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Valuing closely held stock.

Valuing stock in a closely held corporation is always difficult for CPAs. If the owner sells the stock shortly after the valuation date, questions frequently arise as to the impact that sale has on the stock's value.

Eric Saltzman transferred closely held stock he owned to an irrevocable trust. Saltzman served as co-trustee of the trust and was also a director of the company whose stock he transferred. After the transfer, the corporation recapitalized and exchanged the trust's common stock for preferred stock. The IRS argued that the preferred stock was worth less than the common stock, resulting in a gift. The IRS valued the gift based on a sale that occurred 7 months after the recapitalization. Saltzman claimed no gift had occurred and that, if one had taken place, the IRS valued the stock incorrectly by referring to the subsequent sale.

Result: For the taxpayer. The Second Circuit Court of Appeals decided the Tax Court erred in finding a gift because, under New York law, the trustee could claim the proceeds. The court also ruled that, even if there was a gift, the valuation was wrong. The general rule is that property is to be valued at the time of the gift or transfer, without reference to subsequent events. An exception allows reference to subsequent events only if nothing occurs between the valuation date and the subsequent event to affect the value. For this exception to apply, the subsequent event must be reasonably foreseeable at the time the stock is valued. If the event is not foreseeable, it cannot be considered. The fact that the event makes the prior valuation inaccurate is immaterial. The Second Circuit said the sale was not foreseeable and thus the Tax Court should not have considered it.

Although the stock was sold to an unrelated corporation, the court concluded the transaction was not at arm's length because the purchaser was compelled to buy. As a result, the price was inflated and did not represent true fair market value. Normally, sales to unrelated parties are considered to be at arm's length. The court did not explain its reason for concluding that a compulsion existed, and relevant documents are sealed.

This case serves as a reminder to CPAs that they must base all valuations on the price that would be obtained in an arm's length transaction between a willing buyer and a willing seller with neither party forced to participate. The mere fact that the parties are unrelated does not guarantee an arm's length transaction.

* Eric E Saltzman v. Comm., 131 F3d 87; 98-1 USTC [paragraph] 50, 164; 80 AFTR 2d 8365.

Prepared by Edward Schnee, CPA, PhD, Joe Lane Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.
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Title Annotation:taxation
Author:Schnee, Edward J.
Publication:Journal of Accountancy
Date:Aug 1, 1998
Words:459
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