33 T.C.M. (CCH) 1316
EDWIN A. GALLUN, Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
EVELYN J. GALLUN, Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Nos. 2729-73, 2730-73.
United States Tax Court
November 6, 1974
Held: The value of certain stock of a closely held corporation is determined.
Wayne J. Roper, Richard S. Gibbs, and John W. Hein, for the petitioners.
F. Patrick Matthews and Denis J. Conlon, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WILES, Judge:
Respondent has determined the following deficiencies in petitioners' Federal gift tax for the year 1969:
The only issue for decision is the valuation of certain stock of a closely-held corporation that petitioner, Edwin A. Gallun, gave to members of his family. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioners are Edwin A. Gallun (hereinafter referred to as petitioner) and Evelyn J. husband and wife, who resided in Chenequa, Wisconsin, at the time of the filing of the petition herein. On September 29, 1969, petitioner made a gift of 400 shares of common stock of A. F. Gallun & Sons Corporation to members of his family. On April 15, 1970, petitioner and his wife each filed a United States Gift Tax Return for the year 1969 with the district director of internal revenue at Milwaukee, Wisconsin. On these returns petitioner and his wife reported the value of the Gallun stock at $396.24 per share. In his notices of deficiency, respondent determined that the value of the Gallun stock on September 29, 1969, was $661.37 per share. A. F. Gallun & Sons Corporation (hereinafter referred to as the Corporation), a Delaware corporation organized on December 16, 1935 and using a fiscal year ending September 30, is a leather tanning company located in Milwaukee, Wisconsin. In addition to its leather-tanning operation and the land, buildings and equipment pertinent thereto, the Corporation holds a large investment portfolio consisting of stocks and bonds having on September 30, 1969, an aggregate quoted market value of $18,087,263.00. On September 29, 1969, the Corporation had 15,722 shares of common stock outstanding. The Corporation was at all times a closely-held company in that substantially all of its shares were and are held by members of the Gallun family and descendants of the founders of the Corporation or by trusts for their benefit. Prior to the subject gift of the 400 shares of the Corporation, the petitioner Edwin A. Gallun was the largest shareholder in the Corporation, owning then 4,617.5 shares or 28.7 percent of the common stock outstanding. The condensed balance sheet of the Corporation as of September 30, 1969, with comparative figures for 1968, and its earnings statements for the years 1968 and 1969 are as follows:
| Accounts Receivable-Net |
846,686 |
806,167 |
| Inventories |
2,515,804 |
2,387,545 |
| Prepaid Expenses |
15,833 |
32,886 |
| Bonds, at cost |
$ 368,818 |
$ 353,448 |
| Stocks, at cost |
3,347,798 |
4,134,358 |
| Land Contract |
37,233 |
31,201 |
| Life Insurance |
590,457 |
609,787 |
| Property, Palnt & Equipment, |
|
|
| Buildings |
1,333,383 |
1,342,285 |
| Equipment |
1,867,830 |
1,984,536 |
| Depreciation |
2,391,681 |
2,386,569 |
| Total Assets |
$8,707,326 |
$9,474,485 |
| STOCKHOLDERS EQUITY |
1968 |
1969 |
| Notes Payable |
$ 544,500 |
$ 539,000 |
| Accounts Payable |
614,612 |
455,569 |
| Dividend Payable |
47,166 |
94,332 |
| Accrued Expenses |
391,106 |
443,262 |
| Income Taxes |
68,231 |
227,779 |
| Deferred Income Taxes |
$ 130,200 |
$ 138,900 |
| Long Term Debt |
339,326 |
503,800 |
| Common Stock |
$2,660,000 |
$2,660,000 |
| Paid-in Capital |
301,384 |
301,384 |
| Retained Earnings |
4,108,327 |
4,607,985 |
| Less: Treasury stock |
(497,526) |
(497,526) |
| Stockholders Equity |
$8,707,326 |
$9,474,485 |
| Net Sales |
$8,068,937 |
49,705,117 |
| Cost of Sales |
7,103,438 |
8,339,845 |
| Gross Profit |
965,499 |
1,365,272 |
| Administrative Expenses |
778,900 |
907,391 |
| Operating Profit |
186,599 |
457,881 |
| Interest and Dividends |
495,891 |
559,376 |
| Investment Securities |
13,587 |
175,419 |
| Miscellaneous |
58,970 |
174,125 |
| Other Charges |
165,456 |
272,537 |
| Earnings Before Income Tax |
589,591 |
1,094,264 |
| Income Taxes |
104,000 |
233,000 |
| Net Earnings |
485,591 |
861,264 |
| Dividends Paid Per Share |
$ 18.00 |
$ 23.00 |
| beginning of year |
$2,575,072 |
$2,212,667 |
| Add: Net earnings |
485,591 |
861,264 |
| Deduct: Dividends paid |
282,996 |
361,606 |
| of year |
2,777,667 |
2,712,325 |
The following table sets forth pertinent data relating to the Corporation for the periods indicated:
ULTIMATE FINDING OF FACT The fair market value of the stock in issue on the date of the gift in issue was $520.00 per share.
OPINION The only issue for decision is the valuation of 400 shares of stock in the A. F. Gallun & Sons Corporation. Generalized guidelines for such a valuation are contained in section 2031, Internal Revenue Code of 1954, section 20.2031-2(f), Estate Tax Regs., and Rev. Rul. 59-60, 1959-1 C.B. 237. The two expert witnesses offered by petitioner and respondent's expert witness are in agreement that the value of the underlying assets must be emphasized in our determination and that the proper approach is to value first the tannery operation of the Corporation and then value the investment assets held by it. The assets of the tannery operation were valued by petitioner's witnesses at $2,708,900 and $1,470,636. Although we might have anticipated that the respondent's witness would place a higher value on this operation, he has valued it at only $415,000. We find that the value of the tannery operation on September 30, 1969, was $900,000. In arriving at this finding, we have relied only on testimony supporting the two lower valuations. The higher valuation basically represents a computation of the net worth of the tannery operation that we find inappropriate. The tannery operation is one of only a few remaining in the United States and represents an industry that is declining because of foreign competition and the increasing costs of hides. The performance of the tannery operation has been mediocre and it would be difficult to find an investor willing to invest in such an operation. The valuation of $1,470,636 represents the value of the current assets held by the tannery operation. This approach is based on the opinion that the fixed assets of the tannery are worth little. Because of the declining state of the tannery industry in the United States, we believe that any sale of the current assets of the tannery would necessarily be at a discount so that the value of the current assets on the Corporation's books is in excess of the fair market value of the tannery operation. The valuation of $415,000 is based primarily on a comparison of the tannery operation to the operations of Seton Company, a publicly traded corporation that had some leather operations. In our opinion Seton does not provide a good comparison because it made a different kind of leather and also was engaged in chemical operations. Because both of these valuations have certain defects, we have relied exclusively on neither but have taken both of them into account in arriving at our determination. In valuing the investment assets of the Corporation, we first must determine the net asset value of the investment portfolio. We believe that the computation of respondent's witness accurately determines this figure. Respondent's witness observed that the market values of all the stocks and bonds held by the Corporation could be readily determined. He noted, however, that an adjustment for blockage was necessary in the case of two large blocks of stock included in the stock portfolio. He first discounted the market price of those stocks and then took into account the estimated expenses of underwriting a registered secondary public offering. Based on this computation, we find that the net asset value of the investment portfolio was $16,204,439. Our next step in determining the fair market value of the Gallun stock is to determine the proper discount to be applied against this net asset value. The parties urge that we take into account various factors, such a lack of marketability, the retention of income not present in a publicly-traded investment company, the minority interest of the shares being valued and the potential capital gains tax if the stocks and bonds were to be liquidated by the Corporation. The respondent's witness advocated that the net asset value should be discounted by 20 percent to take into account these various factors. Petitioner's first expert witness, Snyder, first discounted the fair market value of the...
