On March 2, 2020, the Tax Court issued a Memorandum Opinion in the case of Grieve v. Commissioner (T.C. Memo. 2020-28). The primary issue presented in Grieve was the valuation of the petitioner’s 99.8% member interests in two LLCs, Rabbit 1, LLC and Angus MacDonald, LLC, transferred to the petitioner from a GRAT and an irrevocable trust, respectively.
Background – A Three Hour Tour
This is the cautionary tale of Pierson Grieve, who I imagine has the look and affectations of Thurston Howell, III, sans the deserted island or the comic relief of Gilligan and the Skipper. Nor did Mr. Grieve have the Professor to engineer a way out of his tax liabilities with little more than coconuts and a sincere suspension of disbelief. He did have a cravat, though; that much I am sure of.
Mr. Grieve had a daughter, Margaret, a lawyer, who took it upon herself to “become involved” with the family fortune by “purchasing” the managerial wing (PMG) of the Grieve Family Limited Partnership (GFLP) for $6,200 and a hug for dear old Thurston. So, from 2012 onward, Margaret had been responsible for daddy’s money. PMG (again, purchased for $6,200) owned a controlling interest in certain closely held entities with approximately $70m in assets held by Goldman Sachs. Margaret also “assisted” her own law firm to develop Thurston’s updated estate planning documents. To accomplish Thurston’s goal of “achieving the family’s wealth-management goals in a tax-efficient manner,” two LLCs were created: Rabbit and Angus.
The exact estate planning that followed is wonderfully complex, if that’s your thing, and I urge you to read about the decision to create 99.8% interests in one entity that held another entity that was beholden to yet another. Great GRATs were created. Certain classes were defined. Tremendous trusts became irrevocable. It was a complex estate planner’s happy place during this time. Until it wasn’t.
Thurston timely filed his 2013 Form 709 (U.S. Gift and GST Tax Return), and with it, valuation appraisal reports prepared by a firm specializing in complex and creative valuations of such things for uncomfortably wealthy people, as Thurston and his issue were. The valuation discounts assigned due to the various shares for lack of control, lack of marketability, and utter lack of reality, were a tad generous in the IRS’s humble estimation.
In January 2018, the IRS politely issued a notice of deficiency to Thurston explaining that his gifts had been a skosh understated, to the tune of approximately $8m. Thurston, Margaret, their butlers, and their butlers’ butlers, took umbrage at such a preposterous suggestion, and timely filed a Tax Court petition for redetermination.
Burden of Proof and Valuation
Determinations in a notice of deficiency are presumed correct in most cases, and the taxpayer bears the burden of proving those determinations to be erroneous. Tax Court Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). The burden of proof may shift to the IRS if the taxpayer establishes that he or she complied with the requirements of IRC § 7491(a)(2)(A) and (B) by substantiating the items properly, by maintaining the required records to establish such substantiation, and by cooperating ever so fully with the IRS’s reasonable requests. The petitioner contends that he meets the requirements of IRC § 7491(a), and, thus, the burden of proof shifts to the IRS regarding the fair market value of his gifts. The determination of fair market value is a question of fact. Estate of Newhouse v. Commissioner, 94 T.C. 193, 217 (1990).
The Tax Court May Deign to Give Weight to Expert Valuations (but the Tax Court may Decide to not so Deign)
The Tax Court observed that, even though it was quite enjoyable to watch the respective parties’ experts duel in open court as to conclusions of value of the transferred interests based on differing interpretations of the relevant facts, at the end of the day, the Tax Court is not bound by the opinion of any expert witness when such “expert” opinion is contrary to the Tax Court’s own “judgment.” Touché. Estate of Hall v. Commissioner, 92 T.C. 312, 338 (1989). The Tax Court resolves valuation issues on the preponderance of the evidence in the record with the guidance of those expert opinions that the Tax Court finds “most helpful.” See Estate of Bongard v. Commissioner, 124 T.C. 95, 111 (2005).
The Tax Court may adopt or reject an expert’s opinion in whole or in part. Estate of Davis v. Commissioner, 110 T.C. 530, 538 (1998); see also Buffalo Tool & Die Mfg. Co. v. Commissioner, 74 T.C. 441, 452 (1980). In situations where experts offer divergent estimates of fair market value, the Tax Court breaks out its scales and weighs each estimate by analyzing the factors which those experts used to arrive at their conclusions. Estate of Davis, 110 T.C. at 538; Casey v. Commissioner, 38 T.C. 357, 381 (1962).
Taxpayers are Bound by Own Valuation Amounts
When a petitioner adopts a valuation and reports it on a return, such reported values are considered by the Tax Court to be an admission by the petitioner. As such, if the petitioner thereafter has valuation remorse, the Tax Court will not permit lower values to be substituted without “cogent proof” that the reported values were actually erroneous. See Estate of Hall, 92 T.C. at 337-38.
To the average consumer of Tax Court opinions, this part of the Grieve opinion likely heralded doom for the taxpayer. Nevertheless, as the Tax Court explains later, when the taxpayer’s valuations are utterly devoid of imagination and completely lacking in anything resembling speculation, such valuations will warm the very cockles of the Tax Court’s heart and will be sustained.
The Tax Court Invokes Daubert Regarding Admissibility of Expert Reports into Evidence
In the landmark case of Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579, 592-93 (1993), the Supreme Court stressed the trial court’s role as a “gatekeeper” in excluding, at the outset, evidence that is unreliable or irrelevant. The reliability and relevancy standards are embodied in Fed. R. Evid. 702, and they apply equally to expert testimony that is not “scientific.” Kumho Tire Co. v. Carmichael, 526 U.S. 137, 148 (1999).
However, the Tax Court noted, Fed. R. Evid. 702 is a rule of admissibility rather than exclusion. See Arcoren v. United States, 929 F.2d 1235, 1239 (8th Cir. 1991). Thus, when an expert’s methodology, not his qualifications, is in dispute (as here), exclusion of the expert report is not warranted. See Synergetics, Inc. v. Hurst, 477 F.3d 949, 956 (8th Cir. 2007).
Gift Tax Valuation Principles (a Study in Hypothetical Consumers)
The Code imposes a tax on the transfer of property by gift made during that taxable year by an individual. IRC § 2501(a). The donor is primarily responsible for paying the gift tax. IRC § 2502(c). The amount of gift tax is based on the aggregate value of taxable gifts made during the year, among other things, IRC § 2502(a), and the total taxable gifts of a donor equals the gifts made during the year, less certain deductions. IRC § 2503(a).
The total amount of taxable gifts in the year is the sum of the values of the gifts made in the year in excess of the exclusion amount in IRC § 2503(b). See Treas. Reg. § 25.2503-1. The value of a gift of property, in turn, is the fair market value (FMV) of the property on the date of the gift under IRC § 2512(a), which FMV, in turn, 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 the relevant facts. See United States v. Cartwright, 411 U.S. 546, 551 (1973); Treas. Reg. § 25.2512-1.
The willing buyer and seller are tax fiction at its finest. Such persons are not actual persons (and most definitely not the actual buyer and seller in the case), their characteristics are no one’s actual characteristics, and their penchant to buy and sell pretty baubles and trinkets and stocks and homes is not actually a factor. Estate of Bright v. United States, 658 F.2d 999, 1005-1006 (5th Cir. 1981); Estate of Kahn v. Commissioner, 125 T.C. 227, 231 (2005); Estate of Davis, 110 T.C. at 535.
The hypothetical willing buyer and the hypothetical willing seller are presumed to be dedicated to achieving the maximum economic advantage. Estate of Davis, 110 T.C. at 535. Transactions that are unlikely and obviously contrary to the economic interests of a hypothetical willing buyer or a hypothetical willing seller are not reflective of FMV. See Estate of Newhouse, 94 T.C. at 232. In valuing an LLC interest the rights, restrictions, and limitations of the various classes of interests must be considered. Id. at 218.
Tax Court Lacks Whimsy and “Does not Engage in Imaginary Scenarios”
One need not look any further than to the “tax fiction” of the hypothetical willing buyer and seller to know that the Tax Court has some appreciation of fantasy. Nevertheless, with its upper lip ever so stiffened, the Grieve opinion notes that the Tax Court has long told itself in the mirror before stepping into the courtroom that it has no sense of imagination and absolutely no whimsy, whatsoever.
As such, the Tax Court is bound, by precedent if not by practice, to be drier than a stale saltine, at least when it comes to valuation. The Grieve opinion could not be clearer on the subject as when the Tax Court observes that it “do[es] not engage in imaginary scenarios as to who a purchaser might be. Estate of Giustina v. Commissioner, 586 F. App’x 417, 418 (9th Cir. 2014), rev’g and remanding T.C. Memo. 2011-141. The Tax Court’s children must have just adored story time.
Elements affecting value that depend upon events or combinations of occurrences which, while within the realm of possibility, are not “fairly shown” to be “reasonably probable” should be excluded from consideration, lest “mere speculation and conjecture” be allowed to become a guide for the ascertainment of value. Indeed, speculation is a thing “to be condemned” in business transaction valuations as well as in the judicial ascertainment of truth. Olson v. United States, 292 U.S. 246, 257 (1934). Therefore, elements affecting the value of an item that depend upon events “within the realm of possibility” should not be considered if the events are not shown to be “reasonably probable.” Olson, 292 U.S. at 257.
The “Speculative Continuum” (the Fifth Circuit’s Words, not Mine)
Not to be outdone by itself, the Tax Court reaffirms its condemnation of imagination when it describes the “speculative continuum,” which like Ouija boards, divining rods, tarot cards, and general quirkiness have absolutely no business in the hallowed halls of the United States Tax Court. The case of McCord v. Commissioner, 120 T.C. 358 (2003), must have been an absolute frolic and detour for the Tax Court, as the Fifth Circuit slapped it down, reversing and remanding it to the Tax Court with instructions to get its head out of the clouds and do some real judging.
In doing so, the Fifth Circuit (which doesn’t have a sense of humor that its aware of) observed that there exists a “speculative continuum,” under which a future event is certain to occur, a future event is more likely than not to occur (“a more certain prophecy” than not), and the utter bane of the court’s valuation-related-existence, a future event that is possible, but with “low odds” (an “undeniably less certain prophecy”). Succession of McCord v. Commissioner, 461 F.3d 614, 629 (5th Cir. 2006). Had Nostradamus not seen this coming, I think he would have taken umbrage at the Fifth Circuit’s implications.
It is odd to think of the IRS as footloose and fancy-free, but in the Grieve case, the Tax Court at the very least found their valuation expert to be downright “creative” in his scenarios of willing buyers and willing sellers, which creativity made him, in the Tax Court’s estimation, about as reliable as a magic 8-ball stuck on “decidedly so.” The real (non-snarky) takeaway from this case should be that a taxpayer owes it to itself to look to prior Tax Court cases to determine what the Tax Court previously deemed reasonable under similar facts and circumstances. The Tax Court has, historically, been fairly generous when it comes to valuation discounts, and if they fall within the range of precedent, and have substantial empirical evidence to back them up, the taxpayer may find itself on the right side of the issue as Thurston, Margaret, and their maids’ housekeepers did in Grieve.
Original opinion: (T.C. Memo. 2020-28) Grieve v. CommissionerAdd to favorites