929 / How are shares of stock in closely held corporations valued for federal transfer tax purposes?

Revenue Ruling 59-60¹ contains a broad discussion of factors that the IRS believes should be considered in valuing shares of stock in closely held corporations or in corporations where market quotations are either lacking or too scarce to be recognized. The Service says that in these cases, “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; and

(h)     The market price of stock of corporations engaged in the same or a similar line of business having their stock actively traded in a free and open market, either on an exchange or over-the-counter.”²

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Planning Point: Taxpayers should go over in detail all the facts with the business appraiser relating to the business that would impact the appraiser’s analysis of the facts laid out in Revenue Ruling 59-60.

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If a block of stock represents a controlling interest in a corporation, a “control premium” generally adds to the value of the stock. If, however, the shares constitute a minority ownership interest, a “minority discount” is often applied to the value. See, e.g., Martin v. Commissioner,³ which deals with discounts applied to shares of stock representing a minority interest in a holding company that, in turn, held minority interests in seven operating companies. A premium may also attach for swing vote attributes where one block of stock may exercise control by joining with another block of stock.⁴ One memorandum valued stock included in the gross estate at a premium as a controlling interest, while applying a minority discount to the marital deduction (see Q 847) portion which passed to the surviving spouse.⁵ Just because an interest being valued is a minority interest does not mean that a minority discount is available.⁶ However, one case valued stock with voting rights at no more than stock without voting rights.⁷

If a donor transfers shares in a corporation to each of the donor’s children, the Service will no longer consider family control when valuing the gift under IRC Section 2512. Thus, a minority discount will not be disallowed solely because a transferred interest would be part of a controlling interest if such interest were aggregated with interests held by family members.⁸ Indeed, a minority discount was allowed even when the person to whom the interest was transferred was already a controlling shareholder.⁹

The Tax Court has determined that an estate would not be allowed a minority discount where the decedent transferred a small amount of stock immediately prior to death for the sole purpose of reducing her interest from a controlling interest to a minority interest for valuation purposes.¹⁰ Also, a partnership or LLC may be included in the gross estate under IRC Section 2036 without the benefit of discounts if a decedent puts everything he owns into the partnership or LLC and retains complete control over the income of the partnership or LLC.¹¹

For a case discussing the valuation of voting trust certificates representing the decedent’s beneficial interest in stock of a closely held corporation, see Estate of McGill v. Commissioner.[12]

In general, when valuing an operating company that sells goods and services, primary consideration is given to earnings, and when valuing a company that merely holds investments, primary consideration is given to asset values. However, if a company is not easily characterized as one or the other, appropriate weight should be given to both earnings and assets.¹³

For the effect of a buy-sell agreement on the valuation of closely held stock, see Q 928.

For additional special valuation rules contained in IRC Chapter 14, see Q 934 to Q 944.