Gift Tax Valuation Update

Transfers between relatives in a closely held corporation

by Jeff Faust, AVA

Huber v. Commissioner, TC Memo 2006-96 (May 9, 2006)

Owners of the J.M. Huber Corp. made gifts of stock to various family members between 1997 and 2000.  The prices used in these transactions were based on an independent valuation that contained a substantial discount for lack of marketability.  The IRS challenged the valuation stating that the company was undervalued and presented significantly lower marketability discounts.

The IRS’ argument was that the taxpayer did not offer the shares for sale to the public and thus failed to obtain the optimum price.  The Court rejected the notion that Huber must offer the shares to the public in order to receive a fair price, noting that, “Courts have long recognized the rights of shareholders in closely held companies to remain private…Further, respondent's assumption that offering a stock to the public would have garnered a higher price is purely hypothetical.”

Another aspect of the IRS’ attack was the lack of negotiations between buyers and sellers suggesting that there was a lack of intent to realize the best price for the shares.  The Court also rejected this, saying, “Respondent fails to cite any case law that holds that negotiation is a necessary element of an arm's-length transaction. In fact, the weight of authority is to the contrary.”

Although this case appears to be a clear victory for clients wishing to make gifts based on independent valuations, it is important to point out here that the valuations in this case were also used for other transactions involving non-profit organizations and redemptions by the company.  Due to the fact that multiple transactions used the price determined in the independent reports, rather than just for gift tax purposes, it appeared unlikely, according to the Courts, that the other parties who used the valuation would “accept an artificially low valuation of the Huber stock so that a few people who may or may not be related to them can pay less estate tax.”  Therefore, even though the Court solidified the rights of shareholders in private companies, it remains critical that the results of a valuation for gift tax purposes be fair for not only the shareholders making the gifts but for other types of transactions as well.

For questions or comments, please feel free to contact Jeff Faust at (510) 797-8661 x249 or jfaust@groco.com