on line 14a, which included
depreciation reported on Schedule A and elsewhere on the return,
should have been added back to arrive at Belle Fourche’s EBDIT.71
71
Arguably, it is possible that Mr. Kimball’s computation of
debt-free cash-flow (DFCF) omitted the same adjustment for
depreciation that was included in cost of goods sold. It also
appears that cost of goods sold for some of the years being
analyzed included amortization expense that should have been
added back to DFCF and earnings before depreciation, interest,
and taxes (EBDIT). We do not adjust for these items, however,
because respondent did not raise them and petitioners did not
have the opportunity to respond to them.
(continued...)
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The omitted Schedule A depreciation adjustments are listed
by year in the table below.
Schedule A
Tax year
depreciation
1989 $2,333,216
1990 $1,857,056
1991 $1,955,040
1992 $2,523,597
1993 $4,924,213
On brief, petitioners explain this omission by assuming that
Mr. Kimball added back the smaller depreciation number to reflect
differences in the methods used by Belle Fourche and the public
companies to compute cost of goods sold. This explanation is
unpersuasive. First, Schedule A reports cost of goods sold
and/or cost of operations. Belle Fourche did not sell goods, it
rendered services. Therefore, the costs reported by Belle
Fourche reflected its cost of operations, which included
depreciation, amortization, operating expenses, vehicle expenses,
operating rents, fuel and power. We are aware of no accounting
method issues that would prevent Mr. Kimball from adjusting net
income for substantial depreciation deductions in order to arrive
at multiples that served as proxies for cash-flows. Second, if
such accounting method issues existed, it seems that adjustments
71
(...continued)
- 228 -
also should have been made to the other multiples that had
incorporated Schedule A depreciation deductions into the
computation of net income. Third, we find it unlikely that Mr.
Kimball would make adjustments for accounting method differences
for Belle Fourche when he assumed that a hypothetical buyer would
not make such adjustments for True Oil.
Respondent asserts that adjusting Mr. Kimball’s numbers by
the aforementioned depreciation amounts would result in the
following values (rounded to the nearest $1,000):
Kimball Respondent’s
report revisions
EBDIT latest 12
months $4,957,000 $9,881,000
EBDIT 5-year
average $6,538,000 $8,837,000
We agree with respondent’s revision to EBDIT latest 12 months,
but we find that the 5-year average amount should have been
$9,257,000. Adjusting for these changes, and using the same
selection of multiples and weighting factors employed by Mr.
Kimball, we find that the Kimball report’s market value of
invested capital (debt and equity) should have been $37,240,000,
rather than $30,770,000.
Another apparent error in Mr. Kimball’s computations relates
to debt owed by Belle Fourche to its shareholders as of the
valuation dates. Mr. Kimball subtracted $17,115,350 of interest-
- 229 -
bearing shareholder debt in computing market value of equity as
of June 4 and June 30, 1994. However, Belle Fourche’s
shareholder debt had been paid down in May 1994, and was only
$15,915,350 at the valuation dates. Therefore, Mr. Kimball
understated market value of equity by $1,200,000.72 Correcting
for the debt, Mr. Kimball’s fair market value of total equity on
a marketable minority basis should have been $21,325,000
(rounded) on both June 4 and June 30, 1994.
Finally, we disagree with Mr. Kimball that Dave True’s
68.47-percent interest in Belle Fourche, valued as of June 4,
1994, should be treated as a noncontrolling interest. Mr.
Kimball considered this interest as being equivalent in value to
a minority interest in a public company, because a hypothetical
buyer would expect the buy-sell agreement to impede his or her
free exercise of voting control. See supra p. 218. However,
under Lauder III, we disregard the Belle Fourche buy-sell
agreement in determining fair market value of the subject
interests. As a result, we reject Mr. Kimball’s reasoning for
treating Dave True’s 68.47-percent interest as noncontrolling.
Having disregarded the buy-sell agreement, we look to
Wyoming law to determine the rights accorded a 68.47-percent
72
Respondent made the same error in his computation of Belle
Fourche’s net asset value. Mr. Lax’s $16,000,000 debt
subtraction presumably reflected the correct debt amount rounded
to the nearest $100,000.
- 230 -
interest in Belle Fourche. Unless the articles of incorporation
provide otherwise, the Wyoming Business Corporation Act requires
the following, in relevant part: (1) Each outstanding share of
stock is entitled to one vote, see Wyo. Stat. Ann. sec. 17-16-
721(a) (Michie 1999)73; (2) all corporate powers are exercised by
the board of directors, see Wyo. Stat. Ann. sec. 17-16-801(b)
(Michie 1999); (3) directors are elected by a plurality of votes
cast by the shares entitled to vote, see Wyo. Stat. Ann. sec. 17-
16-728(a) (Michie 1999); (4) sales of assets other than in the
regular course of business must be approved by a majority of all
votes cast by shares entitled to vote, see Wyo. Stat. Ann. sec.
17-16-1202(e) (Michie 1999); and (5) dissolution of the
corporation must be approved by a majority of all votes cast by
shares entitled to vote, see Wyo. Stat. Ann. sec. 17-16-1402(e)
(Michie 1999).
Belle Fourche’s articles of incorporation and bylaws were
not introduced in evidence. We therefore assume that Belle
Fourche’s governing documents do not vary from the Wyoming
corporate law requirements described above. At his death, Dave
True’s 68.47-percent interest represented a majority of the
shares entitled to vote, which allowed him to control the board
of directors, sell corporate assets, or dissolve the corporation
73
All referenced sections of the Wyoming Business
Corporation Act were in effect at the time of the subject
transfers in 1993 and 1994.
- 231 -
entirely. Accordingly, we find that Dave True owned a
controlling interest in Belle Fourche at his death.
Turning to respondent’s proposed values, we find that the
net asset value method yielded reliable controlling values for
Belle Fourche’s total capital as of June 4 and June 30, 1994.
Mr. Gustavson used the discounted cash-flow method to value Belle
Fourche’s pipeline assets, and verified his results with both the
comparable sales and cost approaches. Under the DCF method, he
computed net cash-flows based on 23 years of Belle Fourche’s
operating data and on published information from regulatory
authorities and industry surveys. Even though Belle Fourche’s
actual throughput had increased in the early 1990's, to be
conservative in his estimates, Mr. Gustavson assumed the higher
throughput decline rates projected by the State of Wyoming.
Although cash-flow projections are inherently speculative, we
find Mr. Gustavson’s estimates to be sufficiently supported by
Belle Fourche’s past performance and by industry data.
Mr. Kimball criticized Mr. Gustavson’s use of a 14-percent
cost of capital to discount projected net cash-flows, claiming
that the rate was unsubstantiated and that it was wrongly based
on the pipeline industry’s regulated profit margin (10-percent
maximum tariff over cost of service). We disagree with
petitioners and accept Mr. Gustavson’s proposed discount rate for
the following reasons.
- 232 -
Generally, a regulated company may only charge customers
what the regulatory authority deems to be a fair rate of return
on the company’s investment. Such companies usually are
regulated because they have a captive market and are in a
monopoly position to supply needed services; thus, their cost of
capital should be considerably lower than that of an average
company. Therefore, allowed rates of return for regulated
companies are viewed as reasonable benchmarks for a minimum
boundary of the overall cost of capital. See Pratt et al.,
Valuing a Business 179 (3d ed. 1996).
In addition, we find Mr. Gustavson’s 14-percent discount
rate to be reasonable given that the Scotia reports used a 10-
percent discount rate to value True Oil under the DCF method and
that Mr. Gustavson’s rate is substantially higher than the 6- to
6.75-percent interest rate charged to Belle Fourche by its
shareholders for outstanding debt during the relevant period.
Finally, we agree, in theory, with petitioners’ observation
that Mr. Gustavson should have consulted with management to
support his throughput, net revenue, and discount rate estimates.
However, in this case, Mr. Gustavson’s oversight does not
significantly undermine his conclusions of value because he was
conservative in his estimates, and he reasonably relied on public
information from a highly regulated industry to derive his
projections.
- 233 -
Accordingly, we accept Mr. Gustavson’s gross asset value of
$34,600,000 (rounded) and subtract the corrected amount of
shareholder debt of $15,915,350, to arrive at respondent’s
marketable controlling value on a net asset value basis of
$18,684,650 as of June 4 and June 30, 1994.
A comparison of the parties’ adjusted marketable values for
Belle Fourche follows:
Kimball reports’ Respondent’s Respondent’s
guideline company net asset value net asset value
method (adjusted) method (adjusted) method (adjusted)
Valuation marketable marketable marketable minority
date minority value controlling value value
June 4, 1994 $21,325,000 $18,684,650 N/A
June 30, 1994 $21,325,000 N/A $16,816,185
Again, we believe that some combination of both parties’
valuation methods would most accurately measure Belle Fourche’s
marketable value. However, because respondent’s marketable
values (shown above) are less than Mr. Kimball’s on both
valuation dates, we accept respondent’s values and treat them as
concessions.
2. Marketability Discounts
a. Kimball Report
In the True Oil section of this opinion, see supra p. 204,
we described the Kimball report’s general discussion of empirical
studies on marketability discounts. This information seems to
have informed Mr. Kimball’s choice of marketability discounts for
- 234 -
all the True companies he valued; therefore we do not repeat that
discussion here.
The Kimball report also addressed aspects of the
Stockholders’ Restrictive Agreements that made the subject shares
in the True companies less liquid than publicly traded shares.
In general, Mr. Kimball found that the corporate buy-sell
agreements had the same negative impact on marketability of
corporate shares as the identical partnership agreement
restrictions had on marketability of partnership interests.
Mr. Kimball also observed that S corporations in general,
and Belle Fourche, Black Hills Trucking, and White Stallion in
particular, had features that affected the fair market value of
their stock. The Kimball report explained that limitations on
the number and types of investors in S corporations reduced
marketability by restricting the pool of willing buyers. On the
other hand, the Kimball report noted that the lack of corporate
level income taxes allowed S corporations to distribute more cash
to shareholders, thus enhancing marketability.
Based on the foregoing, the Kimball reports concluded that
the subject interests in Belle Fourche were not readily
marketable and applied 40-percent marketability discounts to the
marketable minority values as of June 4 and June 30, 1994.
b. Initial and Final Lax Reports
- 235 -
The initial Lax report concluded that a 40-percent
marketability discount was appropriate even for a controlling
interest in a company because of the substantial time and expense
required to sell an interest in the absence of an established
market. For instance, Mr. Lax noted that the sale of an interest
in Belle Fourche would require preparation of a selling
memorandum and audited financial statements, location of a buyer,
drafting of legal documents, and coordination of financing
arrangements.
The final Lax report disclaimed the initial Lax report’s
conclusions and did not apply a marketability discount in valuing
Dave True’s 68.47-percent interest in Belle Fourche. Mr. Lax
explained that there was no empirical evidence suggesting that a
marketability discount would apply to an interest of greater than
50 percent. In fact, AA’s research showed that in many cases,
buyers placed a premium on control that fully offset the
illiquidity problems identified in the initial Lax report,
thereby resulting in a net premium.
c. Respondent’s Position
Respondent relied on Mr. Lax’s final conclusions to argue
that a marketability discount would not apply to Dave True’s
controlling interest in Belle Fourche valued as of June 4, 1994.
However, respondent allowed a 10-percent marketability discount
- 236 -
for Jean True’s minority interest transferred as of June 30,
1994.
d. Court’s Analysis
As stated earlier, under Lauder III we disregard the buy-
sell agreement in determining fair market value of the subject
interests in Belle Fourche. See supra pp. 209-210. We consider
the agreement only to recognize that its existence demonstrates
the True family’s commitment to maintain control over Belle
Fourche. Accordingly, we reject Mr. Kimball’s justifications for
marketability discounts that derive from the buy-sell agreement
restrictions.
We also find that the restricted shares and pre-IPO studies
referenced by Mr. Kimball are not useful in determining
marketability discounts applicable to controlling interests,
because those studies analyzed marketability of noncontrolling
interests.
In the past, we have said that controlling shares in a
nonpublic corporation could suffer from a lack of marketability
because of the absence of a ready private placement market and
the costs of floating a public offering. See Estate of Andrews
v. Commissioner, 79 T.C. at 953. Therefore, we disagree with the
positions of Mr. Lax and respondent that marketability or
illiquidity discounts are never justified in the case of
controlling interests in private corporations.
- 237 -
In Estate of Jameson v. Commissioner, T.C. Memo. 1999-43, 77
T.C.M. 1383, 1397, 1999 T.C.M. (RIA) par. 99,043, at 269-
99, we noted that the terms marketability and illiquidity are
closely related but are not interchangeable. Liquidity is a
measure of the time required to convert an asset into cash and
may be influenced by marketability. On the other hand,
marketability is not a temporal measure--it is a measure of the
probability of selling goods at specified terms, based on two
variables: Demand for the asset and existence of an established
market for buyers and sellers of that asset type. See id. Thus,
if the interest being valued had the power to liquidate the
corporation, then demand for the corporation’s assets (rather
than its stock) and existence of a market for such assets are
most relevant to our analysis of marketability. See id.
In the cases at hand, Dave True’s 68.47-percent interest
could control liquidation of Belle Fourche; therefore, we must
examine the marketability of Belle Fourche’s pipeline assets.
Petitioners did not address directly the demand for pipeline
assets in the region during the relevant period. However, based
on Mr. Gustavson’s conservative projections, a buyer could expect
the Belle Fourche pipeline to continue to generate cash-flow for
another 15 years. Moreover, the stiff competition in the region
suggests that larger pipeline owners might consider buying out
smaller pipeline operations rather than building new lines. This
- 238 -
might explain why Belle Fourche purchased the Thunderbird
pipeline in 1992. For these reasons, we find that Belle
Fourche’s pipeline assets were marketable.
Based on the record, we apply a 20-percent marketability
discount in valuing Dave True’s 68.47-percent interest in Belle
Fourche as of June 4, 1994. This level of marketability discount
on a controlling interest is within the range previously allowed
by this Court. See, e.g., Estate of Jones v. Commissioner, 116
T.C. 11 (2001) (allowing an 8-percent marketability discount on a
83.08-percent controlling interest); Estate of Maggos v.
Commissioner, T.C. Memo. 2000-129 (allowing a 25-percent
illiquidity discount on a 56.7-percent interest conveying
effective operational control); Estate of Hendrickson v.
Commissioner, T.C. Memo. 1999-278 (allowing a 30-percent
marketability discount on a 49.97-percent effectively controlling
interest); Estate of Jameson v. Commissioner, supra (allowing a
3-percent marketability discount on a 98-percent controlling
interest).
To determine the appropriate marketability discount for Jean
True’s 17.23-percent interest in Belle Fourche transferred as of
June 30, 1994, we draw from our earlier discussion of
marketability discounts applicable to minority interests in True
Oil. In our True Oil analysis, see supra pp. 213-214, we began
with Mr. Kimball’s 40-percent discount, presumably derived from
- 239 -
the restricted shares studies, and reduced it to 30 percent to
eliminate the effects on value of the buy-sell agreement
restrictions.
We find that a minority interest in Belle Fourche, like a
minority interest in True Oil, is less marketable than actively
traded interests because: (1) The True family is committed to
keeping Belle Fourche privately owned, (2) the subject interest
lacks control, and (3) Federal tax rules limit the pool of
potential investors in S corporations. However, certain facts
suggest that a minority interest in Belle Fourche would be more
marketable than an equivalent interest in True Oil. First, Belle
Fourche historically has been profitable, unlike True Oil.
Second, on average Belle Fourche’s distributions substantially
exceeded the shareholders’ tax obligations on their distributive
shares of income, while True Oil’s net distributions were not
significant. Third, a purchaser of Belle Fourche stock would not
be subject to joint and several liability.
Based on the foregoing, we conclude that a minority interest
in Belle Fourche is more marketable than the same percentage
interest in True Oil. Therefore, to remain within the 26 to 45-
percent range of discounts observed in the restricted shares
studies, we assign a 27-percent marketability discount to Jean
True’s 17.23-percent interest in Belle Fourche transferred as of
June 30, 1994.
- 240 -
3. Summary of Proposed Values and Court’s Determinations
of Values of Interests in Belle Fourche
Value as of Book value Statutory Kimball Final Lax Respondent’s Court’s
June 4, 1994 reported on notice value reports report position values
return
Entity Value
(Controlling Basis) N/A N/A N/A N/A $17,484,650 $18,684,650
Less: Minority Discount N/A N/A N/A N/A N/A N/A
Marketable Minority Value N/A N/A $13,654,361 N/A N/A N/A
Less: Marketability (5,461,744) (3,736,930)
Discount N/A N/A 40% N/A N/A 20%
Nonmarketable Minority
Value N/A N/A 8,192,617 N/A N/A 14,947,720
Value of 68.47% Interest
Owned at Dave True’s
Death 747,723 19,801,518 5,609,485 4,100,000 11,971,740 10,234,704
Value as of
June 30, 1994
Entity Value
(Controlling Basis) N/A N/A N/A N/A 17,484,650 18,684,650
(1,748,465) (1,868,465)
Less: Minority Discount N/A N/A N/A N/A 10% 10%
Marketable Minority
Value N/A N/A 13,654,361 N/A 15,736,185 16,816,185
Less: Marketability (5,461,744) (1,573,618) (4,540,370)
Discount N/A N/A 40% N/A 10% 27%
Nonmarketable Minority
Value N/A N/A 8,192,617 N/A 14,162,567 12,275,815
Value of 17.23%
Interests (total)
Transferred to True
Sons 183,593 4,982,916 1,411,588 N/A 2,440,210 2,115,123
- 241 -
C. Eighty-Eight Oil
1. Marketable Minority Interest Value
a. Kimball Reports
Mr. Kimball applied the guideline company method to value
the subject interests in Eighty-Eight Oil as of January 1, 1993,
June 4, 1994, and June 30, 1994. First, Mr. Kimball identified
five guideline companies that devoted some or all of their
business to the marketing of crude oil and gas. Mr. Kimball then
analyzed four market multiples: EBIT, EBDIT, Revenues, and
TBVIC. He used data from the latest year and an average of the 5
preceding years to calculate the multiples. Mr. Kimball weighted
the EBDIT and TBVIC multiples at 40 percent each and the rest at
10 percent each.
Mr. Kimball concluded that the fair market value of Eighty-
Eight Oil’s total equity on a marketable minority basis was
$25,174,683 on January, 1, 1993, and $31,069,285 on both June 4
and June 30, 1994.
b. Final Lax Report
The final Lax report also used the guideline company method
and compared Eighty-Eight Oil’s financial results to those of six
companies. As a group, the chosen guideline companies engaged in
all aspects of the oil and gas business, including acquisition of
properties, exploration and production, and transportation and
- 242 -
marketing. Mr. Lax used the same group of companies to value
True Oil, Eighty-Eight Oil, and Smokey Oil.
Mr. Lax applied EBDIT, EBIT, EBT, and book value multiples
to Eighty-Eight Oil’s financial results for the 12-month period
ending May 31, 1994. As with the other True companies, Mr. Lax
did not provide supporting schedules showing how he calculated
the guideline company multiples and Eighty-Eight Oil’s financial
fundamentals.
The final Lax report concluded that the fair market value of
Eighty-Eight Oil’s total equity on a marketable minority basis
was $40 million on June 3, 1994.
c. Respondent’s Position
Respondent offered no expert testimony or other evidence
regarding Eighty-Eight Oil’s total equity value on the relevant
dates. Instead, respondent agrees with Mr. Kimball’s marketable
minority value of $25,174,683 as of January 1, 1993, and with Mr.
Lax’s “entity value” of $40 million as of June 3, 1994.
Respondent did not explain why he rejected Mr. Kimball’s June 4,
1994, value or how he justified the large disparity in entity
values between proximate valuation dates.
Respondent also argues, as he did with True Oil, that Dave
True’s 38.47-percent interest owned at death is not entitled to a
minority discount, because it represented a significant ownership
- 243 -
block that had swing vote potential.74
d. Court’s Analysis
The positions of the parties and the Court’s determinations
of the marketable minority values of Eighty-Eight Oil’s total
equity at each of the valuation dates are summarized infra pp.
250-251.
We accept the agreement of the parties that the marketable
minority value of Eighty-Eight Oil’s total equity was $25,174,683
on January 1, 1993. However, we have reservations regarding the
reliability of this value, which we explain later.
We are critical of respondent’s reliance on the final Lax
report to establish marketable minority value as of June 4 and
June 30, 1994. First, as noted several times in this opinion,
the final Lax report’s guideline company analyses lack adequate
substantiation. In contrast, the Kimball reports are well
documented, and the amounts reported therein are traceable to the
various companies’ Federal income tax returns. We are unable to
reconcile Eighty-Eight Oil’s financial fundamentals as reported
74
This argument is inconsistent with respondent’s acceptance
of Mr. Lax’s entity value as of June 3, 1994, which was derived
on a marketable minority basis. Respondent explicitly argued, in
connection with Dave True’s controlling interests in Belle
Fourche and Black Hills Trucking, that if those entities were
valued on a minority basis, a control premium of 25 percent
should have been applied to derive entity value. It is unclear
whether respondent is making the same argument regarding Dave
True’s significant, but not controlling, ownership of Eighty-
Eight Oil. We need not resolve this issue, however, because we
reject respondent’s swing vote argument infra p. 244.
- 244 -
in the Lax and Kimball reports, even though the reports covered
roughly the same period and allegedly relied on the same tax
return information. Because of the Lax report’s substantiation
problems, we conclude that the Kimball reports provide more
reliable conclusions of value. Second, we find that the Kimball
reports used guideline companies that were more comparable to
Eighty-Eight Oil. Three of the six guideline companies chosen by
Mr. Lax engaged in oil and gas exploration and production and not
in oil and gas marketing activities. These companies may have
been appropriate comparables for True Oil or Smokey Oil, but not
for Eighty-Eight Oil. Third, respondent provides no reasoned
justification for choosing Mr. Kimball’s January 1, 1993, value,
but using Mr. Lax’s significantly higher June 3, 1994, value.
We also reject respondent’s swing vote argument concerning
Dave True’s 38.47-percent interest owned at death, for the
reasons stated in our analysis of True Oil. See supra pp. 201-
202.
On the basis of the foregoing, we accept Mr. Kimball’s
marketable minority value for Eighty-Eight Oil of $31,069,285 as
of June 4 and June 30, 1994.
Although we have accepted Mr. Kimball’s marketable minority
values, based on the agreement of the parties and our problems
with respondent’s reliance on the final Lax report, we note
certain facts that cast doubt on the reliability of Mr. Kimball’s
- 245 -
entity values. First, as of January 1, 1993, Eighty-Eight Oil’s
total equity on a book basis was more than $43.5 million, which
was primarily composed of cash, cash equivalents, and accounts
receivable. Given the lack of any substantial book to fair
market value disparities for these liquid assets, we question the
accuracy of Mr. Kimball’s total equity value of just over $25
million. If this difference only related to the fact that Mr.
Kimball derived a minority value, and not a controlling value,
that would suggest an implied minority discount of approximately
43 percent, which would be excessive.
Second, we are troubled by the differences in the way
petitioners derived the sales price for the interest transferred
by Dave True to his sons on January 1, 1993, compared to Mr.
Kimball’s method for valuing the subject interest. The Eighty-
Eight Oil buy-sell agreement required the selling partner to sell
all or some of his interest for book value, as reflected by his
capital account, as of the day immediately preceding the sales
event. As previously stated, the sales price under the buy-sell
agreement amounted to approximately 5.86 percent of total
partners’ capital as of December 31, 1992. However, Mr. Kimball
valued the subject interests by computing total equity value on a
minority basis, by applying a marketability discount, see infra,
and then by multiplying total discounted equity by 24.84 percent.
Because Eighty-Eight Oil routinely allowed its partners to
- 246 -
maintain disproportionate capital accounts, the two approaches
are fundamentally inconsistent. To the extent that the
partnership agreement defines the interest being transferred, we
doubt that Mr. Kimball has valued the correct interest. As a
general matter, we are also concerned with the anomalous economic
results75 that have occurred due to the allowance of
disproportionate capital accounts.
We account for the abovementioned concerns in our
determination of marketability discounts.
2. Marketability Discounts
a. Kimball Reports
Mr. Kimball treated the subject interests in Eighty-Eight
Oil as not being readily marketable for the same reasons
75
We note again that in 1984, Tamma Hatten had to reduce her
proceeds from the sales of other True companies in order to sell
her interest in “cash cow” Eighty-Eight Oil because of her
negative ending capital account. Also, Dave True’s unusually low
capital balance at the effective date of the 1993 transfers
arguably created an additional gift to his sons, because the True
sons only paid what amounted to 5.86 percent of total partners’
capital ostensibly to purchase the right to an additional 24.84
percent of profits, losses, and partners’ capital. It would
appear that Dave True’s unusual (the day before the sale)
contribution to partners’ capital of more than $6 million was
intended to avoid a sale at a price so low in relation to overall
book value of partners’ capital and the percentage interest in
profits being sold as to be impossible to justify with even a
semblance of a straight face. Petitioners argue on brief that
Dave True “substantially restored” his disproportionate capital
account before the 1993 transfers because Eighty-Eight Oil
required the extra cash to conduct its business. We are
unconvinced by petitioners’ justifications, and we note that Dave
True’s capital account remained disproportionately low even after
the allegedly “substantial” restoration.
- 247 -
described in the True Oil section of this opinion. See supra pp.
204-206. Accordingly, Mr. Kimball applied 35-percent
marketability discounts to the marketable minority values as of
January 1, 1993, June 4, 1994, and June 30, 1994.
b. Final Lax Report
The final Lax report concluded that a minority interest in
Eighty-Eight Oil was relatively illiquid, for the same reasons
described in the True Oil section of this opinion. See supra p.
207. Therefore, Mr. Lax applied a 45-percent marketability
discount to the marketable minority value calculated as of
June 3, 1994.
c. Respondent’s Position
Respondent characterizes the Eighty-Eight Oil interests as
being marketable and therefore proposes a 10-percent discount for
interests being valued as of January 1, 1993, and June 30, 1994,
and no discount (due to swing vote potential) for the interest
being valued as of June 4, 1994.
d. Court’s Analysis
First, we reject Mr. Kimball’s justifications for
marketability discounts that derive from the buy-sell agreement
restrictions. Second, we reject Mr. Lax’s and respondent’s
proffered marketability discounts for the same reasons stated in
the True Oil section of this opinion. See supra p. 213.
- 248 -
We find that a minority interest in Eighty-Eight Oil was not
fully marketable at the valuation dates because: (1) The True
family was committed to keeping Eighty-Eight Oil privately owned;
(2) there were risks that a purchaser would not obtain unanimous
consent to be admitted as a partner; and (3) a purchasing partner
would be exposed to joint and several liability.
However, a minority interest in Eighty-Eight Oil would be
more marketable than an equivalent interest in True Oil or in
comparable public companies. Unlike True Oil, Eighty-Eight Oil
was profitable and consistently made guaranteed payments to its
partners, who considered the company to be a “cash cow”.
Furthermore, during the period being examined, Eighty-Eight Oil
was more liquid than the industry, and the concepts of liquidity
and marketability are closely related. Finally, a general
partner in Eighty-Eight Oil would exert more control over the
business than a shareholder would in a comparable public company.
Under the WUPA, partnership agreements generally govern relations
among the partners and between the partners and the partnership.
See Wyo. Stat. Ann. sec. 17-21-103(a) (Michie 1999). Eighty-
Eight Oil’s partnership agreement required the partners to manage
jointly the partnership’s affairs. Thus under Wyoming law, each
partner had an equal vote in (among other things) appointing
management, setting business policies, making distributions,
buying and selling assets, and amending the partnership
- 249 -
agreement. A minority shareholder could not exercise equivalent
control over a public company because voting power is generally
proportional to a shareholder’s ownership interest.
On the basis of the foregoing, we conclude that minority
interests in Eighty-Eight Oil are more marketable than either
minority interests in True Oil or restricted shares in a publicly
traded oil and gas marketing company. In addition, as previously
stated, we doubt the reliability of the entity values derived by
the parties due to the widely disproportionate capital accounts.
See supra pp. 244-246. These facts suggest that no more than
nominal discounts, if any, would be appropriate for the subject
interests. We, therefore, adopt and apply respondent’s position
allowing no more than 10-percent marketability discounts from
minority value for the Eighty-Eight Oil interests valued as of
January 1, 1993, June 4, 1994, and June 30, 1994.
- 250 -
3. Summary of Proposed Values and Court’s Determinations of Values of Interests
in Eighty-Eight Oil
Value as of Book value Statutory Kimball Final Lax Respondent’s Court’s
January 1, 1993 reported on notice value reports report position values
return
Marketable Minority Value N/A N/A $25,174,683 N/A $25,174,683 $25,174,683
Less: Marketability (8,811,139) (2,517,468) (2,517,468)
Discount N/A N/A 35% N/A 10% 10%
Nonmarketable Minority
Value N/A N/A 16,363,544 N/A 22,657,215 22,657,215
Value of 24.84% Interests
(total) Transferred to
True Sons 2,556,378 13,248,002 4,064,704 N/A 5,628,052 5,628,052
Value as of
June 4, 1994
Marketable Minority Value N/A N/A 31,069,285 40,000,000 40,000,000 31,069,285
Less: Marketability (10,874,250) (18,000,000) (3,106,928)
Discount N/A N/A 35% 45% N/A 10%
Nonmarketable Minority
Value N/A N/A 20,195,035 22,000,000 40,000,000 27,962,357
Value of 38.47% Interest
Owned at Dave True’s
Death 9,546,285 26,505,830 7,769,030 8,463,400 15,388,000 10,757,119
- 251 -
Value as of Book Statutory Kimball Final Respondent’s Court’s
June 30, 1994 value notice reports Lax position values
reported value report
on return
Marketable Minority
Value N/A N/A $31,069,285 N/A $40,000,000 $31,069,285
Less: Marketability (10,874,250) (4,000,000) (3,106,928)
Discount N/A N/A 35% N/A 10% 10%
Nonmarketable Minority
Value N/A N/A 20,195,035 N/A 36,000,000 27,962,357
Value of 17.23%
Interests (total)
Transferred to True
Sons 4,400,744 11,871,469 3,479,605 N/A 6,202,800 4,817,914
- 252 -
D. Black Hills Trucking
1. Value of Total Equity on a Marketable Basis
a. Kimball Report
Mr. Kimball applied a combination of the guideline company
and net asset value methods to value the subject interests in
Black Hills Trucking as of June 4 and June 30, 1994.
Under the guideline company method, Mr. Kimball identified
10 companies from the trucking industry and analyzed revenue and
TBVIC multiples, weighting each multiple equally. He used data
from the latest year and an average of the 5 preceding years to
calculate the multiples. Mr. Kimball selected revenue multiples
that were lower than the lowest guideline company multiples;
however, he selected a TBVIC multiple that approximated the
median value among the guideline companies. After subtracting
debt to shareholders of $2.8 million, Mr. Kimball concluded that
the fair market value of Black Hills Trucking’s total equity on a
marketable minority basis was $5,953,417, under the guideline
company method.
Mr. Kimball calculated total equity on a minority basis even
though he was valuing a 58.16-percent interest as of June 4,
1994, because he found, consistent with his analysis of Belle
Fourche, see supra p. 218, that the Black Hills Trucking buy-sell
agreement eliminated any premium for control that might otherwise
have attached to a block of stock representing voting control.
- 253 -
Under the net asset value method, Mr. Kimball estimated the
market value of Black Hills Trucking’s individual assets by
category. First, he adjusted the company’s book value balance
sheet to eliminate tax basis accumulated depreciation. Second,
he reduced the cost basis of fixed assets to approximately 70
percent of book value. Third, Mr. Kimball subtracted liabilities
to arrive at an adjusted NAV of $10,933,730 as of June 4 and June
30, 1994.
Mr. Kimball applied a 10-percent lack-of-control discount to
adjusted NAV as of June 4 and June 30, 1994, for the same reasons
mentioned above in the guideline company section. Thus, Mr.
Kimball concluded that the fair market value of Black Hills
Trucking’s total equity on a marketable minority basis was
$9,840,357, under the net asset value method.
b. Initial and Final Lax Reports
The initial Lax report used only the net asset value method
to value the subject interests in Black Hills Trucking, because
the company consistently operated at a loss. Mr. Lax physically
inspected only a few of the several hundred vehicles, trailers,
and miscellaneous equipment owned by Black Hills Trucking; when
inspection was infeasible, he relied on information provided by
the company’s representatives such as fixed asset records,
vehicle maintenance logs, and depreciation schedules. In
computing net asset value, Mr. Lax assumed that Black Hills
- 254 -
Trucking equipment could be sold in orderly fashion over a long
period of time, rather than in a forced liquidation.
Mr. Lax used the market approach to value assets in the
power and trailer equipment categories by gathering information
on recent sales of similar property and by determining the most
probable selling price of the subject property. In the process,
Mr. Lax consulted auction guides, trade magazines, and new and
used equipment dealers. He made no adjustments to market values
to reflect physical depreciation or functional or economic
obsolescence, assuming that these factors were incorporated into
the market data.
Mr. Lax used the cost approach to value assets in the
miscellaneous and office equipment category. He determined the
cost of new replacement assets by contacting original
manufacturers or by applying inflation factors to historical
costs and verifying the results with vendors. He then made
adjustments to each replacement cost figure to reflect
depreciation and obsolescence.
After reducing the fair market value of underlying assets by
total liabilities, the initial Lax report concluded that the
controlling marketable value of a 100-percent interest in Black
Hills Trucking was $10,933,730 as of June 3, 1994.
As described in more detail infra, the initial Lax report
applied a 50-percent marketability discount to arrive at a
- 255 -
nonmarketable controlling value for Dave True’s 58.16-percent
interest of $3,179,530.
The final Lax report calculated the same controlling
marketable equity value on a net asset value basis as the initial
Lax report. However, Mr. Lax reduced the controlling value by 50
percent to reflect the fact that a 58.16-percent interest in
Black Hills Trucking would not be entitled to a control premium.
Mr. Lax explained that the 50-percent reduction was not a
marketability discount; instead it reflected Mr. Lax’s impression
that a willing buyer would not pay a price based on a
proportional value of the company’s underlying assets. He
reasoned that because Black Hills Trucking operated at a loss, a
hypothetical buyer with a controlling interest would liquidate
the company’s assets as soon as possible to stem further losses.
Such a rapid disposition of specialized equipment within a
limited geographic region generally would depress value by 50
percent, according to Mr. Lax.
Thus, the final Lax report concluded that the fair market
value of a 58.16-percent equity interest in Black Hills Trucking
was $3,179,530 as of June 3, 1994.
c. Respondent’s Position
Respondent offered no expert testimony or other evidence
regarding Black Hills Trucking’s total equity value on the
relevant dates. Instead, respondent adopted the net asset value
conclusions of the final Lax report and treated $10,933,730 as
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the controlling equity value of Black Hills Trucking on June 4
and June 30, 1994.
Respondent argues that Dave True’s 58.16-percent interest
owned at death should be valued as a controlling interest,
contrary to Mr. Kimball’s minority interest treatment under both
the guideline company and net asset value methods. Respondent
contends that if Mr. Kimball’s minority values are accepted by
the Court, a 25-percent control premium should be added to
reflect Dave True’s control at death. Respondent derived the
premium amount from the initial Lax report, which applied a 25-
percent control premium to compute the marketable controlling
value of Belle Fourche, see supra p. 219.
Respondent also argues, as he did with True Oil, see supra
pp. 194-195, that Jean True’s 37.63-percent interest transferred
as of June 30, 1994, was not entitled to a minority discount,
because it represented a significant ownership block that had
swing vote potential.
d. Court’s Analysis
The positions of the parties and the Court’s determinations
of the marketable value of Black Hills Trucking’s total equity at
each of the valuation dates are summarized infra pp. 266-267.
We accept the final Lax report’s controlling equity value on
a net asset value basis of $10,933,730 as of June 3, 1994. We
believe that a hypothetical buyer would consider underlying asset
value in negotiating a purchase price, especially if purchasing a
- 257 -
controlling interest. Mr. Lax’s approach to valuing the
different categories of fixed assets was reasonable and well
documented. Furthermore, Mr. Kimball and respondent agreed with
Mr. Lax’s net asset value conclusions.
We disagree, however, with the conclusion of the final Lax
report that a 50-percent discount should be applied to arrive at
the fair market value of Dave True’s 58.16-percent interest. Mr.
Lax provided no empirical evidence to support this reduction. At
trial, Mr. Lax tried to distinguish this discount from the 50-
percent marketability discount taken in the initial Lax report.
He explained that a reduction was necessary because a
hypothetical buyer would be forced to sell immediately the
company’s assets to avoid additional operating losses. However,
this statement contradicted Mr. Lax’s earlier testimony, in which
he explained that he had computed Black Hills Trucking’s net
asset value assuming an orderly disposition of assets, not a
forced liquidation. If we accept that a hypothetical buyer would
compute entity value under the orderly disposition premise, there
is no reason for us to assume that the buyer would value a 58.16-
percent interest in Black Hills Trucking under any other
valuation premise. Moreover, the initial and final Lax reports
both arrived at the same ultimate value of $3,179,530 for Dave
True’s interest using very different assumptions regarding
marketability. This suggests that the final Lax report was
result-oriented.
- 258 -
Turning to the Kimball report, we doubt the reliability of
the guideline company method values. First, we question whether
the relationship between revenues, TBVIC, and market value of the
selected public companies has any bearing on the market value of
Black Hills Trucking. The guideline companies were all
profitable over the 5-year period, whereas Black Hills Trucking
sustained losses every year. Also, most of the guideline
companies had significantly higher average revenues over the
analyzed period than Black Hills Trucking. As a result, Mr.
Kimball applied multiples to Black Hills Trucking’s revenues that
were lower than the lowest industry multiples. These facts
suggest a lack of comparability between the selected companies
and Black Hills Trucking.
Second, Mr. Kimball did not adjust the TBVIC multiple to
reflect differences in accounting methods between Black Hills
Trucking and the public companies. TBVIC is a debt-free measure
of a company’s book value. Black Hills Trucking’s book value was
computed on a tax basis, which allowed more accelerated
depreciation deductions than GAAP basis financials. Annually,
the company deducted approximately $2.1 million in depreciation
expense. There is no evidence in the record indicating that Mr.
Kimball adjusted the TBVIC multiples of either the guideline
companies or Black Hills Trucking to reconcile any discrepancies
in accumulated depreciation.
- 259 -
Third, contrary to the Kimball report’s emphasis on the
TBVIC multiple, we find that it is not a meaningful measure of
value in this case. In general, book value of tangible assets
would serve as a meaningful measure of value only if book value
was close to market value on the valuation date. Thus, tangible
asset values first should be adjusted to their respective fair
market values to make price-to-asset-value ratios more relevant.
Moreover, equipment varies from one company to another in age,
condition, and importance to the operations, so that price-to-
asset-value measures are difficult to implement on a comparison
basis and frequently are not helpful. See Pratt et al., Valuing
a Business 217 (3d ed. 1996).
Black Hills Trucking owned a variety of heavy specialized
equipment that was purchased anywhere from 1 to 40 years before
the valuation date. Mr. Kimball calculated the fair market value
of equipment (under the NAV method) to be $11.5 million as of
December 31, 1993, while net book value was $2.5 million. Such a
large disparity between book value and fair market value suggests
that TBVIC is not an appropriate basis for valuing Black Hills
Trucking.
Fourth, we disagree with Mr. Kimball that Dave True’s 58.16-
percent interest in Black Hills Trucking, valued as of June 4,
1994, should be treated as a noncontrolling interest. As we said
in the Belle Fourche section of this opinion, see supra pp. 229-
230, we disregard the buy-sell agreement in computing fair market
- 260 -
value and look to Wyoming law to determine the rights accorded a
58.16-percent interest in Black Hills Trucking.
Wyoming law allows the holder of a majority of the shares
entitled to vote to control the board of directors, sell
corporate assets, or dissolve the corporation. See discussion of
Wyoming law supra p. 230. No articles of incorporation or bylaws
were introduced in evidence for Black Hills Trucking. Therefore,
we assume that the company’s governing documents do not vary from
Wyoming law. Dave True’s 58.16-percent interest represented a
majority of the shares entitled to vote; therefore, Dave True
owned a controlling interest in Black Hills Trucking at his
death. Accordingly, Mr. Kimball should have added a control
premium to compute entity value under the guideline company
method.
For the reasons stated above, we reject Mr. Kimball’s
valuation conclusions under the guideline company method. We
need not discuss the merits of Mr. Kimball’s net asset value
approach because his controlling interest value equaled that of
Mr. Lax, which we have already adopted. However, we reject Mr.
Kimball’s 10-percent lack of control discount to adjusted NAV as
of June 4, 1994, because Dave True owned a controlling interest
at death.
Turning to respondent’s position, we agree that Dave True’s
58.16-percent interest valued at June 4, 1994, is not entitled to
a minority discount. However, we disagree with respondent’s
- 261 -
swing vote argument regarding Jean True’s 37.63-percent interest
transferred as of June 30, 1994, for the reasons stated in our
analysis of True Oil, see supra pp. 202-203, and we find that a
minority discount is warranted. We apply Mr. Kimball’s proposed
10-percent lack-of-control discount to Mr. Lax’s net asset value
to arrive at a marketable minority value as of June 30, 1994, of
$9,840,357 for the interest sold by Jean True to her sons.
A summary of our determinations regarding marketable entity
values for Black Hills Trucking follows:
Net asset value Net asset value
Valuation method marketable method marketable
date controlling value minority value
June 4, 1994 $10,933,730 N/A
June 30, 1994 N/A $9,840,357
2. Marketability Discounts
a. Kimball Report
Based on the reasoning described in the Belle Fourche
section of this opinion, see supra pp. 233-234, Mr. Kimball
concluded that the subject interests in Black Hills Trucking were
not readily marketable, and he applied 45-percent marketability
discounts to the marketable minority values as of June 4 and June
30, 1994.
The table below summarizes the nonmarketable minority values
of the subject interests in Black Hills Trucking calculated using
the guideline company and NAV methods.
- 262 -
Guideline company NAV method
method nonmarketable
Valuation nonmarketable minority value of
date minority value of subject interest
subject interest
June 4, $1,904,000 $3,147,733
1994
June 30, $1,232,149 $2,036,609
1994
Mr. Kimball then applied a 30-percent weight to the
guideline company method valuation conclusions and a 70-percent
weight to the NAV method conclusions, resulting in final
nonmarketable minority values (rounded) for the subject interests
of $2,775,000 as of June 4, 1994, and $1,795,000 as of June 30,
1994.
b. Initial and Final Lax Reports
As previously stated, the initial Lax report concluded that
a 50-percent marketability discount was appropriate even for a
controlling interest in a company because of the substantial time
and expense required to sell an interest in the absence of an
established market.
However, the final Lax report applied no marketability
discounts to Dave True’s 58.16-percent interest in Black Hills
Trucking for the reasons described in the Belle Fourche section
of this opinion. See supra p. 235.
c. Respondent’s Position
Respondent relied on Mr. Lax’s final conclusions to argue
that a marketability discount would not apply to Dave True’s
- 263 -
controlling interest in Black Hills Trucking valued as of June 4,
1994. Similarly, respondent denied any marketability discount to
Jean True’s 37.63-percent interest valued as of June 30, 1994,
because the transferred interest had swing vote potential.
d. Court’s Analysis
As stated earlier, under Lauder III, we disregard the buy-
sell agreement in determining fair market value of the subject
interests in Black Hills Trucking. See supra pp. 209-210.
Accordingly, we reject Mr. Kimball’s justifications for
marketability discounts that derive from the buy-sell agreement
restrictions.
We find that the restricted shares and pre-IPO studies
referenced by Mr. Kimball are not useful in determining
marketability discounts applicable to controlling interests,
because those studies analyzed marketability of noncontrolling
interests.
We also disagree with the positions of Mr. Lax and
respondent that marketability or illiquidity discounts are never
justified in the case of controlling interests in private
corporations. See Estate of Andrews v. Commissioner, 79 T.C. at
953.
In the cases at hand, Dave True’s 58.16-percent interest
could control liquidation of Black Hills Trucking; therefore, we
must examine the marketability of Black Hills Trucking’s assets.
Mr. Lax valued Black Hills Trucking’s power and trailer equipment
- 264 -
by consulting auction guides, trade magazines, and new and used
equipment dealers. This suggests an active market for these
types of assets. However, Black Hills Trucking’s fixed assets
had a low tax basis relative to their resale value, which would
trigger a tax liability on sale. Also, a willing seller would
incur other transaction costs to dispose of the company’s assets
either on a bulk sale or an item-by-item basis.
Based on the record, we apply a 20-percent marketability
discount in valuing Dave True’s 58.16-percent interest in Black
Hills Trucking as of June 4, 1994. This level of marketability
discount on a controlling interest is within the range previously
allowed by this Court. See cases cited supra p. 238.
To determine the appropriate marketability discount for Jean
True’s 37.63-percent interest in Black Hills Trucking transferred
as of June 30, 1994, we draw from our discussion of discounts
applicable to minority interests in Belle Fourche. See supra pp.
238-239.
We find that a minority interest in Black Hills Trucking,
like a minority interest in Belle Fourche, is less marketable
than actively traded interests because: (1) The True family is
committed to keeping Black Hills Trucking privately owned, (2)
the subject interest lacks control, and (3) Federal tax rules
limit the pool of potential investors in S corporations.
Moreover, certain facts suggest that a minority interest in Black
Hills Trucking would be less marketable than a minority interest
- 265 -
in Belle Fourche. First, Black Hills Trucking was unprofitable,
unlike Belle Fourche. Second, Black Hills Trucking’s shareholder
distributions were negligible, while Belle Fourche’s were
significant. In fact, during the period analyzed, shareholders
lent or contributed substantial amounts to Black Hills Trucking.
Based on the foregoing, we conclude that a minority interest
in Black Hills Trucking was less marketable than a minority
interest in Belle Fourche. Therefore, we assign a 30-percent
marketability discount to Jean True’s 37.63-percent interest in
Black Hills Trucking transferred as of June 30, 1994.
- 266 -
3. Summary of Proposed Values and Court’s Determinations of Values of Interests
in Black Hills Trucking
Value as of Book value Statutory Kimball reports Final Lax Respondent’s Court’s
June 4, 1994 reported on notice report position values
return value Guideline co. NAV method
Entity Value
(Controlling Basis) N/A N/A N/A $10,933,730 $10,933,730 $10,933,730 $10,933,730
Less: Minority (1,093,373)
Discount N/A N/A N/A 10% N/A N/A N/A
Marketable Minority
Value N/A N/A $5,953,417 9,840,357 N/A N/A N/A
Less: Marketability (2,679,038) (4,428,161) (2,186,746)
Discount N/A N/A 45% 45% N/A N/A 20%
Nonmarketable Minority
Value N/A N/A 3,274,379 5,412,196 N/A N/A 8,746,984
Value of 58.16% 30% 70%
Interest Owned at
Dave True’s Death 951,467 6,359,055 2,774,727 3,179,5301 6,359,057 5,087,246
1
Mr. Lax applied a 50-percent reduction to controlling marketable equity value to arrive at the value of
the subject interest. He did not consider the reduction to be a marketability discount.
- 267 -
Value as of Book value Statutory Kimball reports Final Respondent’s Court’s
June 30, 1994 reported notice Guideline NAV Method Lax position values
on return value co. report
Entity Value
(Controlling
Basis) N/A N/A N/A $10,933,730 N/A $10,933,730 $10,933,730
Less: Minority (1,093,373) (1,093,373)
Discount N/A N/A N/A 10% N/A N/A 10%
Marketable Minority
Value N/A N/A $5,953,417 9,840,357 N/A N/A 9,840,357
Less: Marketability (2,679,038) (4,428,161) (2,952,107)
Discount N/A N/A 45% 45% N/A N/A 30%
Nonmarketable
Minority Value N/A N/A 3,274,379 5,412,196 N/A N/A 6,888,250
Value of 37.63% 30% 70%
Interests (total)
Transferred to
True Sons 590,511 4,147,164 1,795,271 N/A 4,114,363 2,952,048
- 268 -
E. True Ranches
1. Marketable Minority Interest Values
a. H&H Report
Hall and Hall Mortgage Corp. (H&H) prepared a detailed
appraisal of land and improvements owned by True Ranches as of
January 1, 1993, and June 3, 1994.76 Mr. Hall and his colleagues
gathered data from local sources, including ranch owners,
government offices, other appraisers, and real estate agents.
They also personally inspected the True Ranches properties and
examined comparable sales. Mr. Hall concluded that the highest
and best use of True Ranches’ property was its current use as an
integrated commercial livestock range and finishing operation.
Mr. Hall found the cost approach to be the most reliable
measure of fair market value for True Ranches’ land and
improvements; however, he also used the income and sales
comparison approaches to corroborate his cost approach values.
Mr. Hall explained that the term “cost approach” was misleading,
because even though the method valued improvements based on
estimated replacement cost, it valued land based on comparable
sales.
76
H&H conducted a full appraisal of the subject property as
of June 3, 1994. The H&H report stated that fair market value
did not change between June 3 and June 4, 1994. Mr. Hall
adjusted the June 3, 1994, value to reflect fair market value as
of Jan. 1, 1993, rather than conducting another full appraisal.
These adjustments took into account property acquisitions and
inflation in land values between the two valuation dates.
- 269 -
After computing the total value of land and improvements
under the cost approach, Mr. Hall then reduced this value by a
20-percent size adjustment. Relying on market data, Mr. Hall
concluded that large or noncontiguous parcels of land generally
sold for lower prices per acre. The majority of the available
data used in the cost approach related to sales of relatively
small parcels of land (generally less than 20,000 deeded acres).
However, True Ranches’ land holdings consisted of large, mostly
noncontiguous parcels (approximately 265,000 total deeded acres).
Thus, Mr. Hall applied the 20-percent size adjustment to
eliminate this disparity.
To check the reasonableness of the size adjustment, Mr. Hall
compared the computed per acre value (after size adjustment) of
True Ranches’ largest parcel (Plains Rangeland--183,990 deeded
acres) to the three largest actual sales for which data was
available (each comprising over 30,000 deeded acres) and
concluded that the per acre values were within a reasonable range
of each other. To further support his discount, Mr. Hall cited a
publication prepared by the University of Wyoming, which stated
that in the mid-1990's, ranches of 600 animal units sold for 16
percent less than ranches with 300 to 400 animal units. True
Ranches’ estimated capacity was 12,500 animal units. Finally,
Mr. Hall testified that the 20-percent size adjustment did not
represent a discount for lack of marketability of the land and
improvements.
- 270 -
b. Kimball Reports
Mr. Kimball used the net asset value method to compute
controlling equity value of True Ranches. The company’s major
assets included land and improvements, machinery and equipment,
and feed and livestock inventories. Mr. Kimball relied on the
following appraisals to derive the company’s net asset value:
(1) Land and improvements appraisal prepared by H&H as of
January 1, 1993, and June 3, 1994, (2) machinery and equipment
appraisal prepared by Don Helberg as of June 1994, and (3) feed
and livestock inventories appraisal prepared by the
superintendent of True Ranches as of January 1, 1993, and June 4,
1994. With this information, Mr. Kimball adjusted True Ranches’
book value balance sheet to reflect the fair market value of
assets and liabilities and calculated an adjusted net asset value
of $41,003,000 as of January 1, 1993, and $45,297,509 as of
June 4 and June 30, 1994.
Mr. Kimball then applied a 25-percent minority discount,
reflecting the subject interests’ lack of control, to arrive at a
marketable minority value of $30,752,250 as of January 1, 1993,
and $33,973,132 as of June 4 and June 30, 1994.
c. Final Lax Report
The final Lax report also used the net asset value method to
value True Ranches’ total equity, generally relying on the same
asset appraisals used in preparing the Kimball reports. However,
Mr. Lax adjusted True Ranches’ balance sheet information as of
- 271 -
April 30, 1994, whereas Mr. Kimball adjusted the June 4, 1994,
balance sheet. As a result, the final Lax report arrived at a
net asset value as of June 3, 1994, of $44,643,191, which was
slightly lower than the amount computed by Mr. Kimball.
Next, Mr. Lax applied a combined minority and marketability
discount from net asset value of 60 percent. He derived the
combined discount by examining three published studies containing
economic and market price information on publicly registered real
estate partnerships that traded in secondary markets. According
to the final Lax report, the studies showed that partnerships
owning income producing properties but not making regular cash
distributions sold at average combined discounts of 43 percent in
1992, 51 percent in 1993, and 76 percent in 1994.
Mr. Lax noted that the combined discounts reported in the
studies reflected the lack of control of limited partners over
partnership distributions and liquidation. He explained that the
same lack of control applied to limited partners in private
partnerships. In addition, Mr. Lax found that private
partnerships were less marketable than the study partnerships,
because private partnerships did not trade on an informal
secondary market. He also observed that private partnerships
often placed burdensome transfer restrictions on ownership
interests.
On the basis of the foregoing, Mr. Lax concluded that
general partnership interests in True Ranches were similar to the
- 272 -
limited partnership interests reported in the studies. However,
he found that True Ranches interests were less liquid than the
reported partnerships because True Ranches had not made recent
distributions as of the valuation date and the interests were not
publicly traded. Thus, Mr. Lax chose a 60-percent combined
discount to reflect the increasing trend of average discounts
reported in the studies.
d. Respondent’s Position
Respondent offered no expert testimony or other evidence
regarding True Ranches’ total equity value as of the relevant
dates. Instead, respondent has adopted Mr. Kimball’s adjusted
net asset values of $41,003,000 as of January 1, 1993, and
$45,297,509 as of June 4 and June 30, 1994.
Respondent argues that interests in True Ranches transferred
individually by Dave and Jean True to their sons as of January 1,
1993, and June 30, 1994, respectively, were entitled to minority
discounts of no more than 10 percent. Additionally, respondent
argues that the 38.47-percent interest owned by Dave True at
death is not entitled to a minority discount, because it
represented a significant ownership block that had swing vote
potential.
Based on the foregoing, respondent proposes marketable
minority values for the True Ranches interests transferred as of
January 1, 1993, and June 30, 1994, of $36,902,700 and
$40,767,758, respectively. Respondent argues that the marketable
- 273 -
controlling value for the interest valued as of Dave True’s death
was $45,297,509.
e. Court’s Analysis
The positions of the parties and the Court’s determinations
of the marketable minority values of True Ranches’ total equity
at each of the valuation dates are summarized infra pp. 278-279.
We accept the agreement of the parties that controlling
equity value on a net asset value basis was $41,003,000 as of
January 1, 1993, and $45,297,509 as of June 4 and June 30, 1994.
However, we reject the parties’ proposed minority discounts.
Mr. Kimball derived a 25-percent minority discount from studies
of premiums offered during tenders for control of publicly traded
companies. He found that the observed average control premiums
of 30 to 40 percent translated into minority discounts of 23 to
29 percent. We find this analysis to be unhelpful because a
general partner in True Ranches would exert more control over the
business than a shareholder in a comparable public company. The
True Ranches partnership agreement required the partners to
manage jointly the partnership’s affairs. Thus, each partner had
an equal vote in (among other things) appointing management,
setting business policies, making distributions, buying and
selling assets, and amending the partnership agreement. A
minority shareholder could not exercise equivalent control over a
public company.
- 274 -
Similarly, we reject Mr. Lax’s combined 60-percent minority
and marketability discount, because the studies that he relied on
dealt with transactions in limited partnership interests, not
general partnership interests.
We find respondent’s proposed 10-percent minority discounts
for interests transferred by Dave and Jean True to be
unsubstantiated and insufficient. Even though a general partner
in True Ranches may exert more control than a shareholder in a
public company or a limited partner in a publicly registered
partnership, he would not have unilateral control over business
decisions. Further, we reject respondent’s swing vote argument
regarding Dave True’s 38.47-percent interest owned at death, for
the reasons stated in our analysis of True Oil. See supra pp.
202-203.
Based on the record, we apply a 15-percent minority discount
to the controlling equity values computed by Mr. Kimball to
arrive at a marketable minority value for True Ranches of
$34,852,550 as of January 1, 1993, and $38,502,883 as of June 4,
and June 30, 1994.
2. Marketability Discounts
a. Kimball Reports
Mr. Kimball treated the subject interests in True Ranches as
not being readily marketable for the same reasons described in
the True Oil section of this opinion. See supra pp. 204-206.
Accordingly, Mr. Kimball applied 35-percent marketability
- 275 -
discounts to the marketable minority values as of January 1,
1993, June 4, 1994, and June 30, 1994.
b. Final Lax Report
As previously described, see supra p. 271, Mr. Lax applied a
combined minority and marketability discount from net asset value
of 60 percent. Thus, Mr. Lax’s nonmarketable minority value as
of June 3, 1994, was $6,869,694.77
c. Respondent’s Position
Respondent argues that the size adjustment applied by Mr.
Hall to value True Ranches’ land and improvements reflected the
difficulties associated with marketing such a large ranch.
Respondent contends that the marketability discounts applied my
Messrs. Kimball and Lax incorporated similar considerations.
Therefore, respondent concludes that the marketability discounts
in the Kimball and Lax reports are redundant and allows no
marketability discounts in valuing the subject interests in True
Ranches.
d. Court’s Analysis
We reject Mr. Kimball’s justifications for marketability
discounts that derive from the buy-sell agreement restrictions.
We also reject respondent’s argument that any marketability
discount used to determine the fair market value of an interest
77
Due to a computational error, the final Lax report
incorrectly computed the nonmarketable minority value to be
$7,084,370.
- 276 -
in True Ranches would replicate the size adjustment employed to
determine the underlying value of True Ranches’ net assets.
First, Mr. Hall’s size adjustment under the cost approach was
required to account for substantial differences in size between
the comparable sales and the True Ranches properties being
analyzed. Second, marketability discounts measure the
probability of selling goods at specified terms based on the
demand for those goods and the existence of an established
market. See Estate of Jameson v. Commissioner, T.C. Memo. 1999-
43, 77 T.C.M. 1383, 1397, 1999 T.C.M. (RIA) par. 99,043, at
269-99. Because the subject interests do not have the ability to
liquidate, we focus on the marketability of general partnership
interests in True Ranches. The fact that the underlying asset
values incorporate a size adjustment has no bearing on whether
there is demand for or an active market in True Ranches
partnership interests.
We find that a minority interest in True Ranches was not
fully marketable at the valuation dates because: (1) The True
family was committed to keeping True Ranches privately owned;
(2) there were risks that a purchaser would not obtain unanimous
consent to be admitted as a partner; and (3) a purchasing partner
would be exposed to joint and several liability.
A minority interest in True Ranches suffered from the same
marketability problems as an equivalent interest in True Oil.
Both companies incurred losses in the years being examined, and
- 277 -
neither company made substantial distributions to partners.
Accordingly, we apply the same 30-percent marketability discount
to True Ranches that we applied to True Oil. See supra pp. 213-
214.
- 278 -
3. Summary of Proposed Values and Court’s Determinations of Values of Interests
in True Ranches
Value as of Book value Statutory Kimball Final Lax Respondent’s Court’s values
January 1, 1993 reported on notice value reports report position
return
Entity Value
(Controlling Basis) N/A N/A $41,003,000 N/A $41,003,000 $41,003,000
Less: Minority (10,250,750) (4,100,300) (6,150,450)
Discount N/A N/A 25% N/A 10% 15%
Marketable Minority
Value N/A N/A 30,752,250 N/A 36,902,700 34,852,550
Less: Marketability (10,763,288) (10,455,765)
Discount N/A N/A 35% N/A N/A 30%
Nonmarketable
Minority Value N/A N/A 19,988,962 N/A N/A 24,396,785
Value of 24.84%
Interests
Transferred to True
Sons 3,265,647 12,193,990 4,965,258 N/A 9,166,631 6,060,161
Value as of
June 4, 1994
Entity Value
(Controlling Basis) N/A N/A 45,297,509 44,643,191 45,297,509 45,297,509
Less: Minority (11,324,377) (26,785,915) (6,794,626)
Discount N/A N/A 25% 60%1 N/A 15%
Marketable Minority
Value N/A N/A 33,973,132 N/A N/A 38,502,883
Less: Marketability (11,890,596) (11,550,865)
Discount N/A N/A 35% N/A N/A 30%
Nonmarketable
Minority Value N/A N/A 22,082,536 17,857,276 N/A 26,952,018
Value of 38.47%
Interest Owned at
Dave True’s Death 5,777,943 20,283,447 8,495,152 6,869,694 17,425,952 10,368,441
1
Combined minority and marketability discount
- 279 -
Value as of Book value Statutory Kimball Final Lax Respondent’s Court’s
June 30, 1994 reported notice value reports report position values
on return
Entity Value
(Controlling
Basis) N/A N/A $45,297,509 N/A $45,297,509 $45,297,509
Less: Minority (11,324,377) (4,529,751) (6,794,626)
Discount N/A N/A 25% N/A 10% 15%
Marketable
Minority Value N/A N/A 33,973,132 N/A 40,767,758 38,502,883
Less: Marketability (11,890,596) (11,550,865)
Discount N/A N/A 35% N/A N/A 30%
Nonmarketable
Minority Value N/A N/A 22,082,536 N/A 40,767,758 26,952,018
Value of 17.23%
Interests (total)
Transferred to
True Sons 2,712,212 9,084,581 3,804,821 N/A 7,024,285 4,643,833
- 280 -
F. White Stallion
1. Marketable Minority Interest Values
a. Kimball Report
Mr. Kimball used the net asset value method to compute
controlling equity value of White Stallion. He relied on an
appraisal of land and improvements performed by Jeffery C. Patch
as of June 9, 1991, to derive the company’s underlying asset
value. With this information, Mr. Kimball adjusted White
Stallion’s June 4, 1994, balance sheet to reflect the fair market
value of assets and liabilities and calculated adjusted net asset
value of $1,138,698.78
Mr. Kimball then applied a 20-percent minority discount to
reflect the subject interest’s lack of control. Mr. Kimball
concluded that the marketable minority value of White Stallion as
of June 4, 1994, was $910,958.
b. Initial and Final Lax Reports
The initial and final Lax reports also used the net asset
value method to value White Stallion’s total equity, relying on
the same asset appraisal used in the Kimball report. Mr. Lax
adjusted White Stallion’s balance sheet as of April 30, 1994, to
arrive at net asset value of $1,139,080 as of June 3, 1994.
78
Mr. Kimball’s calculations contained a mathematical error.
Adjusted net asset value should have been $1,139,000.
- 281 -
In the initial Lax report, Mr. Lax applied a 25-percent
minority discount to net asset value, along with a 45-percent
marketability discount.
In the final Lax report, however, Mr. Lax applied a combined
minority and marketability discount from net asset value of 60
percent. He explained that the combined discount was derived
from the studies described in the True Ranches section of this
opinion. See supra p. 271. Mr. Lax considered the subject
interests to be less marketable than the interests in the studies
because White Stallion had no history of paying dividends and
there was no active market for investments of this type.
c. Respondent’s Position
Respondent offered no expert testimony or other evidence
regarding White Stallion’s total equity value as of June 4, 1994.
Instead, respondent adopts Mr. Lax’s net asset value of
$1,139,080.
Respondent argues that the 34.235-percent interest owned by
Dave True at death is not entitled to a minority discount,
because it represented a significant ownership block that had
swing vote potential.
d. Court’s Analysis
The positions of the parties and the Court’s determinations
of the marketable minority values of White Stallion’s total
equity are summarized infra p. 287.
- 282 -
We accept the agreement of the parties that controlling
equity value on a net asset basis was $1,139,080 as of June 3,
1994. However, we reject respondent’s swing vote argument, for
the reasons stated in our analysis of True Oil. See supra pp.
202-203.
We find the final Lax report’s combined discount of 60
percent to be excessive and unsubstantiated. Mr. Lax solely
relied on sales of registered real estate limited partnership
interests as benchmarks for the discount he applied to White
Stallion. However, we do not believe that registered real estate
limited partnerships are comparable to White Stallion, an
operating dude ranch organized as an S corporation. Further, we
cannot evaluate the reasonableness of the final Lax report’s
minority discount relative to Mr. Kimball’s, because of Mr. Lax’s
combined discount approach. We are not convinced that using a
combined discount is appropriate, inasmuch as marketability and
minority discounts are conceptually distinct. See Estate of
Newhouse v. Commissioner, 94 T.C. at 249.
The final Lax report did not discuss the requirements for
control under Arizona law or White Stallion’s governing documents
before concluding that Dave True’s interest lacked control. In
addition, Mr. Lax did not provide a theoretical basis for his
change in approach to calculating discounts (going from separate
to combined discounts) between the initial and final Lax reports.
This makes Mr. Lax’s conclusions seem arbitrary.
- 283 -
Similarly, Mr. Kimball generally based his 20-percent
minority discount on data from studies of premiums offered during
tenders for control of publicly traded companies. He also did
not consider the specific control attributes of White Stallion
stock to arrive at the minority discount.
Unless the articles of incorporation provide otherwise,
Arizona corporate law requires the following, in relevant part:
(1) Each outstanding share of stock is entitled to one vote, see
Ariz. Rev. Stat. Ann. sec. 10-721(A) (West 1996);79 all corporate
powers are exercised by the board of directors, see Ariz. Rev.
Stat. Ann. sec. 10-801(B) (West 1996); (3) directors are elected
by a plurality of votes cast by shares entitled to vote, see
Ariz. Rev. Stat. Ann. sec. 10-728(A) (West 1996); (4) sales of
assets other than in the regular course of business must be
approved by a majority of all votes cast by shares entitled to
vote, see Ariz. Rev. Stat. Ann. sec. 10-1202(E) (West 1996); (5)
dissolution of the corporation must be approved by a majority of
all votes cast by shares entitled to vote, see Ariz. Rev. Stat.
Ann. sec. 10-1402(E) (West 1996).
White Stallion’s articles of incorporation and bylaws were
not introduced in evidence. Therefore, we assume that White
Stallion’s governing documents do not vary from Arizona corporate
79
Title 10, Corporations and Associations, was reorganized
by 1994 Ariz. Sess. Laws ch. 223 (effective Jan. 1, 1996). The
sections cited in our discussion were not substantively changed
but were renumbered by the new law.
- 284 -
law. At his death, Dave True’s 34.235-percent interest did not
represent a majority of the shares entitled to vote. Thus it did
not give him the power to sell corporate assets or to dissolve
the corporation entirely. However, it could have given him a
plurality in electing board members, which would have allowed him
to influence distribution policies.
On this record, we find that a 15-percent minority discount
is appropriate for Dave True’s interest in White Stallion.
2. Marketability Discounts
a. Kimball Report
Mr. Kimball treated the subject interest in White Stallion
as not being readily marketable for the same reasons described in
the Belle Fourche section of this opinion. See supra pp. 233-
234. Accordingly, Mr. Kimball applied a 35-percent marketability
discount to arrive at nonmarketable minority value of $592,123 as
of June 4, 1994.
b. Initial and Final Lax Reports
As previously described, see supra pp. 280-281, the initial
Lax report showed a 45-percent marketability discount, whereas
the final Lax report indicated a combined minority and
marketability discount of 60 percent. Thus, nonmarketable
minority values derived by the initial and final Lax reports as
of June 3, 1994, were $160,860 and $155,986, respectively.80
80
The final Lax report incorrectly computed the
(continued...)
- 285 -
c. Respondent’s Position
Respondent argues that no marketability discount is
appropriate for Dave True’s 34.235-percent interest in White
Stallion because it represented a significant ownership block
that had swing vote potential.
d. Court’s Analysis
We reject Mr. Kimball’s justifications for marketability
discounts that derive from the buy-sell agreement restrictions.
We also reject respondent’s swing vote argument for the
reasons stated in our analysis of True Oil, see supra pp. 202-
203, and Mr. Lax’s combined discount approach for reasons stated
supra p. 282.
We find that a minority interest in White Stallion, like a
minority interest in Belle Fourche, was less marketable than
actively traded interests because: (1) The two branches of the
True family are committed to keeping White Stallion privately
owned; (2) the subject interest lacks control; and (3) Federal
tax rules limit the pool of potential investors in S corporation.
Moreover, certain facts suggest that a minority interest in White
Stallion would be less marketable than a minority interest in
Belle Fourche. Although White Stallion was modestly profitable,
it was not a “cash cow” like Belle Fourche. Also, White Stallion
80
(...continued)
nonmarketable minority value to be $160,860 due to a math error
that arose from Mr. Lax’s change in discount approaches between
the initial and final Lax reports.
- 286 -
made no distributions to shareholders during the analyzed period.
Instead, shareholders lent or contributed funds to the company.
On the basis of the foregoing, we conclude that a minority
interest in White Stallion is less marketable than a minority
interest in Belle Fourche. Therefore, we assign a 30-percent
marketability discount to Dave True’s 34.235-percent interest in
White Stallion, valued as of June 4, 1994.
- 287 -
3. Summary of Proposed Values and Court’s Determinations of Values of Interests
in White Stallion
Value as of Book value Statutory Kimball Final Lax Respondent’s Court’s values
June 4, 1994 reported on notice value reports report position
return
Entity Value
(Controlling Basis) N/A N/A $1,138,698 $1,139,080 $1,139,080 $1,139,080
Less: Minority (227,740) (683,448) (170,862)
Discount N/A N/A 20% 60%1 N/A 15%
Marketable Minority
Value N/A N/A 910,958 N/A N/A 968,218
Less: Marketability (318,835) (290,465)
Discount N/A N/A 35% N/A N/A 30%
Nonmarketable Minority
Value N/A N/A 592,123 455,632 N/A 677,753
Value of 34.235%
Interest Owned at
Dave True’s Death 153,434 389,964 202,713 155,986 389,964 232,029
1
Combined minority and marketability discount
- 288 -
Issue 3. Did Jean True Make Gift Loans When She Transferred
Interests in True Companies to Sons in Exchange for Interest-Free
Payments Received Approximately 90 Days After Effective Date of
Transfers?
On June 30, 1994, and July 1, 1994 (hereinafter sometimes
referred to as the notice dates), Jean True gave notice to her
sons that she wanted to sell her interests in 22 True companies.
The buy-sell agreements governing transfers of interests in the
companies provided that, upon giving this notice, Jean True
became required to sell, and the sons became required to buy, her
interests.
The buy-sell agreements also provided that the “effective
date[s]” of the resulting sales were the notice dates. From and
after June 30, 1994, the True companies treated the income and
expenses associated with the interests sold as belonging to the
sons, not to Jean True. Moreover, the sales prices for Jean
True’s interests were not adjusted for any income or loss of,
distributions made by, or changes in the value of the True
companies, after June 30, 1994.
Notwithstanding the foregoing, the buy-sell agreements gave
the sons 6 months from the notice dates to “consummate” the
sales. Jean True did not receive payment for her interests until
September 30, 1994, 3 months after the notice dates. The total
amount she received, $13,298,978, did not include any interest to
compensate her for this 3-month delay.
- 289 -
Respondent determined in the gift tax statutory notice to
Jean True that this deferred payment arrangement was a “below-
market gift loan” subject to section 7872, which gave rise to a
taxable gift from Jean True to her sons, in the amount of
$192,307. Petitioners dispute this determination.
FINDINGS OF FACT
In 1994, Jean True sold her interests in 22 True companies
to her sons.81 Five of the companies were partnerships, one was
a limited liability company (LLC), and 16 were corporations. All
the corporations were S corporations, except for Midland
Financial Corp., which was a C corporation.
Substantially identical buy-sell agreements governed
transfers of interests in these companies. The buy-sell
agreements were contained in partnership agreements (partnership
buy-sell agreements) and in stockholders’ restrictive agreements
(corporate buy-sell agreements).
The buy-sell agreements were triggered when Jean True gave
her sons notice of her intention to sell her interests. Jean
True gave notice of her intention to sell her stock in the 16
corporations on June 30, 1994. She gave notice of her intention
to sell her interests in the five partnerships and the LLC on
July 1, 1994.
81
See Appendix schedule 3 for a list of these companies.
- 290 -
Once triggered by Jean True’s notice, the buy-sell
agreements required Jean True to sell, and her sons to purchase,
her interests. Each of the buy-sell agreements provided that the
“effective date” of the resulting sale was the applicable notice
date.
Although the buy-sell agreements defined the effective dates
of Jean True’s sales as the notice dates, other provisions of the
buy-sell agreements required only that the “sale and purchase” of
stock or partnership interests “be consummated” within 6 months
after those dates. In fact, Jean True did not receive payment
for her stock and partnership interests until September 30, 1994
(payment date).
The record does not establish exactly what happened on or
around the payment date, other than the receipt of payment by
Jean True. It appears that the reissuance of stock certificates
to the sons was authorized by the corporations’ boards of
directors on September 29, 1994. However, the minutes of the
board meetings authorizing this action refer to “the transfer of
the shares formerly owned” by Jean True, and state that
“appropriate action should be taken * * * to accept and
acknowledge the transfer of ownership that occurred effective
June 30, 1994". The accompanying board resolutions similarly
discuss the “sale and transfer effective June 30, 1994" of “the
shares previously held” by Jean True.
- 291 -
Each of the buy-sell agreements also contained a provision
entitled “Further Assurances”. The further assurances provision
of the partnership buy-sell agreements stated:
Before any retiring Partner, former Partner, or other
person selling his interest shall be entitled to receive
any money in payment of or on account of his partnership
interest * * * he shall deliver or cause to be delivered
to the remaining Partners such instruments as the
remaining Partners may reasonably request in order to
establish a record that the retiring Partner or a former
Partner’s interest in the partnership has passed to and
become vested in the remaining Partners.
The further assurances provision of the corporate buy-sell
agreements stated that each of the stockholders and the relevant
corporation agrees “to make, execute and deliver to the other
parties all assignments, transfers or other documents necessary
to carry out and accomplish the terms” of the corporate buy-sell
agreements. However, the corporate buy-sell agreements did not
state that the seller was not entitled to receive payment until
she supplied whatever documents were required.
The buy-sell agreements required Jean True’s sales to be
made at formula prices based on book value. The price provision
of the partnership buy-sell agreements provided that “The price
of any partnership interest or portion thereof shall be the book
value of the Selling Partner’s capital account as of the close of
business of the day immediately preceding the sales event.” Jean
True’s giving notice of her intention to sell was the sales
event. The partnership buy-sell agreements therefore provided
that the price for Jean True’s sale of a partnership interest was
- 292 -
equal to the book value of her capital account in that
partnership as of the close of business on June 30, 1994, the day
before the day she gave notice of her intent to sell her
partnership interests.
The corporate buy-sell agreements provided:
The price of any shares sold hereunder shall be the book
value of the stock at the end of the preceding fiscal
year, less any and all dividends paid to the
Shareholders prior to the effective date of sale, plus
income computed in accordance with the Internal Revenue
regulations generally requiring allocation on a per
share, per day basis.
As applied to Jean True’s 1994 sales, the corporate buy-sell
agreements therefore provided that the sale price of stock was
equal to: (1) The book value of that stock as of the end of the
corporation’s fiscal year preceding June 30, 1994, minus (2) the
dividends (if any) paid from the end of that fiscal year to
June 30, 1994, plus (3) a pro rata share of the corporation’s
income for the fiscal year including June 30, 1994.
As shown by the foregoing citations to the buy-sell
agreements, the agreements did not provide for any adjustments to
be made to the formula prices on account of the income or loss
of, the dividends paid or distributions made by, or any change in
the value of a True company, after June 30, 1994.82
82
Although the buy-sell agreements did not provide for any
price adjustments to be made on account of the True companies’
financial performance after June 30, 1994, the price paid for
some of Jean True’s stock may have been affected by post-June 30,
1994, events. The corporate buy-sell agreements required the
preceding fiscal year’s ending book value to be increased by a
(continued...)
- 293 -
The buy-sell agreements also did not provide for any
interest to be paid on the sales price on account of any passage
of time between the effective dates of the sales and the date
payment was ultimately made.
From and after June 30, 1994, the 22 True companies
considered the income and expenses associated with the interests
sold by Jean True to belong to her sons, not to Jean True.
Moreover, the True companies filed their Federal income tax
returns consistently with this consideration. For example, as
part of its Federal partnership return (Form 1065) for 1994, True
Oil filed three Forms 8308, “Report of a Sale or Exchange of
Certain Partnership Interests”; these forms reported that the
“Date of Sale or Exchange of Partnership Interest” with respect
to Jean True’s sale of her interest in True Oil was June 30,
82
(...continued)
pro rata share of the corporation’s income for the year of sale,
computed in accordance with the Internal Revenue laws.
Sec. 1377(a)(1) provides that a stockholder’s pro rata share
of S corporation income for a taxable year is calculated by
allocating an equal portion of the corporation’s items to each
day in the year. Under this method, a selling shareholder’s pro
rata share of income for the year of sale will be affected by
corporate items realized after the sale date, because a portion
of such items will be allocated to her period of ownership. Sec.
1377(a)(2), however, provides that under certain circumstances
the shareholders may elect to compute the selling shareholder’s
pro rata share as if the taxable year terminated on the sale
date.
It appears that the True family made the election to compute
Jean True’s pro rata share of income as if the corporation’s
taxable year ended on June 30, 1994, with respect to some (but
not all) of the 15 S corporations in which she sold her stock.
- 294 -
1994. True Oil’s 1994 return also contained schedules showing
that after June 30, 1994, Jean True owned a zero percent share of
True Oil’s income, deductions, losses, credits, capital account,
and other items. Similarly, Belle Fourche’s Federal tax return
(Form 1120S) for 1994 contains a schedule of changes in
ownership; that schedule showed that Jean True owned no Belle
Fourche stock after June 30, 1994.
The amount of the payment Jean True received on the payment
date (September 30, 1994) in exchange for her interest in a True
company was equal to the formula price of that interest as
determined under the corresponding buy-sell agreement. The
parties agree that the prices of Jean True’s interests as
determined under the buy-sell agreements, and the amounts
received by Jean True on the payment date in exchange for those
interests, were as shown in the following table:
- 295 -
Formula price and amount
Entity received on payment date
True Oil $2,528,315
Eighty-Eight Oil 4,400,744
True Ranches 2,712,212
Rancho Verdad 226,759
True Mining Co. 176
True Environmental Remediating 205,886
LLC
Belle Fourche 183,593
Black Hills Trucking 590,511
Midland Financial Corp. 2,226,338
Toolpushers Supply Co. 137,872
Black Hills Oil 60
Bonanza Publishing, Inc. 395
Clareton Oil Co. 58
Equitable Oil Purchasing Co. 2,304
Fire Creek Oil Co. 1,193
Pumpkin Buttes Oil Co. 51
Roughrider Pipeline Co. 55,208
Sunlight Oil Co. 57
True Geothermal Drilling Co. 111
True Wyoming Beef 638
Wind River Oil Co. 59
True Land and Royalty Co. 26,438
Total 13,298,978
Respondent has conceded that the fair market value, as of
June 30, 1994, of the interests sold by Jean True did not exceed
the formula prices of those interests, except in the case of the
- 296 -
following companies: True Oil, Eighty-Eight Oil, True Ranches,
Belle Fourche, and Black Hills Trucking.
As a result of Dave True’s death on June 4, 1994, Jean True
acquired part of the stock and partnership interests she
ultimately sold to her sons. Dave True’s death triggered the
buy-sell agreements and required Jean True and the sons to buy
the interests formerly held by Dave True.
The sales of stock triggered by Dave True’s death apparently
were not formally closed until about September 20, 1994.
Although the record does not establish precisely what happened on
September 20, 1994, it appears that the reissuance of stock
certificates to reflect the transfer of ownership from Dave True
to Jean True and the sons was authorized on that date. However,
the buy-sell agreements defined the effective date of these
transfers as the date of Dave True’s death. Consistent with this
definition, the minutes of the board meetings concerning the
reissuance of Dave True’s stock treat Dave True’s death as the
date ownership of the stock was transferred to Jean True and the
sons.83
On a schedule attached to Jean True’s amended Federal gift
tax return for 1994, Jean True reported the 1994 sales of her
interests to her sons as gifts with a “Value at date of gift” of
83
Respondent has not determined or otherwise asserted that
any gift loans resulted from the sales triggered by Dave True’s
death on June 4, 1994, even though some of those sales may not
have been formally closed until Sept. 20, 1994.
- 297 -
zero. This schedule reported the “Date of gift” as June 30,
1994.
In the statutory notice, respondent determined, without
citing any authority, that the value of the gift Jean True made
by lending her sons the sales price from June 30, 1994, to the
payment date was $192,307. The notice explained that this amount
was equal to 91 days of interest on the $13,298,978 aggregate
sales price, calculated using the 5.9-percent interest rate the
True family used for other intrafamily loans. Although the
notice stated that “Arguably, the 5.9% is below-market”, it also
stated that “no adjustment will be made for this due to the
extreme difficulty of computing it”. The notice did not cite any
authority for these conclusions.
OPINION
I. Summary of Arguments
On June 30, 1994, and July 1, 1994 (notice dates), Jean True
gave her sons notice that she wanted to sell her interests in 22
True companies. This notice triggered the provisions of the buy-
sell agreements that required Jean True to sell her interests to
her sons.
The buy-sell agreements provided that the effective dates of
these sales were the notice dates. However, the buy-sell
agreements also stated that the sales did not have to “be
consummated” until 6 months after those dates. In fact, Jean
True did not receive payment for her interests until September
- 298 -
30, 1994, 3 months after the notice dates. We hereinafter refer
to the deferred payment of the sales price for Jean True’s
interests, pursuant to the provisions of the buy-sell agreements
giving the parties up to 6 months to “consummate” the sales, as
the deferred payment arrangement.
The amount Jean True received on the payment date,
$13,298,978, was equal to the sum of the formula prices for the
interests she sold, calculated as provided in the buy-sell
agreements. This sum did not include any stated interest or any
other adjustments to take account of the 3-month period between
the notice dates and the payment date.
Respondent asserts that the sales of Jean True’s interests
were completed for tax purposes on June 30, 1994, because the
benefits and burdens of ownership were transferred on that date.
Respondent further asserts that because the deferred payment
arrangement allowed 3 months to pass between the sale completion
date and the payment date, Jean True effectively lent her sons
(during that 3-month period) an amount equal to the $13,298,978
sales proceeds she was entitled to receive. Finally, respondent
asserts that this loan was in the nature of a gift, and that Jean
True therefore made a taxable gift to her sons of the value of
the use of the sale proceeds from June 30, 1994, to September 30,
1994.
Respondent has continued to assert, as determined by the
statutory notice, that the value of Jean True’s gift is $192,307.
- 299 -
However, respondent now argues that the reason for this is that
the deferred payment arrangement was a “below-market loan”
subject to section 7872. Sec. 7872(c)(1)(A). Notwithstanding
this new argument, respondent does not explain why the True
family’s 5.9-percent intrafamily interest rate used to calculate
the value of Jean True’s gift in the statutory notice should
apply, rather than the “applicable Federal rate” expressly
referenced by section 7872(e), (f)(1), and (f)(2).
Petitioners make three arguments why the deferred payment
arrangement was not a gift loan. First, petitioners argue that
the sales of Jean True’s interests were completed for tax
purposes on September 20, 1994, instead of on June 30, 1994, as
asserted by respondent. According to petitioners, Jean True was
not entitled to receive the sales proceeds–-and therefore could
not have lent them to her sons–-until the sales were complete.84
Second, petitioners argue that the deferred payment
arrangement cannot be a below-market loan subject to section 7872
because: (1) If the deferred payment arrangement were a
“contract for the sale or exchange of any property” within the
84
Petitioners do not explain why Sept. 20, 1994, is the
relevant date. However, we note that Jean True’s acquisition
(from Dave True) of some of the stock she ultimately sold to her
sons appears to have been closed on that date.
Petitioners also do not explain why, if Sept. 20, 1994, was
the sale completion date, Jean True could not have made a below-
market gift loan from that date to the payment date on Sept. 30,
1994.
- 300 -
meaning of section 483, no portion of the sales price would be
recharacterized as interest under that section; and (2) if the
deferred payment arrangement were a “debt instrument given in
consideration for the sale or exchange of property” within the
meaning of section 1274, no portion of the sales price would be
treated as original issue discount (OID) under that section.
Third and finally, petitioners argue that even if the
deferred payment arrangement was a “below-market loan” to which
section 7872 could apply, it was not a “gift loan” actually
subject to that section, because allowing short delays in the
payment of sales proceeds, without charging interest, is a normal
commercial practice satisfying the ordinary business transaction
exception set forth in section 25.2512-8, Gift Tax Regs.
We consider these arguments seriatim. We conclude that: (1)
The sales of Jean True’s interests were completed for tax
purposes on June 30, 1994, and July 1, 1994 (i.e., on the notice
dates, which are also the effective dates defined by the buy-sell
agreements); (2) sections 483 and 1274 do not prevent the
application of section 7872 to the deferred payment arrangement;
and (3) the deferred payment arrangement is a below-market gift
loan subject to section 7872, rather than an ordinary business
transaction.
II. Jean True’s Sales Were Completed on Notice Dates
The “Further Assurances” provisions of the partnership buy-
sell agreements stated:
- 301 -
Before any retiring Partner * * * shall be entitled to
receive any money in payment of or on account of his
partnership interest * * * he shall deliver or cause to
be delivered to the remaining Partners such instruments
as the remaining Partners may reasonably request in
order to establish a record that the retiring * * *
Partner’s interest in the partnership has passed to and
become vested in the remaining Partners.
Petitioners claim these further assurances provisions were
not satisfied until September 20, 1994, when title to Jean True’s
stock and partnership interests “vested” in her sons.85
Petitioners assert that as a result, Jean True could not have
lent her sales proceeds to her sons on June 30, 1994, as
contended by respondent-–because under the terms of the buy-sell
agreements, Jean True was not entitled to receive those proceeds
until the “vesting” date.
As a preliminary matter, we note that petitioners’ argument
on this point cites no authority and is hard to follow. However,
the thrust of petitioners’ argument appears to be that the sales
of Jean True’s interests were not completed for tax purposes
until September 20, 1994. For the reasons set forth below, we
disagree, and conclude that the sales were completed on June 30,
1994, and July 1, 1994 (the notice dates, also the effective
dates as defined by the buy-sell agreements).
First, we note that the “Further Assurances” provisions of
the corporate buy-sell agreements are different from the
85
As noted supra p. 299, it is not clear why petitioners
believe Sept. 20, 1994, is the relevant date.
- 302 -
provisions of the partnership buy-sell agreements relied upon by
petitioners. The further assurances provisions of the corporate
agreements state only that each of the stockholders and the
relevant corporation agrees “to make, execute and deliver to the
other parties all assignments, transfers or other documents
necessary to carry out and accomplish the terms” of the corporate
buy-sell agreements. However, the corporate buy-sell agreements
do not state that delivery of these documents is a condition
precedent to the right to receive payment, or to any other right
or obligation arising under the agreements.
Second, the buy-sell agreements, when read in their
entirety, show Jean True and her sons intended that a binding
contract of sale would be created on the notice dates, even
though payment was not required to be made on those dates. For
example, the partnership buy-sell agreements define the term
“sales event” to include “the events outlined in Paragraph 18 the
occurrence of which, under the terms hereof, triggers the
mandatory purchase and sale agreement.” Paragraph 18 in turn
provides that a voluntary sale is a “sales event”, and states:
In the event any Partner desires at any time to sell all
or a part of his or her partnership interest in the
Company, he or she shall so notify the Purchasing
Partners in writing. * * * Thereafter, the Selling
Partner shall sell and the Purchasing Partners shall
purchase such partnership interest in accordance with
the terms of paragraphs 19 [restating the buy-sell
agreement, and providing that purchases shall be made by
Purchasing Partners in proportion to interests already
owned], 20 [defining formula price] and 21 [defining
- 303 -
effective date as the notice date] * * * . * * *
[Emphasis added.]
Nothing in these operative provisions suggests that the buy-
sell obligations arising on the notice dates were conditioned
upon the selling partner’s compliance with the “Further
Assurances” provision. Indeed, they do not even refer to the
“Further Assurances” provision.86
Third and most importantly, the terms of the buy-sell
agreements, the conduct of the parties to those agreements, and
the actions of the True companies all show that Jean True and her
sons intended the benefits and burdens of ownership of Jean
True’s interests to shift to her sons on the notice dates.
Petitioners correctly note that Jean True did not receive
payment for her interests in the 22 True companies until
September 30, 1994. In addition, it appears that the
corporations were authorized on or around that date to reissue
the shares Jean True sold in the names of Jean True’s sons.
The record does not establish precisely what happened on or
around the payment date, other than the receipt of payment and
the reissuance of some stock certificates. However, petitioners
have not shown (or even claimed) that the sons did not take
possession of Jean True’s stock certificates, or that the
partnership records did not reflect a change in ownership, well
86
The “sales event” and “sale” provisions of the corporate
buy-sell agreements are substantially the same as the cited
provisions of the partnership buy-sell agreements.
- 304 -
before the payment date. To the contrary, the board minutes and
resolutions concerning the reissuance of stock treat June 30,
1994, as the date ownership of Jean True’s stock passed to the
sons. Similarly, Jean True’s amended 1994 Federal gift tax
return reported that the 1994 sales of her interests occurred on
June 30, 1994.
We also note that under relevant State (Wyoming) law, board
of directors’ approval and recording on the corporate books are
not conditions precedent to a valid transfer of stock ownership.
See Jones v. Central States Inv. Co., 654 P.2d 727 (Wyo. 1982).
Also, although neither party has argued that, until the payment
date, the buy-sell agreements created an incomplete gift, we note
that a stock gift may be complete before the donee receives
possession of or title to the stock. See Estate of Davenport v.
Commissioner,
184 F.3d 1176 (10th Cir. 1999), affg. T.C. Memo.
1997-390.
More generally, a sale is complete for Federal income tax
purposes when the benefits and burdens of ownership shift; this
may occur well before title passes or a formal closing of the
sale occurs. See Derr v. Commissioner, 77 T.C. 708, 723-724
(1981) (for Federal income tax purposes, sale occurs upon
transfer of benefits and burdens of ownership rather than upon
satisfaction of technical requirements for passage of title under
State law; applicable test is facts and circumstances test with
no single factor controlling); Hoven v. Commissioner,
56 T.C. 50,
- 305 -
55 (1971) (in determining date of property transfer, date on
which benefits and burdens or incidents of ownership of property
pass must be considered); Merrill v. Commissioner, 40 T.C. 66, 74
(1963) (where delivery of deed is delayed to ensure payment,
intent of parties as to when benefits and burdens of ownership
are to be transferred, as evidenced by factors other than the
passage of bare legal title, controls for tax purposes), affd.
336 F.2d 771 (9th Cir. 1964); cf. Dyke v. Commissioner,
6 T.C.
1134 (1946) (stock sale not completed until all conditions of
escrow agreement (including payment) were satisfied and stock was
actually delivered, even though buyer was entitled to
corporation’s earnings for approximately 1 month before delivery
date).
Taking into account all the facts and circumstances of the
case at hand, we conclude that Jean True and her sons intended
the benefits and burdens of ownership of Jean True’s stock and
partnership interests to pass to the sons on the notice dates;
i.e., on June 30, 1994, in the case of her stock and on July 1,
1994, in the case of her partnership (and LLC) interests. We
further conclude that the benefits and burdens of ownership in
fact shifted on those dates. These conclusions are based on the
following observations:
1. The buy-sell agreements expressly provided that the
notice dates were the effective dates of Jean True’s sales to her
sons. The buy-sell agreements also expressly provided that on
- 306 -
those dates Jean True became obligated to sell, and her sons
became obligated to buy, her interests in the 22 True companies.
2. From and after June 30, 1994, the 22 True companies
considered the income and expenses associated with the interests
sold by Jean True to belong to the sons, not to Jean True.
Moreover, the True companies filed their Federal tax returns
consistently with this observation.
3. Although the reissuance of some stock certificates to
reflect the change in ownership of Jean True’s stock was
authorized on September 29, 1994, the minutes of the board
meetings concerning this action refer to “the transfer of the
shares formerly owned” by Jean True, and state that “appropriate
action should be taken * * * to accept and acknowledge the
transfer of ownership that occurred effective June 30, 1994".
(Emphasis added.) Similarly, the accompanying board resolutions
discuss “the sale and transfer effective June 30, 1994" of “the
shares previously held” by Jean True. (Emphasis added.)87
4. The partnership buy-sell agreements provided that the
price for a partnership interest owned by Jean True was equal to
87
As noted supra p. 299, petitioners argue that Jean True’s
sales were completed for tax purposes on Sept. 20, 1994. It is
not clear why petitioners chose this date. It appears that a
formal closing of Jean True’s purchase (from Dave True) of some
of the stock she ultimately sold to her sons was held on or
around that date. However, the minutes of the Sept. 20, 1994,
board meetings authorizing the reissuance of Dave True’s stock to
Jean True treat June 4, 1994 (the date of Dave True’s death), as
the effective date of the transfer of ownership of that stock to
Jean True.
- 307 -
the book value of that interest as of the close of business on
June 30, 1994. This price was not adjusted for any income or
loss, distributions made by, or change in the value of the
partnership, for any period after June 30, 1994. As a result,
once Jean True gave notice, all she could receive in exchange for
a partnership interest was its book value as of June 30, 1994.
Jean True’s sons became entitled to the economic benefits, and
would suffer the economic burdens, flowing from the partnerships
after June 30, 1994.
5. Similarly, the corporate buy-sell agreements provided
that the price for stock owned by Jean True was based on the book
value of the stock as of the last day of the fiscal year ending
before June 30, 1994. This price was not adjusted for any income
or loss, distributions made by, or change in the value of the
related corporation, after June 30, 1994.88 As a result, once
Jean True gave notice, all she could receive for her stock was
its book value as of June 30, 1994. Jean True’s sons became
entitled to all the economic benefits, and would suffer all the
economic burdens, flowing from the stock after June 30, 1994.
88
The purchase price of stock did include a pro rata share
of the corporation’s income for the year including June 30, 1994.
With respect to some of the corporations, this pro rata share may
have reflected income realized after June 30, 1994. See supra
pp. 292-293 note 82.
- 308 -
For all these reasons, we hold that for Federal income tax
purposes Jean True sold her stock on June 30, 1994, and her
partnership (and LLC) interests on July 1, 1994.89
III. Sections 483 and 1274 Do Not Prevent Below-Market Loan
Treatment Under Section 7872
The deferred payment arrangement allowed 3 months to pass
between the dates Jean True’s sales were completed for tax
purposes and the payment date. For this reason, respondent
asserts that the deferred payment arrangement should be
considered to be a loan (from Jean True to her sons) of the
$13,298,978 sales price for that 3-month period. Because Jean
True did not charge or receive any interest on this amount,
respondent further asserts that the deferred payment arrangement
was a below-market gift loan to which section 7872 applies.
Petitioners argue that even if Jean True’s sales were
completed on the notice dates (as we have decided), section 7872
cannot apply to the deferred payment arrangement. The buy-sell
agreements required Jean True’s sales to be consummated within 6
months after the notice dates. As a result, if the deferred
payment arrangement were a “contract for the sale or exchange of
89
Respondent maintains that Jean True sold all her interests
on June 30, 1994. We disagree. Jean True did not give notice of
her desire to sell her partnership (and LLC) interests until July
1, 1994. Until she gave notice, she was not required to sell,
and her sons were not required to buy, those interests. Also,
the buy-sell agreements defined the effective date of the sale of
her interests as the notice dates. For these reasons we conclude
that the sale of Jean True’s partnership (and LLC) interests
occurred on July 1, 1994, as stated in the text.
- 309 -
any property” to which section 483 ordinarily could apply, no
portion of the sales price would be recharacterized as interest
under that section. See sec. 483(a), (c)(1) (although sec. 483
generally applies to payments made under any contract for the
sale or exchange of any property, it does not apply unless some
contract payments are due more than 1 year after the sale or
exchange). Similarly, if the deferred payment arrangement were a
“debt instrument given in consideration for the sale or exchange
of property” to which section 1274 ordinarily could apply, no
portion of the sales price would be recharacterized as original
issue discount (OID) under that section. See sec. 1274(c)(1)
(although sec. 1274 generally applies to any debt instrument
given in consideration for the sale or exchange of property, it
does not apply unless some payments under the debt instrument are
due more than 6 months after the date of the sale or exchange).
Petitioners assert that because no portion of the
$13,298,978 aggregate sales price would be recharacterized as
interest or OID under section 483 or 1274, the deferred payment
arrangement cannot be treated as a below-market loan subject to
section 7872. We disagree. In Frazee v. Commissioner, 98 T.C.
554 (1992), we considered the relationship of sections 483, 1274,
and 7872 for gift tax purposes and rejected arguments quite
similar to those made by petitioners in the case at hand.
- 310 -
The taxpayers in Frazee sold property to family members in
exchange for a note. The interest rate on the note, although
less than a market rate, was sufficient to avoid the
recharacterization of any part of the stated principal of the
note as interest under section 483. The Frazee taxpayers argued
that as a result, the note could not be a “below-market loan”
subject to section 7872. We disagreed. In our view, sections
483 and 1274 were enacted to ensure the proper characterization
of payments as principal or interest for income tax purposes. By
contrast, the key issue for gift tax purposes is the valuation of
all payments (both principal and interest). See Krabbenhoft v.
Commissioner, 94 T.C. 887, 890 (1990), affd.
939 F.2d 529 (8th
Cir. 1991). We held in Frazee that sections 483 and 1274 simply
were not relevant for that gift tax purpose.
The Commissioner’s primary position in Frazee was that the
value of the intrafamily note for gift tax purposes should be its
“present value” under section 7872 (i.e., a value determined by
reference to the applicable Federal rate), rather than its fair
market value under general tax principles (i.e., a value
determined by reference to market interest rates). Although we
found this position to be “anomalous” because it was contrary to
the traditional fair market value approach, Frazee v.
Commissioner, supra at 590, we nevertheless accepted the
Commissioner’s treatment of the intrafamily note as a below-
- 311 -
market gift loan subject to section 7872. See id.; cf. Blackburn
v. Commissioner, 20 T.C. 204 (1953).
Petitioners correctly observe that section 7872(f)(8)
provides that section 7872 does not apply to any loan to which
section 483 or 1274 applies. This prohibition is not applicable
to the case at hand. Technically, neither section 483 nor
section 1274 applies to the deferred payment arrangement, because
the buy-sell agreements required payment to be made within 6
months after the notice dates. See sec. 483(c)(1) (sec. 483 does
not apply where no payment is due more than 1 year after the sale
or exchange); sec. 1274(c)(1) (sec. 1274 only applies where at
least one payment is due more than 6 months after the sale or
exchange).
Petitioners also observe that certain proposed section 7872
regulations state that section 7872 does not apply to any loan
given in consideration for the sale or exchange of property,
within the meaning of sections 483(c)(1) and 1274(c)(1), even if
the rules of those sections do not technically apply by reason of
safe harbors or other exceptions. See sec. 1.7872-2, Proposed
Income Tax Regs., 50 Fed. Reg. 33553, 33557 (Aug. 20, 1985). We
note, however, that although proposed regulations constitute a
body of informed judgment on which courts may draw for guidance,
see Frazee v. Commissioner, supra at 582, we accord them no more
weight than a litigating position, see KTA-Tator, Inc. v.
- 312 -
Commissioner, 108 T.C. 100, 102-103 (1997); F.W. Woolworth Co. v.
Commissioner,
54 T.C. 1233, 1265-1266 (1970).
The Commissioner proposed section 1.7872-2, Proposed Income
Tax Regs., supra, in 1985, and has never adopted it in final
form. The Commissioner has since asserted that section 7872 can
apply to loans given in consideration for the sale or exchange of
property, in both Frazee v. Commissioner, supra, and the case at
hand. Moreover, our acceptance in Frazee of the Commissioner’s
position that section 7872 applied to the intrafamily note
necessarily rejected the position taken in the proposed
regulation.
For all these reasons, consistent with our decision in
Frazee, we hold that the deferred payment arrangement may be a
below-market loan subject to section 7872, even though no part of
the sales price would be treated as interest or OID under
sections 483 and 1274.90
90
The Court of Appeals for the Seventh Circuit held, in
Ballard v. Commissioner, 854 F.2d 185 (7th Cir. 1988), revg. T.C.
Memo. 1987-128, that a note should have no gift tax consequences
where it stated interest at the “safe harbor” rate referred to by
sec. 483 and no portion of the note’s stated principal amount
would be recharacterized as interest for that reason. In
Krabbenhoft v. Commissioner,
94 T.C. 887 (1990), affd.
939 F.2d
529 (8th Cir. 1991), we reconsidered our position on the
relevance of sec. 483 for gift tax purposes in light of the
reversal of our Ballard decision, and decided not to follow that
reversal except where required by the Golsen rule (see Golsen v.
Commissioner,
54 T.C. 742 (1970), affd.
445 F.2d 985 (10th Cir.
1971)). Moreover, the Court of Appeals for the Tenth Circuit, to
which an appeal of this case would lie, has agreed with our view,
(continued...)
- 313 -
IV. Deferred Payment Arrangements Are Below-Market Gift Loans
Subject to Section 7872
Section 7872(c)(1)(A) provides (subject to certain
exceptions not relevant to the case at hand) that section 7872
applies to “Any below-market loan which is a gift loan.”
Therefore, section 7872 applies to the deferred payment
arrangement if that arrangement is: (1) A “loan”, (2) a “below-
market loan”, and (3) a “gift loan”.
A. Loan
Section 7872 does not define the term “loan”. However, the
legislative history indicates that “loan” should be interpreted
broadly to include any extension of credit. See Frazee v.
Commissioner, 98 T.C. at 589 (citing conference report). We
concluded in Frazee v. Commissioner, supra at 588-589, that
section 7872 does not apply solely to loans of money; it also
applies to seller-provided financing for the sale of property.
In our view, the fact that the deferred payment arrangement in
the case at hand was contained in the buy-sell agreements, rather
than in a separate note as in Frazee, does not require a
different result.
90
(...continued)
as affirmed by the Court of Appeals for the Eighth Circuit in
Krabbenhoft, that sec. 483 is not relevant for gift tax valuation
purposes. See Schusterman v. United States, 63 F.3d 986 (10th
Cir. 1995).
- 314 -
For these reasons we conclude that the deferred payment
arrangement is a “loan” for purposes of section 7872.
B. Below-Market Loan
Section 7872 sets forth two definitions of below-market
loans. One definition applies to demand loans; the other applies
to term loans. Sec. 7872 (e)(1)(A), (B).
A “demand loan” is defined as “any loan which is payable in
full at any time on the demand of the lender.” Sec. 7872(f)(5).
A “term loan” is defined as “any loan which is not a demand
loan.” Sec. 7872(f)(6).
The deferred payment arrangement required Jean True’s sales
to be consummated “within 6 months” after the notice dates. It
did not give Jean True the right to payment on demand. Because
the deferred payment arrangement was not a “demand loan” as
defined in section 7872(f)(5), it is a “term loan” under section
7872(f)(6).
A term loan is a “below-market loan” if the “amount loaned”
exceeds the present value of all payments due under the loan,
discounted at the applicable Federal rate in effect as of the
date of the loan. Sec. 7872(e)(1)(B), (f)(1). Neither party has
argued that the “amount loaned” was other than the $13,298,978
aggregate sales price of Jean True’s interests under the buy-sell
agreements, and we assume that the “amount loaned” was equal to
that price.
- 315 -
The amount Jean True ultimately received on the payment date
(September 30, 1994) was equal to the $13,298,978 “amount
loaned”. Because the “present value” of $13,298,978 to be paid
up to 6 months in the future, without interest, is less than
$13,298,978, the deferred payment arrangement was a “below-market
loan”. Sec. 7872(e)(1)(B).
C. Gift Loan
Section 7872 applies to certain defined categories of below-
market loans. See sec. 7872(c)(1). One of these categories is
gift loans. See Sec. 7872(c)(1)(A).
A gift loan is defined as “any below-market loan where the
foregoing of interest is in the nature of a gift.” Sec.
7872(f)(3). As we said in Frazee v. Commissioner, supra at 589:
The question of whether the forgoing of interest is in
the nature of a gift is determined under the gift tax
principles of chapter 12. See sec. 7872(d)(2). Under
traditional gift tax principles, we look to whether the
value of the property transferred exceeds the value of
the consideration received, dispensing with the test of
donative intent. Therefore, a below-market loan will be
treated as a gift loan unless it is a transfer made in
the ordinary course of business, that is, unless it is a
transaction which is bona fide, at arm’s length, and
free of donative intent. * * * [Emphasis added.]
See also sec. 25.2512-8, Gift Tax Regs. We also note that
intrafamily transactions are subject to special scrutiny and are
presumed to be gifts. See Harwood v. Commissioner, 82 T.C. 239,
259 (1984), affd. without published opinion
786 F.2d 1174 (9th
Cir. 1986).
- 316 -
As discussed supra under Issue 2 of this opinion, we have
found that Jean True’s sales of her interests in True Oil,
Eighty-Eight Oil, True Ranches, Belle Fourche, and Black Hills
Trucking gave rise to taxable gifts, because the fair market
value of Jean True’s interests in those companies exceeded the
sales prices for those interests determined under the buy-sell
agreements. This establishes that the sales of Jean True’s
interests in those companies, including the parts of the deferred
payment arrangement relating to those sales, were not
transactions in the ordinary course of business and were gifts.
See Frazee v. Commissioner, 98 T.C. at 589.
With respect to the sales of Jean True’s interests in the
remainder of the 22 True companies, respondent has not asserted
that the formula sales prices were less than fair market value.
We have found, however, that Jean True transferred the benefits
and burdens of ownership of her interests in those companies to
her sons on the notice dates, even though the sons were not
required to pay for those interests until 6 months after those
dates. We believe that parties dealing at arm’s length would not
have transferred ownership of such business interests on these
terms. Independent parties would have required either the
payment of interest on the purchase price during the period from
the notice dates to the payment date, or an adjustment to the
- 317 -
formula prices to reflect the financial performance of the True
companies during that period.
For all these reasons, we conclude that the deferred payment
arrangement was not a transaction in the ordinary course of
business and was therefore a gift loan.
V. Amounts of the Gifts–-Application of Section 7872
We have just concluded that for purposes of section 7872,
the deferred payment arrangement was a term loan and a gift loan.
Section 7872 treats the lender of a gift term loan as having
transferred to the borrower, on the date the loan is made, a cash
gift in an amount equal to the excess of: (1) The “amount
loaned”, over (2) the present value of all payments required to
be made under the loan, discounted at the applicable Federal
rate. See sec. 7872(b)(1), (d)(2), (f)(1).
It is not entirely clear how this provision should be
applied to the case at hand. The buy-sell agreements required
payment to be made within 6 months of the notice dates.
Therefore, as of the notice dates, the deferred payment
arrangement could have been considered to be a 6-month loan,
prepayable without penalty.91
91
We note that certain proposed sec. 7872 regulations state
that an option to prepay should be disregarded in determining the
term of a loan. See sec. 1.7872-10, Proposed Income Tax Regs.,
50 Fed. Reg. 33553, 33566 (Aug. 20, 1985).
- 318 -
If the deferred payment arrangement were considered to be a
6-month term loan, then section 7872 would deem Jean True to have
made a gift, on the notice dates, of approximately 6 months’
worth of interest on the $13,298,978 aggregate purchase price.
Although Jean True actually received payment only 3 months after
the notice dates, section 7872 does not appear to provide
explicitly for any adjustment to be made to the amount of the
gift if a gift term loan is prepaid.
Respondent’s determination appears to be a reaction to the
possible harshness of such a result. In the statutory notice,
respondent asserted that the amount of Jean True’s gift arising
from the deferred payment arrangement was $192,307. The notice
stated that this amount represented 91 days of interest on the
$13,298,978 sales price. Although respondent now maintains that
the consequences of the deferred payment arrangement should be
determined under section 7872, respondent has not increased the
amount of the asserted gift.
Respondent’s calculation of the amount of the gift is
consistent with the treatment that would obtain under section
7872, if the deferred payment arrangement were treated as a
demand gift loan rather than a term gift loan.92 Although
92
The provisions requiring payment “within six months” after
the notice dates, the fact that payment was in fact made only 3
months after those dates, and the possible harshness of imputing,
under these circumstances, a gift in an amount equal to the value
(continued...)
- 319 -
respondent apparently could have asserted that a larger gift was
made, we accept respondent’s concession that in the case at hand
the amount of the gift should be computed as though the deferred
payment arrangement were a demand gift loan. However, consistent
with this opinion (and with respondent’s position that section
7872 applies), respondent’s determination should be modified in
two respects. First, the portion of the aggregate sales price
attributable to Jean True’s partnership (and LLC) interests
should be considered to be a loan outstanding from July 1, 1994
rather than from June 30, 1994. Second, the amount of the gift
should be computed using the applicable Federal rates prescribed
by section 7872, rather than the 5.9-percent True family rate
referred to in the statutory notice.93
92
(...continued)
of 6 months’ use of the amount lent, suggest that the deferred
payment arrangement might preferably be viewed as a demand loan
of indefinite maturity, rather than a term loan. Sec. 7872(f)(5)
gives the Secretary regulatory authority to treat indefinite
maturity loans as demand loans. However, because the Secretary
has not exercised that authority, a loan that is not a demand
loan ordinarily must be treated as a term loan for sec. 7872
purposes. See sec. 7872(f)(6); KTA-Tator, Inc. v. Commissioner,
108 T.C. 100, 104-105 (1997).
93
The short-term applicable Federal rate for June 1994,
based on semiannual compounding, was 5.48 percent; the
corresponding rate for July, 1994, was 5.55 percent. See Rev.
Rul. 94-44, 1994-2 C.B. 190; Rev. Rul. 94-36, 1994-1 C.B. 215.
Respondent’s trial memorandum erroneously referred to the
5.9-percent interest rate used to value the gift in the statutory
notice as the “applicable Federal rate”.
- 320 -
Issue 4. Are Petitioners Liable for Valuation Understatement
Penalties Under Sections 6662(a), (g), and (h)?
FINDINGS OF FACT
On an attachment to his 1993 gift tax return, Dave True
disclosed the sale to his wife and sons of 30-percent interests
in the True partnerships listed in Appendix schedule 1. The
attachment listed the partnerships whose interests were sold and
indicated, in general terms, that the sales price was book value,
without providing actual numbers. The 1993 gift tax return
reported zero as the value of gifts attributable to these
transactions. Petitioners did not engage a professional
appraiser to value the transferred interests in the True
partnerships for gift tax reporting purposes.
The estate tax return did not list individually the
interests in True companies that Dave True owned at death.
Instead, it showed on Schedule F, Other Miscellaneous Property
Not Reportable Under any Other Schedule, the value of Dave True’s
living trust, which owned his interests in the True companies at
death. Another schedule attached to the estate tax return
provided a breakdown of the assets owned by the living trust as
of June 4, 1994, which included cash of $39,349,150, investments,
notes receivable from some of the True companies, and
miscellaneous assets. Total book value of all the True companies
owned by Dave True at his death was $37,894,797, see Appendix
schedule 2. The living trust document, which was attached to the
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estate tax return, listed the interests in the True companies
that Dave True originally conveyed to the living trust at its
inception. The estate tax return made no further disclosure of
the valuation of the True companies under the buy-sell
agreements.
On brief, petitioners explained that the book value of Dave
True’s interests in the True companies was reported as a cash
asset of the living trust because, under the terms of the buy-
sell agreements, the sales were deemed to have been transacted as
of the day before Dave True’s death, or June 3, 1994.
Petitioners hired Mr. Lax to value Dave True’s interests in
the True companies before filing the estate tax return.
Petitioners instructed Mr. Lax to disregard the buy-sell
agreements in so doing. For the most part, Mr. Lax’s values for
the disputed companies approximated book value. However, book
values for the subject interests in Belle Fourche and Black Hills
Trucking were only 18.20 and 29.92 percent, respectively, of Mr.
Lax’s values. In any event, petitioners did not use any of Mr.
Lax’s values, but instead in effect reported the interests at
book value.
On an attachment to her amended 1994 gift tax return,94 filed
on or around June 19, 1996, Jean True disclosed the sale to her
94
Jean True’s 1994 gift tax return as originally filed did
not disclose the sales of her remaining interests in the True
companies.
- 322 -
sons of her entire interest in the True companies listed in
Appendix schedule 3. The attachment listed the interests in the
partnerships and corporations that were sold and indicated, in
general terms, that the sales price was book value, without
providing actual numbers. The amended 1994 gift tax return
reported zero as the value of gifts attributable to these
transactions. Jean True did not disclose the gift loan that
arose out of the deferred payment transaction on either her
original or her amended 1994 gift tax return.
In the August 1988, “Policy for the Perpetuation of the
Family Business” (policy), the True family agreed that tax
planning played a crucial role in every business decision. The
policy stated: “In considering potentially controversial tax
issues, we will include the criteria [sic] whether we are willing
to take the issue to court.”
In the statutory notices, respondent determined accuracy-
related penalties under section 6662(a), (g), and (h)
attributable to valuation misstatements allegedly reported in the
1993 and 1994 gift tax returns and the estate tax return.
Respondent continued to argue for imposition of these penalties
at trial and on brief.
OPINION
Section 6662 imposes a 20-percent penalty on any portion of
an underpayment of tax that is attributable to, inter alia, any
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substantial estate or gift tax valuation understatement. See
sec. 6662(a) and (b).95 An estate or gift tax valuation
understatement is substantial if the value of any property
claimed on an estate or gift tax return is 50 percent or less of
the amount determined to be the correct value. See sec.
6662(g)(1). No penalty is imposed unless the portion of the
underpayment attributable to substantial estate or gift tax
valuation understatements for the taxable period (or with respect
to the estate of the decedent) exceeds $5,000. See sec.
6662(g)(2). The penalty is increased from 20 percent to 40
percent and is a gross valuation misstatement, if the value of
95
SEC 6662. IMPOSITION OF ACCURACY-RELATED PENALTY.
(a) Imposition of Penalty.--If this section applies to
any portion of an underpayment of tax required to be shown on a
return, there shall be added to the tax an amount equal to 20
percent of the portion of the underpayment to which this section
applies.
(b) Portion of Underpayment to Which Section
Applies.--This section shall apply to the portion of any
underpayment which is attributable to 1 or more of the following:
(1) Negligence or disregard of rules or regulations.
(2) Any substantial understatement of income tax.
(3) Any substantial valuation misstatement under
chapter 1
(4) Any substantial overstatement of pension
liabilities.
(5) Any substantial estate or gift tax valuation
understatement.
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any property claimed on the return is 25 percent or less of the
amount determined to be the correct value. See sec. 6662(h).
Section 6664 provides an exception to the imposition of
accuracy-related penalties if the taxpayer shows that there was
reasonable cause for the understatement and that the taxpayer
acted in good faith. See sec. 6664(c); see also United States v.
Boyle, 469 U.S. 241, 242 (1985). Whether a taxpayer acted with
reasonable cause and in good faith is a factual question. See
sec. 1.6664-4(b), Income Tax Regs. Generally, the most important
factor is the extent to which the taxpayer exercised ordinary
business care and prudence in attempting to assess his or her
proper tax liability. See Estate of Simplot v. Commissioner,
112
T.C. 130, 183 (1999) (citing Mandelbaum v. Commissioner, T.C.
Memo. 1995-255), revd. on another issue
249 F.3d 1191 (9th Cir.
2001); sec. 1.6664-4(b), Income Tax Regs.
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Under section 6662(g),96 respondent apparently takes the
position that the determination whether the percentage threshold
for a substantial or gross valuation understatement has been
reached is made on a property-by-property basis. See Part XX
Penalties Handbook, Internal Revenue Manual (RIA), sec.
120.1.5.11.2. In the absence of any argument to the contrary by
any of the parties in this case, we use this specifically
targeted approach.
96
SEC 6662(g). SUBSTANTIAL ESTATE OR GIFT TAX VALUATION
UNDERSTATEMENT.
(1) In General.--For purposes of this section, there is
a substantial estate or gift tax valuation understatement if the
value of any property claimed on any return of tax imposed by
subtitle B is 50 percent or less of the amount determined to be
the correct amount of such valuation.
* * * * * * *
(h) INCREASE IN PENALTY IN CASE OF GROSS
VALUATION MISSTATEMENTS.
(1) In General.--To the extent that a portion of the
underpayment to which this section applies is attributable to one
or more gross valuation misstatements, subsection (a) shall be
applied with respect to such portion by substituting “40 percent”
for “20 percent”.
(2) Gross Valuation Misstatements.--The term “gross
valuation misstatements” means--
* * * * * * *
(C) any substantial estate or gift tax valuation
understatement as determined under subsection (g) by substituting
“25 percent” for “50 percent”.
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The penalty applies to all property included in the gross
estate under section 2031 or transferred for less than adequate
and full consideration under sec. 2512(b). See Estate of Owen v.
Commissioner, 104 T.C. 498, 505-506 (1995) (applying section
6660, which was the precursor of section 6662(g)).
In the cases at hand, we determine whether the percentage
threshold for a substantial or gross valuation understatement has
been reached by individually comparing the book value of the
subject interests in the disputed companies claimed on the 1993
and 1994 gift tax returns and the estate tax return97 with our
determinations of the correct values of those interests. The
table below shows reported value as a percentage of actual value
97
The way in which the transactions were reported (as sales
on the gift tax returns and as cash proceeds in the living trust
on the estate tax return) might raise a question about whether
there was an understatement of value of property “claimed on any
return of tax imposed by subtitle B”. However, petitioners
raised no such question. Indeed, they contend that they
disclosed the value of the transferred interests at book value,
according to the terms of the buy-sell agreements. Petitioners’
brief states:
the Estate reported on the Estate Tax Return an amount
equal to the book value price of the interests owned by
Dave True as of the date of his death. In calculating
their gift tax, Dave and Jean True valued the interests
that they sold at book value so there was no gift to
report. Therefore, the accuracy-related penalty
mathematically should be calculated based on the
difference between the correct value of the property
and the book value used to calculate the tax as
reported.
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(as determined by the Court) for each of the subject interests in
the disputed companies.
Actual value Reported as a
Subject interest claimed on Reported determined by percentage of
estate or gift tax return book value Court actual value
True Oil
1993 gift tax return $5,226,006 $6,204,908 84.22%
Estate tax return 5,538,423 8,288,746 66.82%
1994 gift tax return 2,528,315 3,712,376 68.11%
Belle Fourche
Estate tax return 747,723 10,234,704 7.31%
1994 gift tax return 183,593 2,115,123 8.68%
Eighty-Eight Oil
1993 gift tax return 2,556,378 5,628,052 45.42%
Estate tax return 9,546,285 10,757,119 88.74%
1994 gift tax return 4,400,744 4,817,914 91.34%
Black Hills Trucking
Estate tax return 951,467 5,087,246 18.70%
1994 gift tax return 590,511 2,952,048 20.00%
True Ranches
1993 gift tax return 3,265,647 6,060,161 53.89%
Estate tax return 5,777,943 10,368,441 55.73%
1994 gift tax return 2,712,212 4,643,833 58.40%
White Stallion
Estate tax return 153,434 232,029 66.13%
- 328 -
As the table indicates, the subject interests in Belle
Fourche were valued on the estate tax return and the 1994 gift
tax return at less than 25 percent of the correct value, which
result in gross valuation misstatements under section 6662(h).
The subject interest in Eighty-Eight Oil was valued on the 1993
gift tax return at more than 25 percent, but less than 50 percent
of the correct value, which results in a substantial gift tax
valuation understatement under section 6662(g). Finally, the
subject interests in Black Hills Trucking were valued on the
estate tax return and the 1994 gift tax return at less than 25
percent of the correct value, resulting in gross valuation
misstatements under section 6662(h).98
Unless the reasonable cause exception to the accuracy-
related penalties applies, the 40-percent penalty will apply to
the portion of any underpayment of estate tax or 1994 gift tax
attributable to the gross valuation understatement of the subject
interests in Belle Fourche and Black Hills Trucking. Moreover,
the 20-percent penalty will apply to the portion of any
underpayment of 1993 gift tax attributable to the substantial
valuation understatement of the subject interest in Eighty-Eight
Oil.
98
The gift loan derived from the deferred payment
transaction was not property “claimed on any return of tax
imposed by subtitle B” and is therefore not subject to the
valuation understatement penalties.
- 329 -
There is no statutory, regulatory, or case law guidance for
the calculation of the portion of the underpayment attributable
to a substantial or gross valuation understatement for estate or
gift tax purposes. However, section 1.6664-3, Income Tax Regs.,
provides rules for determining the order in which adjustments to
a return are taken into account to compute penalties imposed
under the first three components of the accuracy-related penalty
(i.e., penalties for negligence or disregard of rules or
regulations, substantial understatement of income tax, and
substantial (or gross) valuation misstatements under chapter 1).
See secs. 1.6662-1 and 1.6664-3, Income Tax Regs. Therefore, we
draw from those regulations to determine the portions of the
underpayments attributable to substantial or gross valuation
understatements in the cases at hand.
According to the regulations, in computing the portions of
an underpayment subject to penalties imposed under sections 6662
and 6663, adjustments to a return are considered made in the
following order:
(1) Those with respect to which no penalties have been
imposed.
(2) Those with respect to which a penalty has been
imposed at a 20 percent rate (i.e., a penalty for
negligence or disregard of rules or regulations,
substantial understatement of income tax, or substantial
valuation misstatement, under sections 6662(b)(1)
through 6662(b)(3), respectively).
- 330 -
(3) Those with respect to which a penalty has been
imposed at a 40 percent rate (i.e., a penalty for a
gross valuation misstatement under sections 6662(b)(3)
and (h)).
(4) Those with respect to which a penalty has been
imposed at a 75 percent rate (i.e., a penalty for fraud
under section 6663). [Sec. 1.6664-3(b), Income Tax
Regs.]
Examples under the regulations, and our opinion in Lemishow
v. Commissioner, 110 T.C. 346 (1998), illustrate how the
regulations would apply to the cases at hand. Step 1 is to
determine the portion, if any, of the underpayment on which no
accuracy-related penalty or fraud penalty is imposed by
increasing reported taxable income for understated income that is
not subject to penalty (adjustment 1), recomputing the tax, and
comparing it to the tax shown on the return. Step 2 determines
the portion, if any, of the underpayment on which a penalty of 20
percent is imposed by increasing taxable income derived in step 1
for understated income subject to the 20-percent penalty
(adjustment 2), recomputing the tax, and comparing it to the tax
computed in step 2. Finally, step 3 determines the portion, if
any, of the underpayment on which a penalty of 40 percent is
imposed by computing the total underpayment attributable to all
understated income and subtracting the portions of such
underpayment calculated in steps 1 and 2. See Lemishow v.
Commissioner,
110 T.C. 346 (1998); see also Todd v. Commissioner,
- 331 -
89 T.C. 912 (1987), affd.
862 F.2d 540 (5th Cir. 1988; sec.
1.6664-3(d), Income Tax Regs.
In the cases at hand, the same methodology should apply to
compute the portions of the underpayments attributable to the
substantial and gross valuation understatements, identified
above, that were reported on the 1993 and 1994 gift tax returns
and on the estate tax return.
Finally, we hold that the reasonable cause exception to the
accuracy-related penalties does not apply to the cases at hand.
The facts of record indicate that petitioners did not exercise
ordinary business care and prudence in attempting to assess the
proper estate and gift tax liabilities for the years in question.
In having the 1993 gift tax return prepared, Dave True did
not engage a professional appraiser to value the transferred
interests in the True partnerships. Instead, he wanted to test,
through litigation, the ability of the buy-sell agreements to fix
Federal gift tax value. Petitioners claimed to rely on the
decisions in the 1971 and 1973 gift tax cases, which held that
book value equaled fair market value, when they valued the
subject interests in the cases at hand at book value. We find
that such reliance was not reasonable; petitioners did not engage
counsel to advise them of the legal effects of those cases on
future transfers pursuant to the buy-sell agreements. Moreover,
the opinions of the District Court in the 1971 and 1973 gift tax
cases did not address whether the buy-sell agreements were
- 332 -
testamentary devices; therefore, those opinions and the resulting
decisions did not provide adequate support for petitioners’
reporting positions on the gift and estate tax returns.
In having the estate tax return prepared, petitioners
engaged Mr. Lax to value Dave True’s interests in the True
companies as of June 3, 1994. However, petitioners obviously did
not rely on Mr. Lax’s conclusions. If they had done so, they
would not have grossly understated the date-of-death value of
Dave True’s interest in Belle Fourche and substantially
understated the date-of-death value of his interest in Black
Hills Trucking.
Unlike the taxpayers in Mandelbaum v. Commissioner, T.C.
Memo. 1995-255, Dave True and the True family had substantial
sophistication in legal, valuation, and tax matters; they were
accustomed to working with and using lawyers on both tax99 and
non-tax100 matters. In fact, the family’s business policy
99
See, e.g., True v. United States, 190 F.3d 1165 (10th Cir.
1999); True Oil Co. v. Commissioner,
170 F.3d 1294 (10th Cir.
1999), affg. Nielson-True Partnership v. Commissioner,
109 T.C.
112 (1997); True v. United States,
35 F.3d 574 (10th Cir.
1994)(unpublished opinion); True v. United States,
894 F.2d 1197
(10th Cir. 1990); True v. United States, 80 AFTR 2d 97-7918, 97-2
USTC par. 50,946 (D. Wyo. 1997); True v. United States, 72 AFTR
2d 93-5660, 93-2 USTC par. 50,461 (D. Wyo. 1993); True v. United
States,
629 F. Supp. 881 (D. Wyo. 1986); True v. United States,
547 F. Supp. 201 (D. Wyo. 1982); True v. United States, Docket
No. C79-131K (D. Wyo., Oct. 1, 1980)
100
See, e.g., Walker v. Toolpushers Supply Co., 955 F. Supp.
1377 (D. Wyo. 1997); True Oil Co. v. Sinclair Oil Corp.,
771 P.2d
781, 794 (Wyo. 1989); True v. High Plains Elevator Mach. Co., 577
(continued...)
- 333 -
explicitly stated that for every business deal they would
consider its tax consequences, and they would evaluate whether to
litigate potentially controversial tax issues. In the cases at
hand, the True family was well aware of the issues in controversy
and the dollars at stake. They took aggressive positions on the
estate and gift tax returns to test the effectiveness of the buy-
sell agreements to fix transfer tax values. They did not rely,
in good faith, on professional appraisals or obtain professional
advice on the effects of the decisions in the prior gift tax
cases. Accordingly, we hold that the reasonable cause exception
to the accuracy-related penalties does not apply to the cases at
hand.
To reflect the foregoing,
Decisions will be entered
under Rule 155.
100
(...continued)
P.2d 991 (Wyo. 1978); True Oil Co. v. Gibson, 392 P.2d 795 (Wyo.
1964).
- 334 -
Appendix
Schedule 1
1993 Transfers by Dave True
Fair market value
Fair market of True sons’ Total purchase
Interest value of 100% 24.84% aggregate price paid by
transferred interest per 1993 interests per 1993 True sons
to True sons(1) gift tax notice(2) gift tax notice (book value)
Disputed Companies
True Oil 24.84% $56,120,008 $13,940,210 $5,226,006
Eighty-Eight Oil 24.84% 53,333,341 13,248,002 2,556,378
True Ranches 24.84% 49,090,137 12,193,990 3,265,647
Subtotal 158,543,486 39,382,202 11,048,031
Undisputed Companies
Rancho Verdad 24.84% 2,175,048 540,282(3) 327,012
True Drilling 24.84% 4,605,773 1,144,074(3) 848,208
True Geothermal Energy 24.84% 1,226,039 304,548 304,548
True Mining 24.84% 1,027 255 255
True Envir. Rem. LLC 24.84% 1,111,256 276,036 276,036
Subtotal 9,119,143 2,265,195 1,756,059
Grand total 167,662,629 41,647,397 12,804,090
(1)
Aggregate interests in each company transferred by Dave True to Hank, Diemer, and David L. True.
Interests sold to Jean True were not included in the 1993 gift tax notice.
(2)
The 1993 gift tax notice did not separately state the values of the transferred interests. The values shown above
are based on the Revenue Agent’s Reports and the 1994 estate tax notice.
(3)
Respondent no longer asserts a gift tax deficiency related to this entity.
- 335 -
Schedule 2
1994 Transfers by Estate
Fair market value
Fair market of Dave True’s Total purchase
Interest owned value of 100% interest owned price paid by
by Dave True interest per 1994 at death per 1994 Jean True & True
at death(1) estate tax notice(2) estate tax notice sons (book value)
Disputed Companies
True Oil 38.47% $52,097,003 $20,041,717 $5,538,423
Eighty-Eight Oil 38.47% 68,900,000 26,505,830 9,546,285
True Ranches 38.47% 52,725,363 20,283,447 5,777,943
Belle Fourche 68.74% 28,919,991 19,801,518 747,723
Black Hills Trucking 58.16% 10,933,726 6,359,055 951,467
White Stallion 34.235% 1,139,080 389,964 153,434
Subtotal 214,715,163 93,381,531 22,715,275
Undisputed Companies
Rancho Verdad 38.47% 2,175,053 836,743(3) 506,308
True Drilling 38.47% 4,605,776 1,771,842(3) 938,940
Tool Pushers 70.683% 6,500,000 4,594,395(3) 2,173,211
Midland Financial 68.47% 20,000,001 13,694,001(3) 8,761,108
Roughrider Pipeline 68.47% 325,001 222,528(3) 217,396
Smokey Oil 72.394% 2,399,983 1,737,444(3) 1,733,359
True Geothermal Energy 38.47% 662,516(2) 254,870 254,870
True Mining 38.47% 1,024 394 394
True Envir. Rem. LLC 38.47% 1,234,656 474,972 474,972
Black Hills Oil Marketers 68.47% 349 239 239
Bonanza Publishing 68.47% 2,294 1,571 1,571
Clareton Oil 68.47% 334 229 229
Donkey Creek Oil 68.47% 334 229 229
Equitable Oil Purchasers 56.51% 5,764 3,257 3,257
Fire Creek Oil 68.47% 6,282 4,301 4,301
Pumpkin Buttes Oil 68.47% 296 203 203
Sunlight Oil 68.47% 332 227 227
True Geothermal Drilling 68.47% 894 612 612
True Wyoming Beef 68.47% 4,092 2,802 2,802
Wind River Oil 68.47% 340 233 233
True Land & Royalty 68.47% 153,441 105,061 105,061
Subtotal 38,078,762 23,706,153 15,179,522
Grand total 252,793,925 117,087,684 37,894,797
(1)
Dave True’s total interest in each company as of his death. Respondent has agreed that any adjustment to the
value of the interest transferred to Jean True qualifies for the marital deduction.
(2)
Fair market value of 100% interest amounts for True Geothermal Energy and following were extrapolated from 1994
estate tax notice
(3)
Respondent no longer asserts an estate tax deficiency related to this entity.
- 336 -
Schedule 3
1994 Transfers by Jean True
Fair market value
Fair market of aggregate Total purchase
Interest value of 100% interests transferred price paid by
transferred interest per 1994 by Jean True per True sons
by Jean True gift tax notice 1994 gift tax notice (book value)
Disputed Companies
True Oil 17.23% $52,097,000 $8,976,312 $2,528,315
Eighty-Eight Oil 17.23% 68,900,000 11,871,469 4,400,744
True Ranches 17.23% 52,725,360 9,084,581 2,712,212
Belle Fourche 17.23% 28,920,000 4,982,916 183,593
Black Hills Trucking 37.93%(1) 10,933,730 4,147,164 590,511
Subtotal 213,576,090 39,062,442 10,415,375
Undisputed Companies
Rancho Verdad 17.23% 2,175,051 374,761(2) 226,759
Tool Pushers 4.54% 6,500,000 295,100(2) 137,872
Midland Financial 17.23% 20,000,000 3,446,000(2) 2,226,338
Roughrider Pipeline 17.23% 320,417 55,208(2) 55,208
True Mining 17.23% 1,023 176 176
True Envir. Rem. LLC 17.23% 1,194,929 205,886 205,886
Black Hills Oil Marketers 17.23% 347 60 60
Bonanza Publishing 17.23% 2,292 395 395
Clareton Oil 17.23% 334 58 58
Equitable Oil Purchasers 40.00% 5,761 2,304 2,304
Fire Creek Oil 17.23% 6,924 1,193 1,193
Pumpkin Buttes Oil 17.23% 295 51 51
Sunlight Oil 17.23% 330 57 57
True Geothermal Drilling 17.23% 642 111 111
True Wyoming Beef 17.23% 3,700 638 638
Wind River Oil 17.23% 340 59 59
True Land & Royalty 17.23% 153,441 26,438 26,438
Subtotal 30,365,826 4,408,495 2,883,603
Grand total 243,941,916 43,470,937 13,298,978
(1)
Jean True’s percentage interest should be 37.63%.
(2)
Respondent no longer asserts a gift tax deficiency related to this entity.
