Opinion
Docket No. 6563-83 42107-84.
1986-08-5
ESTATE OF LUCRETIA DAVIS JEPHSON, DECEASED; DAVID S. PLUME,DERMOND IVES AND THE CHASE MANHATTAN BANK, N.A., CO-EXECUTORS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
John Y. Taggart and Myron G. Finley, for petitioner. Jack Klinghoffer, for the respondent.
Decedent owned all the stock of two investment companies on the date of her death. The assets of both companies consisted solely of cash and marketable securities. HELD: the value of the stock of each investment company is its net asset value reduced by the cost of liquidation. John Y. Taggart and Myron G. Finley, for petitioner. Jack Klinghoffer, for the respondent.
JACOBS, JUDGE:
By statutory notice of deficiency, respondent determined a deficiency of $847,458.38 in estate tax due from the Estate of Lucretia Davis Jephson, deceased. In his amended answer, respondent claimed a $263,655.19 increased deficiency; thus the total amount in controversy is $1,111,113.57.
After concessions, the only matter left for determination is the value of all the outstanding stock of two investment companies, R.B. Davis Investment Company and Davis Jephson Finance Company, owned by Lucretia Davis Jephson at her death.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulations of fact and attached exhibits are incorporated herein.
Lucretia Davis Jephson died on April 9, 1979; petitioner is her estate. Petitioner's address at the time the petition was filed was New York, New York.
Petitioner reported in a timely filed Federal estate tax return the decedent's stock ownership in two wholly-owned corporations, R.B. Davis Investment Company (R.B. Davis) and Davis Jephson Finance Company (Jephson Finance). R.B. Davis and Jephson Finance were investment companies, the former with 4,997 shares outstanding and the latter with 20,000 outstanding shares. R.B. Davis, formed under the laws of New Jersey in 1905, manufactured baking powder until 1955, when its assets were sold; thereafter, it operated as a holding company. Jephson Finance was formed in Delaware in 1933, and has been a holding company since its inception. The assets of both corporations consisted primarily of unleveraged portfolios (managed by Chase Manhattan Bank) of marketable securities with readily ascertainable fair market values on April 9, 1979 (the valuation date), as follows:
+------------------------------------------------------------------+ ¦R. B. DAVIS ¦ +------------------------------------------------------------------¦ ¦Bonds ¦ +------------------------------------------------------------------¦ ¦Face value¦ ¦Market value¦ +----------+------------------------------------------+------------¦ ¦$30,000 ¦N.Y. State 3.6% due 5/1/87 ¦$22,839 ¦ +----------+------------------------------------------+------------¦ ¦20,000 ¦N.Y. State 3.6% due 11/1/87 ¦14,980 ¦ +----------+------------------------------------------+------------¦ ¦50,000 ¦N.Y. State 3.6% due 11/1/85 ¦30,865 ¦ +----------+------------------------------------------+------------¦ ¦70,000 ¦Penna. State Gen. Oblig. 5.9% due 12/15/92¦67,277 ¦ +----------+------------------------------------------+------------¦ ¦50,000 ¦Suffolk County Gen. Oblig. 3/5% due 9/1/83¦33,630 ¦ +----------+------------------------------------------+------------¦ ¦ ¦ ¦169,591 ¦ +------------------------------------------------------------------+
Certificate of Deposit Market value Continental Illinois Bank 9 1/2% due 3/30/79 principal and accrued $116,306 interest
Common Stocks Number of shares Market value 1,800 Merck & Co. $119,700 1,000 Schlumberger Ltd. 106,563 6,286 Scudder Managed Reserves 53,042 500 Smithline Corp. 47,156 2,800 Standard Oil Co. of Indiana 177,450 8,000 Virginia Electric & Pwr. Co. 101,500 2,500 Yellow Freight Systems Inc. 51,562 3,500 Aluminum Co. America 190,313 1,500 AT&T 92,625 1,000 Avon Products 46,750 4,000 Carolina Power & Light 83,000 2,000 Caterpillar Tractor 116,750 800 Coca-Cola Co. 33,000 4,000 Continental Oil 137,250 1,000 Digital Equipment 55,812 800 E.I. DuPont & Co. 114,250 1,300 Eastman Kodak 84,013 4,000 Florida Power Corp. 122,500 2,500 General Electric 119,219 3,500 General Mills, Inc. 87,859 2,200 Houston Ind. Inc. 66,412 500 IBM 159,188 4,000 International Paper 186,250 2,500 Lowes' Co. Inc. 120,312 2,000 Mapco Inc. 62,250 1,000 McDonald's Corp. 42,125 2,579,851 Total bonds, certificate of deposit, and stocks 2,865,748
+----------------------------------------------------------------------------+ ¦JEPHSON FINANCE ¦ +----------------------------------------------------------------------------¦ ¦Bonds ¦ +----------------------------------------------------------------------------¦ ¦Face value ¦ ¦Market value¦ +-------------+-------------------------------------------------+------------¦ ¦$100,000 ¦Baltimore Gen. Oblig. 4.1/4% due 10/15/85 ¦$87,000 ¦ +-------------+-------------------------------------------------+------------¦ ¦100,000 ¦California Gen. Oblig. 3.1/2% due 7/1/81 ¦94,390 ¦ +-------------+-------------------------------------------------+------------¦ ¦50,000 ¦Kentucky Gen. Oblig. 3.1/8% due 7/1/87 ¦40,030 ¦ +-------------+-------------------------------------------------+------------¦ ¦100,000 ¦Los Angeles City Unified School 3.1/2% due 2/1/84¦88,450 ¦ +-------------+-------------------------------------------------+------------¦ ¦50,000 ¦Mass. Bay Trans. Auth. 3.8% due 3/1/98 ¦32,510 ¦ +-------------+-------------------------------------------------+------------¦ ¦100,000 ¦Milwaukee Met. Sewr. Dist. 33.4% due 2/1/83 ¦89,980 ¦ +-------------+-------------------------------------------------+------------¦ ¦100,000 ¦Minn./St. Paul 3.7% due 1/1/85 ¦87,240 ¦ +-------------+-------------------------------------------------+------------¦ ¦50,000 ¦Nassau County Gen. Oblig. 3.4% due 11/15/82 ¦44,525 ¦ +-------------+-------------------------------------------------+------------¦ ¦100,000 ¦New Jersey Gen. Oblig. 3% due 3/1/85 ¦82,960 ¦ +-------------+-------------------------------------------------+------------¦ ¦50,000 ¦NYS Gen. Oblig. 4% due 11/15/84 ¦44,070 ¦ +-------------+-------------------------------------------------+------------¦ ¦100,000 ¦NYS Gen. Oblig. 4% due 11/15/86 ¦83,760 ¦ +-------------+-------------------------------------------------+------------¦ ¦70,000 ¦Oakdale CA Sewr. Dist. 3.05% due 7/1/2004 ¦36,000 ¦ +-------------+-------------------------------------------------+------------¦ ¦75,000 ¦Oregon Gen. Oblig. 3.3/4% due 8/15/79 ¦74,460 ¦ +-------------+-------------------------------------------------+------------¦ ¦175,000 ¦Penna. Gen. Auth. 4.4% due 7/15/83 ¦160,860 ¦ +-------------+-------------------------------------------------+------------¦ ¦(Unspecified)¦Texas Gen. Oblig. 3% due 8/1/86 ¦20,093 ¦ +-------------+-------------------------------------------------+------------¦ ¦ ¦ ¦1,066,328 ¦ +----------------------------------------------------------------------------+
The book and market values of the assets, liabilities and shareholder's equity of each company on the valuation date were as follows:
+-----------------------------------+ ¦R. B. DAVIS ¦ +-----------------------------------¦ ¦Book and Market Value ¦ +-----------------------------------¦ ¦April 9, 1979 ¦ +-----------------------------------¦ ¦SECURITIES:¦Book Value¦Market value¦ +-----------+----------+------------¦ ¦Bonds ¦$336,000 ¦$169,591 ¦ +-----------+----------+------------¦ ¦Stocks ¦2,271,073 ¦2,579,851 ¦ +-----------+----------+------------¦ ¦ ¦2,607,073 ¦2,749,442 ¦ +-----------------------------------+
CASH ACCOUNTS: Certificate of deposit and accrued interest 116,306 116,306 Investment advisory-principal 326 326 -income 3,902 3,902 Checking 94,996 94,996 Accrued income 3,079 8,136 Total assets 2,825,682 2,973,108 Less:Accounts payable 1,650 1,650 NET WORTH 2,824,032 2,971,458 Common stock 499,700 499,700 Paid in surplus 444 444 Retained earnings 2,323,888 2,323,888 Appreciation - market value --- 147,426 SHAREHOLDER'S EQUITY 2,824,032 2,971,458 Per share (4,997 shares) 565.15 594.65
+----------------------------------+ ¦JEPHSON FINANCE ¦ +----------------------------------¦ ¦Book and Market Value ¦ +----------------------------------¦ ¦April 9, 1979 ¦ +----------------------------------¦ ¦SECURITIES¦Book value¦Market value¦ +----------+----------+------------¦ ¦Bonds ¦$1,694,963¦$1,066,327 ¦ +----------+----------+------------¦ ¦Stocks ¦3,694,687 ¦5,179,091 ¦ +----------+----------+------------¦ ¦Total ¦5,659,650 ¦6,245,418 ¦ +----------------------------------+
CASH ACCOUNTS: Certificate of deposit and accrued interest 536,411 536,411 Investment advisory-principal 916 916 -income 15,733 15,733 Checking 231,251 231,251 Prepaid Federal Taxes 3,731 3,731 Accrued income --- 24,072 Total assets 6,447,692 7,057,532 Less: Accounts payable --- --- NET WORTH 6,447,692 7,057,532 Common stock 2,000,000 2,000,000 Paid in surplus 2,778 2,778 Retained earnings 4,444,914 4,444,914 Appreciation - market value --- 609,840 SHAREHOLDER'S EQUITY 6,447,692 7,057,532 Per share (20,000 shares) 322.38 352.88
The cost of liquidating R. B. Davis on the valuation date would have been $48,672.30. The cost of liquidating Jephson Finance on the valuation date would have been $46,164.13.
Petitioner valued for estate tax purposes the decedent's interests in R.B. Davis and Jephson Finance by applying discounts of 28 percent and 31.3 percent, respectively, to their net asset values, to reflect the lack of marketability of the stock of each company. The amount of the discount was determined by reference to the discount from net asset value of 10 publicly traded closed-end investment funds which had portfolio profiles similar to those of the two companies involved herein.
Respondent claims that the values of the companies are their net asset values, less liquidation expenses. Respondent argues that no discount for lack of marketability is appropriate because any purchaser of decedent's 100 percent interest in the investment companies would acquire unconditional control over, and access to, their underlying cash and securities. Respondent further contends that direct ownership of the cash and securities could be obtained in a tax-free transaction pursuant to section 337.
All section references are to the Internal Revenue Code of 1954, as amended and in effect on the date of decedent's death.
ULTIMATE FINDINGS OF FACT
1. On April 9, 1979, the stock of R.B. Davis Investment Company had a value of $2,922,786 (i.e., its net asset value, less liquidation expenses).
2. On April 9, 1979, the stock of Jephson Finance Company had a value of $7,011,368 (i.e., its net asset value, less liquidation expenses).
OPINION
Section 2031(a) mandates inclusion in gross estate of the value of all property owned by a decedent at the time of death. For estate tax purposes, in general, value means fair market values on the applicable valuation date.
Fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under compulsion to buy or to sell and both having reasonable knowledge of all relevant facts. Section 20.2031-1(b), Estate Tax Regs.
A decedent's gross estate is valued as of the date of death unless the executor elects (pursuant to section 2032) the alternate valuation. Here, no such election was made.
Valuing stock of a closely held corporation is a factual determination for which there is no talismanic formula. A weighing of all relevant facts and circumstances is required. In determining such value, section 2031(b) requires that consideration be given, in addition to all relevant factors, to the price of stock of corporations engaged in the same or similar line of business which are listed on an exchange.
After considering all relevant facts and circumstances, we find that the date of death values of R.B. Davis and Jephson Finance Company are their respective net asset values, less the cost of liquidation. The factors that persuaded us in reaching this finding are: (1) all the assets of both investment companies were liquid assets, i.e., cash and marketable securities; (2) neither corporation had any liabilities which had to be seriously considered in valuing the companies; (3) the decedent's 100 percent ownership of both companies gave her (or her estate) the unqualified right to liquidate both companies at any time. In our opinion, neither the decedent nor her estate nor a hypothetical seller would have sold the stock of either company for less than that which could have been realized through liquidation. We further believe that a hypothetical purchaser would be willing to pay such an amount.
The hypothetical purchaser, by purchasing the companies, would save brokerage fees that otherwise would have to be paid to acquire approximately $9 million of marketable securities.
We recognize that the value of an interest in an investment company is not always equal to its proportionate share of the company's net asset value. For example, we have applied a discount where a minority interest was being valued. Harwood v. Commissioner, 82 T.C. 239, 264-269 (1984), affd. 786 F.2d 1174 (9th Cir. 1986); Estate of Piper v. Commissioner, 72 T.C. 1062 (1979); Estate of DeGuebriant v. Commissioner, 14 T.C. 611 (1950), reversed on another issue sub nom, Claflin v. Commissioner, 186 F.2d 307 (2d Cir. 1951). We have also allowed a discount for the nonmarketability of an investment company's stock, particularly where its assets consist of real estate or other non-liquid assets. Estate of Piper v. Commissioner, 72 T.C. 1062 (1979); Estate of Andrews v. Commissioner, 79 T.C. 938 (1982). Here, however, there is neither a minority interest nor any non-liquid assets.
Petitioner does not argue that it is entitled to a minority interest discount, since it owns all of the stock of both companies. Nevertheless, petitioner indirectly seeks to obtain a minority interest discount by analogizing R.B. Davis and Jephson Finance to publicly traded closed-end investment companies. We agree that in many respects R.B. Davis and Jephson Finance are comparable to closed-end investment companies. Also, we recognize that stock in closed-end investment companies often sells for less than net asset value. However, an investor in a closed-end investment company has little or no say in the selection of the company's investment advisor or the company's portfolio and cannot easily force the liquidation of the company. Petitioner did not present any evidence of sales of controlling interests in closed-end investment companies. The sale of a controlling interest in a closed-end investment company might well command a premium, rather than be subject to discount. In any event, we find inapposite petitioner's comparison of the sale of 100 percent interests in R.B. Davis and Jephson Finance to sales of minority interests in publicly traded closed-end investment companies.
Petitioner next argues that a discount for nonmarketability is warranted. Petitioner contends that marketable securities and cash, when held in corporate solution, are not readily marketable. This argument ignores the fact that complete ownership of each corporation enables petitioner to obtain, at any time, direct ownership of the corporate assets either through a partial or complete liquidation or through a dividend in kind.
Lastly, petitioner argues that a purchaser of the stock of R.B. Davis and Jephson Finance would demand a discount for the existence of unknown liabilities. Only R.B. Davis was an operating company
— it manufactured baking powder prior to 1955. The potentially hazardous substance allegedly included in the baking powder manufactured by R.B. Davis is alum, which around 1905 was thought to be hazardous to health. Petitioner submitted no evidence that alum is hazardous to health or that any liability for its use was ever imposed on R.B. Davis or any other manufacturer of baking powder, or that any hazardous effects of alum had remained undetected for the 24 years which had elapsed between the date R.B. Davis ceased to manufacture baking powder and the date of decedent's death. In any event, any claim brought against R.B. Davis would probably have been time-barred. In short, we are not persuaded by this argument and believe that here no discount is warranted for unknown liabilities.
As previously noted, Jephson Finance was at all times an investment company.
Respondent conceded that there should be a reduction for the transactional costs which the owner of R.B. Davis and Jephson Finance stock would incur in obtaining direct ownership of the corporate assets through a liquidation. We have accordingly taken these costs into account in valuing both companies.
To reflect the foregoing and the concessions of the parties,
Decision will be entered under Rule 155.