Worthen v. United States

• Decision Date: 03 April 1961
• Docket Number: Civ. A. No. 58-1113-F.
• Citation: 192 F. Supp. 727
• Parties: Joseph W. WORTHEN and Boston Safe Deposit and Trust Company, Executors of the Will of Robert M. Stone, Deceased v. UNITED STATES of America.
• Court: U.S. District Court — District of Massachusetts

192 F. Supp. 727

Joseph W. WORTHEN and Boston Safe Deposit and Trust Company, Executors of the Will of Robert M. Stone, Deceased v. UNITED STATES of America.

Civ. A. No. 58-1113-F.

United States District Court D. Massachusetts.

April 3, 1961.

Joseph W. Worthen, Palmer B. Worthen, Roger B. Coulter, Parker, Coulter, Daley & White, Boston, Mass., for plaintiff.

Elliot L. Richardson, U. S. Atty., James C. Heigham, Asst. U. S. Atty., Boston, Mass., L. Lee Philips, Dept. of Justice, Washington, D. C., for defendant.

FRANCIS J. W. FORD, District Judge.

This is an action to recover an alleged overpayment of estate taxes made by plaintiffs as executors under the last will of Robert M. Stone. Two issues are involved: (1) the valuation of certain shares of stock owned by decedent and included in his estate, and (2) the question of whether certain payments amounting to $30,000 made to Stone's widow were properly included in Stone's estate.

Valuation of Stone and Forsyth Stock

Stone and Forsyth Company is a Massachusetts corporation, incorporated in 1914, as successor to a partnership which had carried on the same business for many years before that date. It is engaged in business chiefly as a wholesaler of coarse paper products. In the five years preceding Stone's death 75 per cent of its sales and 60 per cent of its profits were derived from this branch of its business. It also owns and operates a factory in which it manufactures folding paper boxes for sale at wholesale. Since 1950 it has had a wholly owned subsidiary, Symonds Paper Company, which is engaged in a similar wholesale paper business.

Robert M. Stone at the time of his death on November 30, 1953, was treasurer and one of the seven directors of Stone and Forsyth Company. He owned 840 out of the 4,528 shares of its common stock then issued and outstanding. It is the fair market value of those shares as of that date which is at issue here. The executors included these shares in the assets of the estate at a valuation of $100 per share. The Commissioner of Internal Revenue made a deficiency assessment based on his determination that the fair market value was $175 per share.

The stock of the corporation has not been listed on any exchange nor has it been transferred in over the counter transactions. It is owned chiefly by officers and employees. The only transfers in recent years have been between the corporation and its employees or their families at a fixed price which has no significance as to the real market value of the stock.

Where there are no actual sales or bona fide bid and asked prices available from which the value of shares of stock can be determined, the fair market value must be arrived at by a consideration of all the factors which would be taken into account by an informed purchaser and seller. Among such factors are the soundness of the corporation, its business prospects and the economic outlook generally and in the specific industry involved, the net worth of the corporation, the book value of its stock, the earning power of the corporation, its dividend paying capacity, and the value of stocks of corporations engaged in the same or a similar line of business which are listed on an exchange. Internal Revenue Code of 1939, § 811(k), 26 U.S.C. § 811(k); Treasury Regulations 105, § 81.10(a) and (c); Rev.Rul. 59.60, 1959-1 Cum. Bull. 237.

The testimony of each of the parties on this issue consisted chiefly of the testimony of an expert witness who analyzed the various factors to be considered, and on the basis of this analysis arrived at an opinion of the fair value of the stock of the corporation. The differences between the two approaches of these experts can best be understood by briefly outlining the analysis made by each one.

Plaintiffs' expert found that the corporation stock had a book value of $295 per share and a net working capital of $158. In view of the fact that no liquidation or merger was likely and that the corporation did not use its assets as effectively as some comparable companies which had a higher percentage return on invested capital, he concluded that, based on asset value alone, a fair valuation for the stock would be $170 per share.

The earning power of the corporation was next considered. Since the two years immediately preceding Stone's death were years when the corporation's earnings were unusually low, the average over the preceding ten-year period, including these low years and the unusually high years of the Korean war period, was given particular weight as being a more accurate reflection of the prospective earning power of the corporation. On this point in particular the expert relied on the earnings figures of three companies he selected as being fairly comparable to Stone and Forsyth Company, for the purpose of arriving at a value per share of stock which would give a price earnings ratio similar to the price earnings ratio of the companies chosen for comparison. On this basis the expert's valuation of the stock was $125 per share.

In considering his third important factor, yield, plaintiffs' expert gave considerable weight to the fact that although earnings of the company had varied substantially from year to year, the corporation has consistently paid an annual dividend of $7 per share. Concluding from this that the corporation had a fixed policy of paying such a dividend and taking into account the ratio between the price of the stocks of the companies selected for comparison and the dividends paid by them, he fixed the value of the Stone and Forsyth stock on the basis of yield considered alone at $85 per share.

In arriving at a final valuation the expert gave by far the greatest weight to the factor of earnings, while giving what he called moderate weight to the figures derived from net worth and yield, and reached a figure of $123 per share as the intrinsic worth of the stock. In the light of the difficulties which would be encountered in actually selling a minority holding of shares not listed on any exchange or publicly traded, he felt that this intrinsic value should be discounted by about 15 per cent to give a figure of $104 as the fair market value of the stock.

The expert for the government also took into consideration statistics of ten companies which he considered comparable. His list included none of the companies used by plaintiffs' expert. One highly important difference in the procedure of the two experts arises from the fact that government's expert considered that the corporation had an excess investment in United States government securities. On the basis of the holdings of such securities by the companies he used for comparison he concluded that 7 per cent of total tangible assets would be an adequate and normal investment. Holdings beyond this amount he considered excessive, to be treated as a separate element in the valuation of the stock. These government security holdings he computed to be about $60 per share.

The income of the corporation was considered, excluding the income from United States government securities valued separately and also income from the subsidiary. On the basis of the price earnings ratio of the ten companies chosen for comparison, a value for the stock based on earning power was found to be approximately $75 per share. The value of the stock of the subsidiary Symonds Paper Company, Inc. owned by Stone and Forsyth Company was considered separately, being valued in the same way by applying to its income the price earnings ratio of the companies chosen for comparison and valuing separately the holdings of United States government securities considered to be excessive. The result was a valuation for the investment in Symonds of $38.65 per share of Stone and Forsyth stock.

The combination of these three factors produced a total value of $173.65. The expert believed that this should be increased because of the high book value of the stock. By applying the ratio of price to book value of the stocks of the companies selected for comparison to the book value of the Stone and Forsyth stock, he reached a value for the stock on that basis alone of $245 to $248 per share. A similar comparison ratio of the prices of these stocks to dividends paid gave a valuation for the Stone and Forsyth stock of about $107 per share. This figure he considered too low because the earnings record showed a capacity to pay dividends in excess of the $7 dividend which it appears it was the policy of the company to pay. On the basis of all these factors the expert reached a value of $180 per share. This he believed should be discounted at least 10 per cent because of unfavorable factors, chief of which was the lack of marketability. Hence he arrived at a final value for the stock of $163 per share.

The principal differences between the two experts lie in their choice of companies to be used for purposes of comparison and in their handling of the corporation's holdings of government securities.

Clearly no company was found by either side which was perfectly comparable in all respects to Stone and Forsyth. However, the companies used by plaintiff seem to be more closely comparable than those used by the government. Not one of these companies was a wholesaler and only one was a non-integrated converter. Stone and Forsyth was, of course, primarily a wholesaler with a substantial business as a non-integrated converter. None were closely comparable in size. Stone and Forsyth sales, including its subsidiary, were less than $4,000,000 annually while only one of those companies had annual sales less than $13,000,000. The three companies used by plaintiffs' expert, while larger than Stone and Forsyth, were much closer in size than defendant's companies, two of them were engaged in wholesale distribution of paper products and one was an integrated converter of paperboard.

The more important difference, however, lies in the treatment of Stone and Forsyth's holdings of government...