The Kress Case #2

“What... is the air-speed velocity of an unladen swallow?” Monty Python and the Discount for Lack of Marketability?
July 14, 2020

As I mentioned in my lastemail, the recent case of James F. Kress and Julie Ann Kress,  v. United States of America,  (Case No. 16-C-795, United StatesDistrict Court Eastern District of Wisconsin, March 25, 2019) dealt with anumber of really interesting valuation issues. One of these related to therelevance of restrictions on the transfer of ownership interests included in anoperating agreement in determining the appropriate discount for lack ofmarketability.  

26 U.S.C. § 2703(a) statesthat in order to be considered in the determination of a discount a restrictionmust meet each of  three tests (this iswhere I see the makings of a possible sequel to Monty Python and the HolyGrail!) – that the restriction  (1) is a "bona fide businessarrangement;" (2) is not a device to transfer such property to members ofthe decedent's family for less than full and adequate consideration in money ormoney's worth; and (3) includes terms that are comparable to similararrangements entered into by persons in an arms' length transaction shall beconsidered when valuing such property.

You will recall that in thiscase the IRS challenged the values of gifts made by Mr. and Mrs. Kress of non-controllingstock in Green Bay Packaging (“GBP”), a very large manufacturer of cardboardpackaging.

GBP’s bylaws stated that theKress family shareholders could only gift, bequest or sell their shares to othermembers of the Kress family. One of the valuation experts in this case tookthat restriction into account in determining a relatively high discount forlack of marketability for the shares in question.

The IRS maintained that thisrestriction should have been ignored.

The court accepted the Kressfamily argument that the restriction was a bona fide business arrangement sinceit ensured that the Kress family retained control of GBP, minimized the risk ofdisruption to GBP's affairs by a dissident shareholder, ensured confidentialityof GBP's affairs, and ensured that all sales of GBP minority stock were toqualified subchapter S shareholders.

The court said the second testwas met since the statute only applied to a transfer on death and in this casethe transfers were made during the donors’ lives.

However, the court said thatthe third test was not met - the Kress family had not shown comparability to similarterms in arms’ length transactions. As a result, the restriction could not betaken into account in determining the discount for lack of marketability.

The court however, was stillfaced with the task of determining what the appropriate discount for lack ofmarketability should be. Each of the three experts in the case had applieddifferent discounts as follows:

IRS expert – 11%

Kress expert #1 – 20%

Kress expert #2 – 28%

The court found the arguments forthe 28% discount to be most convincing although they reduced the applicablediscount by 3% to 25% since this was the expert that had taken the transferrestriction into account which, as noted above, the court held was notappropriate.

Having reread this email, Irealized that my proposed sequel would not have the mass-market appeal toattract funding from a major studio. However, if anyone wants to invest in anindie film to be shown at next year’s Sundance Festival, let me know. (I won’thold my breath).