Novel IRS Valuation Theory Gets Shot Down

Tried and tested approaches find faor
July 16, 2020

In these troubled times, I find comfort in looking back to the good oldpre Covid days...remembering when we didn’t think twice about getting ahaircut, visiting loved ones and going to a new craft brewery (secure in theknowledge it was probably going to close down in the next couple months due tooversaturation of the market).

Due to the slightly warped world I inhabit, I also used to find comfort inreading cases where the Tax Court soundly rejected positions taken by the IRSto the ultimate benefit of the taxpayer. The decision in Grieve v. Commissioner(T.C. Memo 2020-28) which was handed down in March, therefore rekindled thosewarm feelings of yore.

The case related to the value of 99% of the units (designated as non-votingClass B units) in an LLC holding marketable securities with a value of over $31million. The taxpayer’s valuation expert applied discounts for both lack ofcontrol (13%) and lack of marketability (25%) in determining the fair marketvalue of the Class B units on a non-controlling, non-marketable basis.

The IRS expert took a novel approach, assuming that the hypothetical buyer ofthe Class B units would try and maximize the value of this investment by alsoacquiring the 1% Class A voting units, thereby effectively removing thenon-controlling, non-marketable characteristics of the B units. The expertconceded that a buyer would have to pay a purchase premium to acquire thevoting units and concluded that in effect the amount of this premium wouldequal the discount applicable to the 99% nonvoting Class B units.

The Court rejected the “economic realities” that the IRS expert claimedshould be reflected in the valuation. The valuation was “of the class B unitson the date of the gift and notthe value of the class B units on the basis of subsequent events that, whilewithin the realm of possibilities, are not reasonably probable nor the value ofthe class A units.” The Court further noted that it was not probable that awilling buyer of the Class B units would purchase the Class A units evenassuming that the Class A units were for sale.

This was a satisfying win for the taxpayer - with the added bonus that theCourt left intact a combined discount of 35% for the nonvoting interest. Thecase leaves a warm glow that I hope will sustain us all through theuncertainties ahead.