, Ten-Z6=00 O9:3fam = From= T2894 P.04/10 «F079 Ty STATE OF FLORIDA DEPARTMENT OF REVENUE TALLAHASSEE, FLORIDA 32399-0100 General Tax Administration Child Support Enforeament January 18, 2000 Property Tax Administration LH. Fuchs Administrative Services Executive Director Information Services Paul Bakker P.O. Box 10127 Bradenton, FL. 34280-0127 COPY Re: Notice of Decision Woodruff & Sons Inc. DTA #: 9901156 Source #: 9814112040-035 Corporate Intangible Tax Audit Assessment Period: 01/01/94-01/01/98 Proposed Assessment Amount: $ 5,473.32 Sustained Amount: — $ 5,473.32 Balance Due: * § 5,646.37 * Includes payments and updated interest through 01/24/00. Interest continues to accrue at $0.88 per day until the postmark date of payment. Dear Mr. Bakker: This is the Department's response to the protest letter dated September 1, 1999, filed against the referenced assessment. The letter of protest, the case file, and other available information have been carefully reviewed. This reply constitutes the issuance of our Notice of Decision, pursuant to the provisions of Rule 12-6.003, F.A.C. It represents our position based on applicable law to the issues under protest. ISSUE The taxpayer is requesting the dismissal of the Corporate Intangible tax, penalty and interest assessed during the audit. FACTS Woodruff & Sons, Inc., herein Woodruff, was audited by the Florida Department of Revenue. The audit resulted in the assessment of additional Corporate Intangible tax, penalty and interest for the audit period beginning January 1, 1994 and ending January 1, 1998. The tax computed during the audit was based on the valuation of the Company’s (Woodruff) closely held corporate stock. The Company elected to report “as agent for stockholders.” The taxpayer is protesting the assessment of tax, penalty and interest and requests a “dismissal” of the entire assessment. 1998 Florida Sterling Award Winner e ne werTan26=00 09:32am = From= : T-294 -P.05/10 «F078 Notice of Decisioy “Page 2 W ed TAXPAYER ARGUMENT The taxpayer states that the auditor determined the value of Woodruff’s stock using methods that are other than generally accepted valuation methods. He further states that the auditor used judgmental factors in determining the final value of the stock without substantial cause or justification. In addition, the taxpayer says thac the auditor did not give any weight to an independently prepared stock valuation report or to the recent sales of the Company’s (Woodruff‘s) stock. Specifically, the taxpayer cites the following four items to substantiate their claim. First, in the calculation of the Company’s average yearly after-tax income, the auditor used a four-year moving average dropping 1993 from the computation. Woodruff maintains that the elimination of this “not as profitable year” violates generally accepted valuation methodology, as specified in I.R.S. ruling 59-60. Secondly, the auditor arbitrarily, and without substantiation, increased the capitalization factor from eight (8) to eleven (11). Thirdly, the auditor used a twenty (20) percent “lack of marketability” discount to reduce the value of Woodruff’s stock. This was not in agreement with the thirty-six (36) percent discount recommended in the taxpayer’s independent valuation report dated March 31,1998. And lastly, the auditor deemed the independent report’s stock valuation of $271.83 per share to be unacceptable for Florida Department of Revenue purposes. LAW section 199.103 Florida Statutes states im part: ALL intangible personal property shall be subject to the tax at its just valuation as of January 1 of each year. Such property shall be valued in the following manner: 4) ° shares of stocks, bonds, or similar instruments of corporations not listed on any public stock exchange or not regularly traded over-the-counter shall be valued as of January 1 of each year on the basis of those factors customarily considered in determining fair market value. Rule 12C-2.002, Florida Administrative Code, states in part: (1) The following are examples of property subject to annual taxation: (e) Closely Held Stock - stock in a corporation which is held by a small number of ‘persons and is not traded on any exchange or over-the-counter. also cites a study by T.A Solber from 1979. Additionally, the CPA 4 aces * \ 2 oF san 26-00 09:33am = From 1-284 P.O/10. F078 Notice of Decisioly ad Page 3 DIs SION & ANALYSIS The primary area of disagréement lies in the methods, factors and percentages used in the valuation of the Woodruff’s closely held corporate stock. The auditor used “straight capitalization” of earnings to value the company’s stock. There are three major methods of valuing stocks based on earnings. Straight capitalization is by far the most commonly used. This method involves averaging the net income of the company over a representative number of years, normally five, and then multiplying the average figure by a fair capitalization factor. Taxpayer states that the auditor should not have dropped tax year 1993 from the moving-average used in determgning the company’s average yearly after-tax income. A review of after-tax income for the years 1990-1998 reveals that 1993 was an unusual and exceptional year. After-tax income for that year was approximately $138,000 and grossly smaller than the other years of the audit period. T.R.S Revenii® Ruling 59-60 states that, “in the event that the exceptional items are so large that the average does not appear accurate, the wnusual items should be discounted or eliminated entirely before determining the average.” It is the Department's position, that the after-tax net income for tax year ending 3/31/93 was not representative of the taxpayer’s normal business activity. Therefore, the average was computed using a four year period. The taxpayer disagrees with the capitalization factor and claims that it was arbitrarily increased from eight (8) to eleven (11). In choosing the capitalization factor the auditor considered the nature of the business, the risk involved, and the stability and direction of earnings. Capitalization factors that were used are as follows: sight (8) for the year ending 3/31/94, ten (10) for the years ending 3/31/95 and 3/31/96 and eleven (11) for the years ending 3/31/97 and 3/31/98. An initial capitalization factor of eight (8) appears to be a conservative beginning estimate. Increasing the factors incrementally to eleven (11): is justified in consideration of the ever-increasing flow of after-tax income. . Between the years 1994 and 1998 after-tax income increased one : hundred and forty- cone | (142) (percent. In disagreement with ‘the auditor’ s twenty percent (208) “lack of marketability” discount, the taxpayer argues for a thirty-six percent (36%) discount. This “lack of marketability” discount is sometimes given to companies with closely held corporate stock. The purpose of which is to reduce the value of those stocks to comperisate for their inherent lack of marketability. The taxpayer cites the independent valuation report done for them by Crowe,Chizek and Co. LLP. In this report the author states that a “discount of 36% is deemed appropriate for Woodruff.” The report quotes discount factors some of which are twenty years old. It also cites a study by T.A Solber from 1979. Additionally, the CPA ee RRR << NCI NERNBE RT o NErere re ee ore Jan“26-00 08:32an From 1-204 P.06/10 F+078 ‘Notice of Decisiol, wi Page 4 who authored this report is not licensed to practice in Florida. The discount rate of 36% is excessive by today’s standards and not realistic for an entity that has produced increasing profits year after year. The final argument cited by the taxpayer is the auditor’s failure to consider the independent report's stock valuation of $271.83 per share. A review of the computations used in the report reveals that the $271.83 quote is not an accurate per share valuation. This figure was arrived at with a combination of voting and non- voting shares. It is generally accepted that voting stock is more valuable than non-voting. No allowance was given for this difference. In addition, the author of the report uses a “lack of marketability” discount of thirty-six percent (36%). This excessive discount flaws the final value per share, which without the discount would be considerably higher. The auditor's workpapers show that the Department’s stock valuations are significantly lower than those of the independent report for 1994- 1996. Averaging the Department's value per share for the audit peried indicates an average per share value of $247.63. This figure is $24.20 less than that of the taxpayer’s report. CONCLUSION Based on the information available, it appears that the Department used generally accepted methods in their valuation of the taxpayer's corporate stock. The capitalization procedures were calculated in accordance with I.R.S Revenue Ruling 59-60. The “lack of marketability” discount offered is fair and realistic by today's standards. The taxpayer has not submitted any documentation which would indicate that the amount of tax, penalty, or interest assessed by the Department is in error. Therefore, the audit assessment is sustained in full. The Department declines to offer any compromise in this Notice. Compromise of any tax, interest or penalty is authorized under Section 213.21(3), F.S., which provides, in part: (a) A taxpayer's liability for any tax or interest specified in s. 72.011(1) may be compromised by the department upon the grounds of doubt as to liability for or collectibility of such tax or interest. A taxpayer's liability for penalties under any of the chapters specified in s. 72.011(1) may be settled or compromised if it is determined by the department that the noncompliance is due to reasonable cause and not to willful negligence, willful neglect, or fraud. {fe.s.) The term "may" denotes a pérmissive rather than mandatory term. Harper _v. State, 217 So. 2d 591 (Fla. 4th DCA 15968), gert. dismissed, 224 So. 2d 684 (Fla. 1969). This language is clearly ap pene se bain Jan*26-00 08:32am From T-204 P.O7/10 FR078 Notice of Decision y wd Page 5 permissive and dees not compel the Department to compromise penalty. Enclosed for your convenience is a Computation of Total Liability. Payment, including interest to the postmark date of payment, should be returned in the enclosed envelope. The check should reflect the tax type and source number. TAXPAYER APPEAL RIGHTS This Notice of Decision constitutes the final position of the Department unless a Petition for Reconsideration is filed on a timely basis, in which event the Notice of Reconsideration will be the Department's final position. The requirements for a Petition for Reconsideration are set forth below. Pursuant to Section 72.011({2), F.8., and Rule 12-6, F.A.C., the assessment is final as of the date of this Notice of Decision unless you file a written Petition for Reconsideration postmarked within thirty (30) days of the date of this Notice of Decision and addressed to the Office of General Counsel, Technical Assistance and Dispute Resolution, Post Office Box 7443, Tallahassee, FL 32314-7443. The Petition for Reconsideration must contain new facts or arguments; otherwise it is subject to dismissal. Absent a timely-filed Petition for Reconsideration, the assessment reflected in the Notice of Decision is final and you have three alternatives for further review: 1) Pursuant to Section 72.011, F.S., and Rule 12-6, F.A.C., you may contest the assessment in circuit court by filing a complaint with the clerk of the court. THE COMPLAINT MUST BE RECEIVED BY THE CLERK OF THE CIRCUIT COURT WITHIN SIXTY (60) DAYS OF THE DATE OF THIS NOTICE OF DECISION. Section 72.011(3), F.S., provides that no circuit court action may be brought unless you pay to the Department the amount of taxes, penalties and accrued interest assessed by the Department which are uncontested and tender or post a bond for the remaining disputed amounts unless a waiver is granted as provided in that section. Failure to pay the uncontested amounts will result in the dismissal of the action and imposition of an additional penalty in the amount of twenty-five percent (25%) of the tax assessed. The requirements of Section 72, F.S. are jurisdictional; 2) Pursuant to Sections 72.011, 120.569, 120.57 and 120.80(14), F.S. and Rule 12-6, F.A.C., you may contest the assessment in an administrative forum by filing a petition for a Chapter 120 administrative hearing with the Department of Revenue, Office of General Counsel, Post Office Box 6668, Tallahassee, FL 32314-6668. THE PETITION MUST BE RECEIVED BY THE DEPARTMENT WITHIN SIXTY (60) DAYS OF THE DATE OF THIS NOTICE OF DECISION. The petition should conform to the requirements of the Uniform Rules promulgated an _ Jan?26-00 09:33am = From- 7-204 =P.08/10 = F+079 . Notice of Decisio Page 6 ~ ad pursuant to Section 120.54(5), F.S. Section 120.80(14), F.S., provides that before you file a petition under Chapter 120, F.S., you must pay to the Department the amount of taxes, penalties and accrued interest which are not being contested. Failure to pay those amounts will result in the dismissal of the petition and imposition of an additional penalty in the amount of twenty~five percent of the tax assessed. Mediation is not available pursuant to Section 120.573, F.S. The requirements of Section 72.011(2) and (3)(a) are jqurisdictional for any action contesting an assessment or refund denial under Chapter 120, F.S.; OR 3) Pursuant to Section 120.68, F.S., you may contest the assessment in the appropriate district court of appeal by filing a Notice cof Appeal meeting the requirements of Rule 9.110, Florida Rules of Appellate Procedure, with i) the Clerk of the Department of Revenue, Office of General Counsel, Post Office Box 6668, Tallahassee, FL 32314-6668 and ii) with the clerk of the appropriate district court of appeal, accompanied by the applicable filing fee. THE NOTICE OF APPEAL MUST BE FILED WITH BOTH THE DISTRICT COURT OF APPEAL AND THE DEPARTMENT OF REVENUE WITHIN THIRTY (30) DAYS OF THE DATE OF THIS NOTICE OF DECISION. For appellate review purposes the Department will treat factual matters asserted in a protest or petition for reconsideration as allegations, not as established facts. Should you have any further questions concerning this matter, please do not hesitate to contact me. Sincerely, Chbged) Charles J. Dunning Senior Tax Specialist Technical Assistance & Dispute Resolution (850) 922-4700 Enclosure: Computation of Total Liability cc: Compliance Support NOTICE ER THE AMERTCANS WITH DISABILIT AcT Persons needing an accommodation to participate in any proceeding before the Technical Assistance and Dispure Resolution Office, should contact that office at 950-488-0717 (voice), or 800-DOR- 8331 (TDD), at least five working days before such proceeding. You may also call via the Florida Relay System at 800-955-8770 (voice), or 800-955-8771 (TDD). . copmpeatg ‘REV-RUL, Valuation of stocks and bonds., Rev. Rul. 59-60, 1959-1 CB 237, (Jan. 01, 1959) ' Copyright 2000, CCH Incorporated any Rev. Rul. 59-60, 1959-1 CB 23 \d SECTION 2031.--DEFINITION OF GROSS ESTATE 26 CFR 20.2031-2: Valuation of stocks and bonds. (Also Section 2512.) . (Also Part I, Sections 811(k), 1005, Regulations 105, Section 81.10.) In valuing the stock of closely held corporations, or the stock of corporations where market quotations are not available, all other available financial data, as well as all relevant factors affecting the fair market value must be considered for estate tax and gift tax purposes. No general formula may be given that is applicable to the many different valuation situations arising in the valuation of such stock. However, the general approach, methods, and factors which must be considered in valuing such securities are outlined. Revenue Ruling 54-77, C.B. 1954-1, 187, superseded. [Text] SECTION 1. PURPOSE. The purpose of this Revenue Ruling is 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. The methods discussed herein will apply likewise to the valuation of corporate stocks on which market quotations are either unavailable or are of such scarcity that they do not reflect the fair market value. SEC. 2. BACKGROUND AND DEFINITIONS. .01 All valuations must be made in accordance with the applicable provisions of the Internal Revenue Code of 1954 and the Federal Estate Tax and Gift Tax Regulations. Sections 203 1(a), 2032 and 2512(a) of the 1954 Code (sections 811 and 1005 of the 1939 Code) require that the property to be included in the gross estate, or made the subject of a gift, shall be taxed on the basis of the value of the property at the time of death of the decedent, the alternate date if so elected, or the date of gift. .02 Section 20.2031~-1(b) of the Estate Tax Regulations (section 81.10 of the Estate Tax Regulations 105) and section 25.2512-1 of the Gift Tax Regulations (section 86.19 of Gift Tax Regulations 108) define fair market value, in effect, as the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts, Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property. .03 Closely held corporations are those corporations the shares of which are owned by a relatively limited number of stockholders. Often the entire stock issue is held by one family. The result of this situation is that little, if any, trading in the shares takes place. There is, therefore, no established market for the stock and such sales as occur at irregular intervals seldom reflect all of the elements of a representative transaction as defined by the term “fair market value.” SEC. 3. APPROACH TO VALUATION. -01 A determination of fair market value, being a question of fact, will depend upon the circumstances in each case. No formula can be devised that will be generally applicable to the multitude of different valuation issues arising in estate and gift tax cases. Often, an appraiser will find wide differences of opinion as to the fair market value of a particular stock. In resolving such differences, he should maintain a reasonable attitude in recognition of the fact that valuation is not an exact science. A sound valuation will be based upon all the relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance. 02 The fair market value of specific shares of stock will vary as general economic conditions change from “normal” to “boom” or “depression,” that is, according to the degree of optimism or pessimism with which the investing public regards the future at the required date of appraisal. Uncertainty as to the stability or continuity of the future income from a property » decreases its value by increasing the risk of loss of earnings and value in the future. The value of shares of stock of a company With very uncertain future prospects is highly speculative. The appraiser must exercise his judgment as to the degree of risk attaching to the business of the corporation which issued the stock, but that judgment must be related to all of the other factors affecting value. -03 Valuation of securities is, in essence, a prophesy as to the future and must be based on facts available at the required date of appraisal. As a generalization, the prices of stocks which are traded in volume in a free and active market by informed persons best reflect the consensus of the investing public as to what the future holds for the corporations and industries represented. When a stock is closely held, is traded infrequently, or is traded in an erratic market, some other measure of value must be used. In many instances, the next best measure may be found in the prices at which the stocks of companies engaged in the same or a similar line of business are selling in a free and open market. Page I *REV-RUL, Valuation of stocks and bonds., Rev. Rul. 59-60, 1959-1 CB 237, (Jan. 01, 1959) ‘ Copyright 2000, CCH Incorporated a ao sae SEC. 4. FACTORS TO consweted .01 It is advisable to emphasize that in the valuation of the stock of closely held corporations or the stock of corporations where market quotations are either lacking or too scarce to be recognized, all available financial data, as well as all relevant factors affecting the fair market value, should be considered. The following factors, although not all-inclusive are fundamental and require careful analysis in each case: (a) The nature of the business and the history of the enterprise from its inception. (b) The economic outlook in general and the condition and outlook of the specific industry in particular. (c) The book value of the stock and the financial condition of the business. (d) The earning capacity of the company. (e) The dividend-paying capacity. (f) Whether or not the enterprise has goodwill or other intangible value. (g) Sales of the stock and the size of the block of stock to be valued. (h) The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter. .02 The following is a brief discussion of each of the foregoing factors: (a) The history of a corporate enterprise will show its past stability or instability, its growth or lack of growth, the diversity or lack of diversity of its operations, and other facts needed to form an opinion of the degree of risk involved in the business. For an enterprise which changed its form of organization but carried on the same of closely similar operations of its predecessor, the history of the former enterprise should be considered. The detail to be considered should increase with approach to the required date of appraisal, since recent events are of greatest help in predicting the future; but a study of gross and net income, and of dividends covering a long prior period, is highly desirable. The history to be studied should include, but need not be limited to, the nature of the business, its products or services, its operating and investment assets, capital structure, plant facilities, sales records and management, all of which should be considered as of the date of the appraisal, with due regard for recent significant changes. Events of the past that are unlikely to recur in the future should be discounted, since value has a close relation to future expectancy. (b) A sound appraisal of a closely held stock must consider current and prospective economic conditions as of the date of appraisal, both in the national economy and in the industry or industries with which the corporation is allied. It is important to know that the company is more or less successful than its competitors in the same industry, or that it is maintaining a stable position with respect to competitors. Equal or even greater significance may attach to the ability of the industry with which the company is allied to compete with other industries. Prospective competition which has not been a factor in prior years should be given careful attention. For example, high profits due to the novelty of its product and the lack of competition often lead to increasing competition. The public’s appraisal of the future prospects of competitive industries or of competitors within an industry may be indicated by price trends in the markets for commodities and for securities. The loss of the manager of a so-called “one-man” business may have a depressing effect upon the value of the stock of such business, particularly if there is a lack of trained personnel capable of succeeding to the management of the enterprise. In valuing the stock of this type of business, therefore, the effect of the loss of the manager on the future expectancy of the business, and the absence of management-succession potentialities are pertinent factors to be taken into consideration. On the other hand, there may be factors which offset, in whole or in part, the loss of the manager’s services. For instance, the nature of the business and of its assets may be such that they will not be impaired by the loss of the manager. Furthermore, the loss may be adequately covered by life insurance, or competent management might be _ employed on the basis of the consideration paid for the former manager’s services. These, or other offsetting factors, if found to exist, should be carefully weighed against the loss of the manager’s services in valuing the stock of the enterprise. , preferably in the form of comparative annual statements for two or more years immediately preceding the date of appraisal, together with a balance sheet at the end of the month preceding that date, if corporate accounting will permit. Any balance sheet descriptions that are not self-explanatory, and balance sheet items comprehending diverse assets or liabilities, should be clarified in essential detail by supporting supplemental schedules. These statements usually will disclose to the appraiser (1) liquid position (ratio of current assets to current liabilities); (2) gross and net book value of principal classes of fixed assets; (3) working capital; (4) long-term indebtedness; (5) capital structure; and (6) net worth. Consideration also should be given to any assets not essential to the operation of the business, such as investments in securities, real estate, etc. In general, such nonoperating assets will command a lower rate of return than do the operating assets, although in exceptional cases the reverse may be true. In computing the book value per share of stock, assets of the investment type should be revalued on the basis of their market price and the book value adjusted accordingly. Comparison of the company’s balance sheets over several years may reveal, among other facts, such developments as the acquisition of additional production facilities or subsidiary companies, improvement in financial position, and details as to recapitalizations and other changes in the capital structure of the corporation. Ifthe corporation Page 2 i ‘ ora ” REV-RUL, Valuation of stocks and bonds., Rev. Rul. 59-60, 1959-1 CB 237, (Jan. 01, 1959) Copyright 2000, CCH Incorporated a Scere has more than one class of stochstanding, the charter or certificate of incorporation should be examined to ascertain the explicit rights and privileges of the various stock issues including: (1) voting powers, (2) preference as to dividends, and (3) preference as to assets in the event of liquidation. (d) Detailed profit-and-loss statements should be obtained and considered for a representative period immediately prior to the required date of appraisal, preferably five or more years. Such statements should show (1) gross income by principal items; (2) principal deductions from gross income including major prior items of operating expenses, interest and other expense on each item of long-term debt, depreciation and depletion if such deductions are made, officers’ salaries, in total if they appear to be reasonable or in detail if they seem to be excessive, contributions (whether or not deductible for tax purposes) that the nature of its business and its community position require the corporation to make, and taxes by principal items, including income and excess profits taxes; (3) net income available for dividends; (4) rates and amounts of dividends paid on each class of stock; (5) remaining amount carried to surplus; and (6) adjustments to, and reconciliation with, surplus as stated on the balance sheet. With profit and loss statements of this character available, the appraiser should be able to separate recurrent from nonrecurrent items of income and expense, to distinguish between operating income and investment income, and to ascertain whether or not any line of business in which the company is engaged is operated consistently at a loss and might be abandoned with benefit to the company. The percentage of earnings retained for business expansion should be noted when dividend-paying capacity in considered. Potential future income is a major factor in many valuations of closely-held stocks, and all information concerning past income which will be helpful in predicting the future should be secured. Prior earnings records usually are the most reliable guide as to the future expectancy, but resort to arbitrary five-or-ten-year averages without regard to current trends or future prospects will not produce a realistic valuation. If, for instance, a record of progressively increasing or decreasing net income is found, then greater weight may be accorded the most recent years’ profits in estimating earning power. It will be helpful, in judging risk and the extent to which a business is a marginal operator, to consider deductions from income and net income in terms of percentage of sales. Major categories of cost and expense to be so analyzed include the consumption of raw materials and supplies in the case of manufacturers, processors and fabricators; the cost of purchased merchandise in the case of merchants; utility services; insurance; taxes; depletion of depreciation; and interest. (e) Primary consideration should be given to the dividend-paying capacity of the company rather than to dividends actually paid in the past. Recognition must be given to the necessity of retaining a reasonable portion of profits in a company to meet competition. Dividend-paying capacity is a factor that must be considered in an appraisal, but dividends actually paid in the past may not have any relation to dividend-paying capacity. Specifically, the dividends paid by a closely held family company may be measured by the income needs of the stockholders or by their desire to avoid taxes on dividend receipts, instead of by the ability of the company to pay dividends. Where an actual or effective controlling interest in a corporation is to be valued, the dividend factor is not a material element, since the payment of such dividends is discretionary with the controlling stockholders. The individual or group in control can substitute salaries and bonuses for dividends, thus reducing net income and understating the dividend-paying capacity of the company. It follows, therefore, that dividends are less reliable criteria of fair market value than other applicable factors. : (f) In the final analysis, goodwill is based upon earning capacity. The presence of goodwill and its value, therefore, rests upon the excess of net earnings over and above a fair return on the net tangible assets. While the element of goodwill may be based primarily on earnings, such factors as the prestige and renown of the business, the ownership of a trade or brand name, and a record of successful operation over a prolonged period in a particular locality, also may furnish support for the inclusion of intangible value. In some instances it may not be possible to make a separate appraisal of the tangible and intangible assets of the businesses. The enterprise has a value as an entity. Whatever intangible value there is, which is supportable by the facts, may be measured by the amount by which the appraised value of the tangible assets exceeds the net book value of such assets. he (g) Sales of stock of a closely held corporation should be carefully investigated to determine whether they represent transactions at arm’s length. Forced or distress sales do not ordinarily reflect fair market value nor do isolated sales in small amounts necessarily control as the measure of value. This is especially true in the valuation of a controlling interest in a corporation. Since, in the case of closely held stocks, no prevailing market prices are available, there is no basis for making an adjustment for blockage. It follows, therefore, that such stocks should be valued upon a consideration of all the evidence affecting the fair market value. The size of the block of stock itself is a relevant factor to be considered. Although it is true that a minority interest in an unlisted corporation’s stock is more difficult to sell than a similar block of listed stock, it is equally true that control of a corporation, either actual or in effect, representing as it does an added element of value, may justify a higher value for a specific block of stock. (h) Section 2031(b) of the Code states, in effect, that in valuing unlisted securities the value of stock or securities of corporations engaged in the same or a similar line of business which are listed on an exchange should be taken into consideration along with all other factors. An important consideration is that the corporations to be used for comparisons have capital stocks which are actively traded by the public. In accordance with section 2031(b) of the Code, stocks listed on an exchange are to be considered first. However, if sufficient comparable companies whose stocks are listed on an exchange cannot be found, other comparable companies which have stocks actively traded in on the over-the-counter market also may be used, The essential factor is that whether the stocks are sold on an exchange or over-the-counter there is evidence of an active, free public market for the stock as of the valuation date. In selecting corporations for comparative purposes, care should be taken to use only comparable companies. Although the only restrictive requirement as to comparable corporations specified in the statute is that their lines of business be the same or similar, yet it is obvious that consideration must be given to other relevant factors in order that the most valid comparison possible will be obtained. For Page 3 sonst . “REV-RUL, Valuation of stocks and bonds., Rev. Rul. 59-60, 1959-1 CB 237, (Jan. 01, 1959) e Copyright 2000, CCH Incorporated ae en illustration, a corporation avin or more issues of preferred stock, bonds or dStentures in addition to its common stock should not be considered to be directly comparable to one having only common stock outstanding. In like manner, a company with a declining business and decreasing markets is not comparable to one with a record of current progress and market expansion. SEC. 5. WEIGHT TO BE ACCORDED VARIOUS FACTORS. The valuation of closely held corporate stock enitails the consideration of all relevant factors as stated in section 4. Depending upon the circumstances in each case, certain factors may carry more weight than others because of the nature of the company’s business. To illustrate: (a) Earnings may be the most important criterion of value in some cases whereas asset value will receive primary consideration in others. In general, the appraiser will accord primary consideration to earnings when valuing stocks of companies which sell products or services to the public; conversely, in the investment or holding type of company, the appraiser may accord the greatest weight to the assets underlying the security to be valued. (b) The value of the stock of a closely held investment or real estate holding company, whether or not family owned, is closely related to the value of the assets underlying the stock. For companies of this type the appraiser should determine the fair market values of the assets of the company. Operating expenses of such a company and the cost of liquidating it, if any, merit consideration when appraising the relative values of the stock and the underlying assets. The market values of the underlying assets give due weight to potential earnings and dividends of the particular items of property underlying the stock, capitalized at rates deemed proper by the investing public at the date of appraisal. A current appraisal by the investing public should be superior to the retrospective opinion of an individual. For these reasons, adjusted net worth should be accorded greater weight in valuing the stock of a closely held investment or real estate holding company, whether or not family owned, than any of the other customary yardsticks of appraisal, such as earnings and dividend paying capacity. SEC. 6. CAPITALIZATION RATES. In the application of certain fundamental valuation factors, such as earnings and dividends, it is necessary to capitalize the average or current results at some appropriate rate. A determination of the proper capitalization rate presents one of the most difficult problems in valuation. That there is no ready or simple solution will become apparent by a cursory check of the rates of return and dividend yields in terms of the selling prices of corporate shares listed on the major exchanges of the country. Wide variations will be found even for companies in the same industry. Moreover, the ratio will fluctuate from year to year depending upon economic conditions. Thus, no standard tables of capitalization rates applicable to closely held corporations can be formulated. Among the more important factors to be taken into consideration in deciding upon a capitalization rate in a particular case are: (1) the nature of the business; (2) the risk involved; and (3) the stability or irregularity of earnings. SEC. 7. AVERAGE OF FACTORS. Because valuations cannot be made on the basis of a prescribed formula, there is no means whereby the various applicable factors in a particular case can be assigned mathematical weights in deriving the fair market value. For this reason, no useful purpose is served by taking an average of several factors (for example, book value, capitalized earnings and capitalized dividends) and basing the valuation on the result. Such a process excludes active consideration of other pertinent factors, and the end result cannot be supported by a realistic application of the significant facts in the case except by mere chance. SEC. 8, RESTRICTIVE AGREEMENTS. Frequently, in the valuation of closely held stock for estate and gift tax purposes, it will be found that the stock is subject to an agreement restricting its sale or transfer. Where shares of stock were acquired by a decedent subject to an option reserved by the issuing corporation to repurchase at a certain price, the option price is usually accepted as the fair market value for estate tax purposes. See Rev. Rul. 54-76, C.B. 1954-1, 194. However, in such case the option price is not determinative of fair market value for gift tax purposes. Where the option, or buy and sell agreement, is the result of voluntary action by the stockholders and is binding during the life as well as at the death of the stockholders, such agreement may or may not, depending upon the circumstances of each case, fix the value for estate tax purposes. However, such agreement is a factor to be considered, with other relevant factors, in determining fair market value. Where the stockholder is free to dispose of his shares during life and the option is to become effective only upon his death, the fair market value is not limited to the option price. It is always necessary to consider the relationship of the parties, the relative number of shares held by the decedent, and other material facts, 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 his bounty for less than an adequate and full consideration in money or money’s worth. In this connection see Rev. Rul. 157 C.B. 1953-2, 255, and Rev. Rul. 189, C.B. 1953-2, 294. SEC. 9, EFFECT ON OTHER DOCUMENTS. Revenue Ruling 54-77, CB. 1954-1, 187, is hereby superseded. Page 4 a cee reps

Docket for Case No: 00-001261