Polack v. C.I.R., 03-1295.

• Decision Date: 03 May 2004
• Docket Number: No. 03-1295.,03-1295.
• Citation: 366 F.3d 608
• Parties: Leo J. POLACK, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

366 F.3d 608

Leo J. POLACK, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 03-1295.

United States Court of Appeals, Eighth Circuit.

Submitted: December 18, 2003.

Filed: May 3, 2004.

COPYRIGHT MATERIAL OMITTED

Counsel who presented argument on behalf of the appellant was Kay Nord Hunt of Minneapolis, MN. Glenn R. Kessel and Barry A. O'Neil appeared on the brief.

Counsel who presented argument on behalf of the appellee was Joan I. Oppenheimer, Justice Dept., Washington, D.C. Jonathan S. Cohen of Washington, D.C. appeared on the brief.

Before LOKEN, Chief Judge, WOLLMAN and HANSEN, Circuit Judges.

LOKEN, Chief Judge.

Leo Polack gave 1,040,000 shares of Zip Sort, Inc. nonvoting common stock to his children. On his 1992 gift tax return, he reported $520,000 in taxable gifts, relying on appraiser Gerald Gray's opinion that the shares were worth $.50 each at the time of the gifts. The Commissioner of Internal Revenue valued the shares at $1.65 each and assessed a gift tax deficiency of $442,200. Polack paid the assessed tax and petitioned the United States Tax Court for a redetermination of the deficiency. At trial, the Commissioner did not contend that the stock was worth $1.65 per share, instead relying on appraiser Brad Cashion's valuation of $.88 per share. The Tax Court found that the evidence supported the Commissioner's valuation and redetermined the gift tax based on a value of $.88 per share. Polack v. Commissioner, 83 T.C.M. (CCH) 1811 (2002). Polack appeals, challenging the court's exclusion of Zip Sort's 1993 and 1994 financial statements and the court's valuation determination. We affirm.

For gift tax purposes, the amount of a gift is the value of the property on the date of the gift. 26 U.S.C. § 2512(a). "The value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts." 26 C.F.R. § 25.2512-1. The value of publicly traded stock is usually based on market prices. See 26 C.F.R. § 25.2512-2(b)(1). For closely held companies such as Zip Sort, stock value is best ascertained by relying on arms-length sales or transfers near the valuation date. See Estate of Fitts v. Commissioner, 237 F.2d 729, 731 (8th Cir.1956). If as in this case there were no contemporaneous transfers of the stock, or of stock in similar companies, the Commissioner and the courts examine a variety of factors in determining the fair market value of the company and its stock on the date in question. See Rev. Rul. 59-60, 1959-1 C.B. 238-39.

Polack purchased Zip Sort in 1987. The company prints bulk mail pieces and prepares them for mailing. Prior to 1991, Zip Sort pre-sorted bulk mail according to United States Postal Service criteria to obtain a four-cent postage discount, which Zip Sort shared equally with its customers. In 1991, the company qualified for a new value-added refund program, in which USPS granted a nine-tenths of a cent discount for pre-sorted bulk mail bearing printed bar codes. Zip Sort retained all the value-added refund income (VARI) that it received in 1991, resulting in the pre-sorting division's first profitable year. In 1992, as a result of customer pressure to share VARI, Zip Sort retained $1,029,674 of its $1,147,100 in gross VARI. Thus, to determine the value of Zip Sort common stock at the time of the December 1992 gifts, it was important to estimate both the amount of future VARI and the portion of future VARI that Zip Sort would share with its customers.

Gerald Gray prepared his valuation report at Polack's request a few months after the December 1992 gifts. Based on discussions in which Polack estimated that Zip Sort would retain only 25-35% of future VARI, Gray projected that Zip Sort's net VARI would equal 3.89% of its future sales, or $350,000 in 1993. Gray also projected that Zip Sort's future capital expenditures would be $200,000 per year from 1993 through 1995 and $150,000 per year thereafter, and he excluded a $170,000 non-operating asset reflected on Zip Sort's unaudited financials because Polack advised that it was substantially offset by a $150,000 debt to Polack.

Brad Cashion prepared his appraisal of the Zip Sort stock many years later, at the Commissioner's request. Cashion's report was based in part on an April 1999 tour of Zip Sort's facilities during which he questioned Dana Rhoads, Zip Sort's president in charge of operations, to gather background information. Based on Rhoads's answers, Cashion projected that, as of December 31, 1992, the date of the gifts to be valued, Zip Sort's gross VARI would equal 18% of future sales and that Zip Sort would retain 50% of its VARI receipts, resulting in net VARI of $810,000 in 1993. Cashion projected Zip Sort's annual capital expenditures to be $100,000 in most years, and he included the $170,000 non-operating asset in estimating the company's value at the time of the gifts.

The appraisals by Gray and Cashion were in substantial agreement except for three significant items — future net VARI, future capital expenditures, and whether to include the non-operating asset. Thus, the decision whether to value the Zip Sort nonvoting common shares at $.50 or $.88 per share at the time of the gifts turned on whether Gray or Cashion made the more credible analysis of these three items. The Tax Court credited Cashion. With respect to net VARI, the court found that Cashion reasonably relied on what Rhoads told him, that Cashion's projection of 50% VARI retention was consistent with Zip Sort's retention of other USPS discounts, and that Gray's "bald projection of $350,000" was not based on credible evidence. With respect to capital expenditures, the court found Cashion's projections "reliable and probative of [Zip Sort's] value" because they were based on Rhoads's statements and Zip Sort's operational history. With respect to the non-operating asset, the court rejected Polack's uncorroborated testimony of an offsetting debt "in the face of the evidence that the asset was listed on [Zip Sort's] balance sheet at a value approximating $170,000."

On appeal, Polack first argues that the Tax Court abused its discretion when it excluded Zip Sort's 1993 and 1994 financial data and refused to permit Polack's expert Gray to use that data to refute or impeach Cashion's 1999 estimate of the common stock's fair market value in December 1992. The Tax Court sustained the Commissioner's objection, observing that "what happened in 1994 is not going to change the Court's view on what was a reasonable appraisal." Counsel for Polack then made the following offer of proof:

The 1993 and 1994 financial statements indicate, in fact, that the income numbers that Zip Sort experienced were less than the appraisal that has been submitted by [Gray], and were over $650,000 less than the appraisal that's been submitted by [Cashion], which would...