Estate of O'Connell v. C. I. R.

• Decision Date: 20 February 1981
• Docket Number: No. 79-7090,79-7090
• Citation: 640 F.2d 249
• Parties: 81-1 USTC P 13,395 ESTATE OF J. E. O'CONNELL, James O'Connell, Executor, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 249

640 F.2d 249

81-1 USTC P 13,395

ESTATE OF J. E. O'CONNELL, James O'Connell, Executor Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 79-7090.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Nov. 4, 1980.

Decided Feb. 20, 1981.

James E. Merritt (argued), Benjamin J. Delancy, Morrison & Foerster, San Francisco, Cal., on brief for petitioner-appellant.

George L. Hasting, Jr., Washington, D. C., argued for respondent-appellee; Gilbert E. Andrews, Washington, D. C., on brief.

Appeal from a Decision of The Tax Court of the United States.

Before SNEED and ANDERSON, Circuit Judges, and EAST ^*, District Judge.

SNEED, Circuit Judge:

This case involves a dispute over the valuation for estate tax purposes of two blocks of stock in close corporations held by the decedent, J. E. O'Connell, at his death. One block is an 80% interest in R. V. Ranch Corporation (R.V.); the other is a 95% interest in Capri Corporation (Capri). The applicable code section is 26 U.S.C. § 2031. The appellant seeks to overturn the valuations fixed by the Tax Court. This court's jurisdiction lies under 26 U.S.C. § 7482 (1976). We affirm in part and reverse and remand in part.

I. THE FACTS

Capri was a holding company whose assets consisted of various pieces of real estate, a portfolio of securities, several non-operating subsidiaries, and a 73% interest in Glacier General Assurance Company. The values of all of Capri's assets, other than its interest in Glacier General Assurance Company (Glacier), were stipulated between the parties. The dispute with respect to the Capri stock centers on the value of Capri's interest in Glacier, and on the method for The disputed issue with respect to the R.V. stock is whether the Tax Court should have valued that stock at a discount from its net asset value per share because the stock was not readily marketable. Taxpayer contends that, because the Tax Court found that the highest and best use of the R.V. land was as an operating cattle ranch, and because that operation had shown a consistent history of losses and had no immediate prospect of profitable operation, and because of costs that would be incurred if the assets were liquidated, the Tax Court should have valued the R.V. stock at a discount from its net asset value per share. Commissioner contends that any potential purchaser would view the purchase of the estate's 80% interest in R.V. as equivalent to the purchase of an 80% interest in the underlying assets, and that, therefore, the Tax Court's denial of any discount for marketability was correct.

valuing Capri's stock relative to its net asset value. The Estate contends that Glacier should have been valued according to a formula which essentially computes its net asset value, whereas Commissioner-respondent contends that the Tax Court's reliance on a capitalization of 1972 earnings was proper. The Estate further contends that the Tax Court should have valued Capri's stock at a discount from its net asset value per share because of various factors that rendered its stock unmarketable. Commissioner contends that the Tax Court's finding, that all of Capri's assets other than its interest in Glacier were readily marketable and, therefore, not deserving of a discount, and that the value for Glacier already contained a discount for the unmarketability of Glacier, was correct and warranted the court's further finding that the proper value for Capri's stock was its undiscounted net asset value per share.

II. HOLDING AND DISCUSSION

We hold that the Tax Court's valuation of Glacier is supported by the evidence. However, we further hold that the Tax Court erred in its interpretation of the legal effect of a contract restricting Capri's assets. That error requires reconsideration of the value of Capri's stock. Taxpayer's claim of error in the valuation of the R.V. stock, on the other hand, is without merit. We therefore affirm in part, reverse in part, and remand for reconsideration in light of this opinion.

A. Valuation of Capri

1. Valuation of Glacier Stock

Taxpayer insists that four errors on the part of the Tax Court mar its valuation of Glacier: First, it erred in rejecting taxpayer's proposed method of valuation by net asset value. Second, even if the Tax Court's selection of a capitalized earnings approach to valuing Glacier were permissible, the court erred in basing that capitalization on only one year's earnings. Third, the trial court used clearly erroneous earnings figures for Glacier in applying its capitalization of earnings approach to the valuation of Glacier's stock. Fourth, the Tax Court erred by failing to follow uncontradicted testimony in the record to the effect that Glacier was a "one man" company. We shall discuss each of these alleged errors.

Method of Valuation. Under this heading the taxpayer argues that its proposed method of valuation by net asset value was standard in the industry, and that, therefore, the court below erred in using another method. Although there is testimony in the record to support taxpayer's position, such testimony was given solely by Mr. Hayden, president of Glacier. R.T. at 198-203, 210-11, 227-30. Further, the statutory standard for evaluating closely held stock incorporates a number of alternative methods of valuation, and merely directs the trial court to consider all relevant methods. 26 U.S.C. § 2031(b) (1976); Rev.Rul. 59-60, 1959-1 C.B. 237. The applicable case law directs the trial court to consider all relevant information, but grants it broad discretion in determining what method of valuation most fairly represents the fair market value of the stock in issue in light of the facts presented at trial. Palmer v. Commissioner, 523 F.2d 1308 (8th Cir. 1975); Righter v. United States, 439 F.2d 1204 (Ct.Cl. 1971); Hamm v. Commissioner, 325 F.2d 934 (8th Cir. 1963); In re Nathan's Estate, 166 F.2d 422 (9th Cir. 1948); Richardson v. Commissioner, 151 F.2d 102 (2d Cir. 1945); Zanuck v. Commissioner, 149 F.2d 714 (9th Cir. 1945); Bank of California v. Commissioner, 133 F.2d 428 (9th Cir. 1943). In light of the testimony of Commissioner's expert valuing the Glacier stock on the basis of capitalized earnings, R.T. at 320-21; Respondent's Exhibit (Resp.Ex.) F at 2-16 to 2-19, and of the wide discretion given the trial court to weigh the credibility of witnesses at trial and to determine the appropriate weight to give various methods of valuation, we do not believe the Tax Court erred in its choice of a method other than net asset value.

Erroneous earnings figures. Taxpayer claims that the trial court used clearly erroneous earnings figures for Glacier in valuing Glacier according to the capitalized earnings approach. This claim is based on the Tax Court's failure to fully adjust Glacier's statutory earnings to reflect the results of the adjustments required by the Montana Insurance Examination of Glacier's accounts as of December 31, 1972, and its failure to adjust Glacier's generally accepted accounting principles (GAAP) earnings at all to accord with that examination. The report of the taxpayer's expert contained an explanation of statutory accounting for insurance companies that indicated that there was a standard relationship between such statutory accounting and GAAP, but it did not provide the details required to transform one set of figures into the other. Pet.Ex. 11, app. X. To preserve his claim of error on appeal, taxpayer's burden was not only to show that the trial court's findings were incorrect, but to provide the information from which correct findings could have been made. Plaut v. Munford, 188 F.2d 543 (2d Cir. 1951); see Mahler v. Commissioner, 119 F.2d 869 (2d Cir.), cert. denied, 314 U.S. 660, 62 S.Ct. 114, 86 L.Ed. 529 (1941). Although there was some testimony by the taxpayer's expert concerning the effect of the adjustments to Glacier's statutory earnings, taxpayer did not supply the figures that it now contends are correct nor did it supply the court below with sufficient information from which to derive correct figures. Taxpayer has not met his burden, and has, therefore, failed to preserve the correctness of the earnings figures for appeal.

Use of one year's earnings. Taxpayer insists that the Tax Court erred as a matter of law in basing its capitalization of Glacier's earnings on earnings of only one year. The applicable standard requires that courts use representative earnings freed of abnormal or non-recurring gains or losses. Plaut v. Munford, 188 F.2d 543 (2d Cir. 1951); White & Wells Co. v. Commissioner, 50 F.2d 120 (2d Cir. 1931). The purpose of requiring the use of representative earnings is to provide a reliable basis for predicting expected future earnings, which are the true indicators of present worth. Rev.Rul. 59-60, 1959-1 C.B. 237, 238-42. The question presented by taxpayer's claim is therefore whether or not Glacier's earnings in 1972 were representative. So long as the trial court's findings on that question are within the range suggested by the evidence, they will not be reversed unless clearly erroneous. Palmer v. Commissioner, 523 F.2d 1308 (8th Cir. 1975); Grace Bros. v. Commissioner, 173 F.2d 170 (9th Cir. 1949); Zanuck v. Commissioner, 149 F.2d 714 (9th Cir. 1945).

A careful review of the record convinces us that we cannot say that the Tax Court's finding was clearly erroneous. The earnings figures found by the Tax Court reflect dramatic increases in earnings on both a statutory and a GAAP basis in the years from 1968 to 1971, followed by a more moderate increase in 1972 on a GAAP basis and a moderate decline on a statutory basis. C.T. at 61. Commissioner's expert, who presented substantial qualifications to the court, Resp.Ex. F at Exhibit I, stated that Glacier's 1972 earnings were the most representative, id. at 2-16. Although the taxpayer's expert disagreed with that conclusion the trial court was not bound to accept the...