The Ninth Circuit, for the second time this month, has reversed and remanded a Tax Court ruling regarding valuation of an estate's shares of stock for estate tax purposes. (The first was Mitchell v. Commissioner, No. 99-70421 (9th Cir. 5-2-2001).)

When Richard Simplot died in 1993, he owned 18 shares (23%) of voting stock (Class A) and 3,942 shares (2.8%) of non-voting stock (Class B) in a family-owned corporation. His estate valued both classes of stock at $2,650 per share. 

The IRS issued a notice of deficiency of over $7 million based on its determination that the Class A stock should be valued at $801,994 per share and the Class B stock, at $3,585 per share.

The estate petitioned the Tax Court for review, and the IRS conceded that the assessed deficiency was erroneous. The IRS presented testimony of expert witnesses who argued that because of the skewed relation of the number of voting shares to the number of non-voting shares, a premium should be placed on the voting stock. The estate's expert witnesses testified that the estate's minority interest in the Class A stock could not extract economic benefits for the shareholder.

The Tax Court rejected the testimony of all witnesses but agreed that a premium should be added to the value of the Class A shares because of their "inherent potential for influence and control." After constructing hypothetical scenarios regarding who might purchase the Class A shares and under what circumstances, the Tax Court applied a 3% premium for voting privileges and a 35% discount for lack of marketability to arrive at a per-share taxable value of $215,539.

A majority of the Ninth Circuit judges disagreed and ruled that the Tax Court erred in three ways:

• By departing from the purely hypothetical willing buyer and willing seller standard and constructing "imaginary scenarios;"
• By finding what premium all the Class A shares as a block would demand and then dividing this premium per each Class A share;
• By applying a premium in the first place. (According to Ahmanson Foundation v. United States, 674 F.2d 761, 770 (9th Cir. 1981), even a controlling block of stock is not to be valued at a premium for estate tax purposes unless the IRS can show that a purchaser would be able to use the control "in such a way to assure an increased economic advantage worth paying a premium for.")