Ames v. O'MALLEY

• Decision Date: 03 July 1950
• Docket Number: Civ. A. No. 13-48.
• Citation: 91 F. Supp. 463,39 AFTR 735
• Parties: AMES v. O'MALLEY, Collector of Internal Revenue.
• Court: U.S. District Court — District of Nebraska

91 F. Supp. 463

39 AFTR 735

AMES v. O'MALLEY, Collector of Internal Revenue.

Civ. A. No. 13-48.

United States District Court D. Nebraska, Omaha Division.

July 3, 1950.

C. Petrus Peterson and James N. Ackerman, Lincoln, Neb., for plaintiff.

William B. Waldo, and Francis Donahoe, Washington, D. C., Joseph T. Votava, United States Attorney, Omaha, Neb., for defendant.

DONOHOE, Chief Judge.

This is a suit to recover the amount of a deficiency assessment levied by the Collector of Internal Revenue and paid by the petitioner under protest. In determining the deficiency the Collector increased the net income of the petitioner by reducing the basis of certain shares of stock on which a capital gain was realized in 1943 as a result of a taxable exchange. In that year the taxpayer exchanged 180 shares of stock in Bankers Life of Nebraska for 18,000 trust certificates, which, by stipulation, have a value of $30 each, or a total value of $540,000. This means that for each share of Bankers the taxpayer received property worth $3,000; consequently the amount realized on the exchange is not in dispute. The taxable gain is computed by subtracting from the amount realized the basis of the stock exchanged. This property was acquired prior to March 1, 1913, and the parties agree that the March 1, 1913 value is higher than the adjusted basis to that date. Therefore we are able to focus our attention on a single issue: What was the fair market value of Bankers' stock on March 1, 1913? This will be the basis for computing the gain. 26 U.S.C.A. § 113(a) (14).

Pinpointing the issue does not in itself solve our difficulties. The valuation of an intangible asset as of a certain date is one of the most complex problems with which courts are forced to deal. In legal appraisals the problem of value is often obfuscated by an inaccurate or insufficient definition of value as the "fact to be found". We can derive from the substantive law only formal definitions, so broad as to leave the close questions of meaning entangled with inquiries as to the relevance and weight of evidence. For instance, the present Revenue Code provides that all property, except inventories, should be appraised at "fair market value". 26 U.S.C.A. § 113 (a) (1) to (22). The ambiguities of this definition of value become immediately apparent. What is the "market" value is not always the "fair" value, and vice versa. In many situations there is no market for the property in question. What test should govern then? The law tells us that fair market value is a question of fact and in determining the March 1, 1913 fair market value of stock in a corporation due regard should be given to the fair market value of the corporate assets on that date. 26 U.S. C.A. § 113(a) (14); Treas.Reg. 111, Sec. 29-113(a) (14)-1(c). Let us assume that this standard removes all the confusion as to exactly "what value" we are searching for. The appraisal of the stock in question is still fraught with difficulty. "This is necessarily true because valuations involve economic prophecies based on a complex and highly controversial technique of inferences from the known to the unknown." See I Bonbright, Valuation of Property, Chap. VII, p. 127.

There is little dispute in this case with respect to the known. The assets of the corporation, the insurance in force, the dividends paid, the capital contributions, and many other factors which might be given weight in determining the value of the stock, are not contested. Most of these facts have been stipulated. The difficulty arises in crossing the transcendental divide from the known to the unknown. How much weight, if any, should each of the above factors be given in solving our problem? What formula should be used? In brief, we are asked to criticize these "highly controversial techniques of inferences" and accept the most reasonable. The court, recognizing the insurmountable difficulties of the task, aware of its incapabilities in the field, but obligated by virtue of its authority, has analyzed, in the best manner at its disposal, the maze of evidence and myriad of confusing formulae introduced at the trial to aid in the solution of the problem.

We may start with the basic, but somewhat empty, proposition that fair market value is the price which a willing and informed purchaser, under no compulsion to buy, would pay for an article to a willing and informed seller, under no compulsion to sell. Olson v. United States, 292 U.S. 246, 257, 54 S.Ct. 704, 78 L.Ed. 1236. Actual sales are good evidence of the market, but in this case we are dealing with the stock of a closely held corporation and there were no actual sales at or near March 1, 1913. Of course, such sales are not essential to the determination of market value. As Judge Woodrough points out in Helvering v. Kendrick Coal & Dock Co., 8 Cir., 1934, 72 F.2d 330, 333: "To ascertain the fair market value of property, as the Treasury Regulations above quoted import, it is not necessary that the property actually shall have been sold in a market. Where personal property is sold in a definite and established market, or changes hands for money so regularly that a market price for it is created or maintained, it is obvious that it must have a fair market value. When the question arises as to its fair market value in litigation, the question merely is as to the price it commanded in the market at the particular time. Where, however, there is no such market, but the property has an intrinsic value, then the evidence must show what price that intrinsic value would command on a market where willing buyer and willing seller met." With this in mind, we shall consider the first method introduced at the trial to prove the fair market value of Bankers' stock on March 1, 1913.

I Valuation of Assets Underlying Stock

A common method of valuing stocks which are not ordinarily sold on the open market is to determine the value of the tangible assets underlying the stock and then assign each share its proportionate part of these assets. See 10A Mertens, Law of Federal Income Taxation, Sec. 59.26-59.28, p. 55, and the multitude of cases cited. We are aware of the weak assumption on which this formula is based, i. e. equality between the so-called asset values and share values. II Bonbright, Valuation of Property, p. 1056. However, since both the Internal Revenue Code and the court decisions have indicated there is some merit in this method of valuation, we have carefully considered the plaintiff's evidence along this line. Both Mr. Lounsbury and Mr. Best gave expert opinions as to the value of the stock. These opinions were based upon the value of the insurance in force, the stockholder's equity in the deferred dividend reserve, the capital contributions, and finally the stockholder's interest in certain surplus. The court recognizes the expert skill of these witnesses and is constrained to accept, as far as credible, their testimony in the matter. But, in view of the slight divergence in their conclusions, we deem it necessary to reconsider the factors upon which their opinions are based.

(a) Deferred Dividend Reserve. On December 31, 1912, Bankers had a deferred dividend reserve of $1,464,910. The question arises as to what extent, if any, this reserve should be considered in valuing the assets of the corporation for the purposes of computing the fair market value of its stock. In the case of a mutual company the entire reserve should be considered since all the surplus funds belong to one group, the policyholders. Duffy v. Mutual Benefit Life Insurance Co., 272 U.S. 613, 47 S.Ct. 205, 71 L.Ed. 439, held that legally required reserves constitute an investment of capital for the purpose of determining the excess profits tax limitation. Moncure v. Atlantic Life Insurance Co., 4 Cir., 1930, 44 F.2d 167, extended this doctrine to stock as well as mutual companies. It should be noted, however, that these cases do not quite cover the situation under consideration. It is not a question of whether the reserve is invested capital for the purpose of ascertaining the excess profits tax, but rather a question of the consideration which a willing purchaser would give this reserve item in determining a fair price for the corporate stock. In a stock company there are obviously two conflicting interests in a reserve which is "set apart, apportioned, provisionally ascertained, calculated, or held awaiting apportionment upon certain deferred dividend policies". The evidence indicates that, in the discretion of the corporate directors, the assets underlying the reserve could be used for the benefit of the stockholders as well as the policyholders. There was a fixed liability to neither. See New York Life Insurance Company v. Bowers, 283 U.S. 242, 245, 51 S.Ct. 399, 75 L.Ed. 1005. Distinguish Lucas v. Alexander, 279 U.S. 573, 49 S.Ct. 426, 73 L.Ed. 851, 61 A.L.R. 906, in which the insured was given an option at the end of a certain period of receiving on each policy the sum of $50,000 "and in addition the cash dividend then apportioned by the company". Exercise of this option would to a certain extent fix the liability of the company to the policyholder. However, merely because one policyholder has an ascertained interest in the reserve, this does not mean that the entire reserve should be considered as a fixed liability to policyholders; the decision in Lucas v. Alexander is not quite that broad.

A willing purchaser, aware that the assets underlying the deferred dividend reserve are primarily available for the protection of the policyholders even though they may also be used for the stockholders, would certainly value the assets at less than full value in determining a fair price for the stock. How much less we can not say. Mr. Lounsbury testified that the reserve should be valued at only 30.6% of its total value. In other words, the reserve should be considered an asset to the extent of $479,187.74. This figure is...