SCOTUS Reports

Tag: stock valuation

  • McMillan v. Commissioner, 4 T.C. 263 (1944): Valuation of Stock Gifts in Large Blocks for Gift Tax Purposes

    McMillan v. Commissioner, 4 T.C. 263 (1944)

    When valuing large blocks of publicly traded stock for gift tax purposes, the fair market value should reflect the impact of the block’s size on the market, considering methods like secondary distribution or sales over a reasonable period, rather than assuming a single-day open market sale.

    Summary

    The case concerns the valuation of Montgomery Ward & Co. and United States Gypsum Co. stock that the petitioner gifted to trusts for his daughters and their husbands. The Commissioner assessed gift taxes based on the mean between the highest and lowest quoted selling price on the date of the gifts. The petitioner argued that the large blocks of stock should be valued considering the impact of their size on the market, specifically through secondary distribution. The Tax Court determined that for gift tax purposes, there were four separate gifts, but that valuation should consider how such large blocks would realistically be sold, not on a single day on the open market.

    Facts

    The petitioner made gifts of Montgomery Ward & Co. and United States Gypsum Co. stock on December 31, 1940, placing the stock in trust for his two daughters and their respective husbands. The total gift consisted of 26,000 shares of Montgomery Ward and 16,000 shares of Gypsum stock. The trust agreements specified separate trusts for each daughter and her husband, with each trust receiving half of the stock. The stock was publicly traded. The Commissioner determined the value of the stock based on the average of the high and low trading prices on the date of the gift.

    Procedural History

    The Commissioner assessed gift taxes based on a valuation of the stock using the average trading price on the date of the gift. The petitioner contested the Commissioner’s valuation in the Tax Court, arguing that the valuation should reflect the impact of the large block size. The Tax Court reviewed the Commissioner’s determination.

    Issue(s)

    1. Whether the gifts should be considered as one, two, or four separate gifts for valuation purposes under gift tax statutes.
    2. Whether the fair market value of the stock should be determined based on the mean between the highest and lowest quoted selling price on the date of the gift, or whether the size of the stock blocks necessitates consideration of alternative valuation methods.

    Holding

    1. Yes, because the trust instruments specifically created separate trusts for each daughter and her husband, the gifts should be considered four separate gifts for valuation purposes.
    2. No, because the sheer size of the stock blocks would have a depressing effect on the market if sold at once, the fair market value should be determined considering alternative methods like secondary distribution or sales over a reasonable period.

    Court’s Reasoning

    The court reasoned that the trust agreements explicitly created separate trusts for each daughter and her husband, indicating the donor’s intent to make individual gifts to each beneficiary. Citing Helvering v. Hutchings, the court emphasized that the number of donees is determined by the trust instrument. Regarding valuation, the court acknowledged the Commissioner’s reliance on regulations dictating the use of average trading prices for listed stocks. However, the court also recognized the principle that the size of the block can impact the per-share value, citing Helvering v. Maytag. The court stated that “the correct criterion is the fair market value of all of the stock comprising the gift, not merely a single share thereof.” The court found that selling such large blocks on the open market on a single day would have demoralized the market. Instead, the court considered the likelihood of secondary distribution or sales over a reasonable period. The court considered expert testimony and the trend of prices to determine the fair market value, which was lower than the Commissioner’s assessment.

    Practical Implications

    This case provides guidance on valuing large blocks of stock for gift tax purposes. It highlights that the size of the block is a critical factor that cannot be ignored when valuing stock gifts, particularly when dealing with significant holdings that would affect market prices. Practitioners must consider alternative valuation methods beyond the simple average of high and low trading prices, such as secondary distributions or sales over a reasonable time frame. The case emphasizes the importance of presenting expert testimony to support alternative valuation methods. It also reinforces the principle that gift tax is applied to the donee rather than the trust itself, solidifying the legal implications of clearly drafted trust documents that clearly outline the intended beneficiaries. Later cases would cite this one when considering blockage discounts.

  • McCann v. Commissioner, 2 T.C. 702 (1943): Valuing Restricted Stock Gifts at Book Value

    2 T.C. 702 (1943)

    When stock is subject to a binding agreement requiring sale back to the corporation at a defined book value, the value of the stock for gift tax purposes is limited to that book value, regardless of other valuation factors.

    Summary

    The case concerns the valuation for gift tax purposes of shares of stock in McCann-Erickson, Inc., gifted from one employee to another. The stock was subject to restrictions outlined in the company’s bylaws, limiting ownership to employees and requiring that the stock be sold back to the corporation at a defined book value upon termination of employment. The Tax Court held that the value of the stock for gift tax purposes was limited to the book value due to the restrictions, reversing the Commissioner’s higher valuation based on other factors such as net worth and earning power.

    Facts

    Harrison K. McCann gifted 2,500 shares of Class B stock of McCann-Erickson, Inc. to his wife on November 27, 1939. Both McCann and his wife were employees of the corporation. The Class B shares were incentive shares issued only to employees. The company’s bylaws restricted ownership of the shares to employees only. Upon termination of employment, the employee was required to sell the shares back to the corporation, and the corporation was obligated to purchase them, at a price equal to the book value at the end of the following month. The certificate of incorporation prevented an employee-shareholder from assigning shares to another employee except by special permission of the board of directors, which was granted in this case.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in McCann’s gift tax for 1939, increasing the valuation of the stock from $89,887.50 to $219,400. McCann challenged the Commissioner’s determination in the United States Tax Court. The Tax Court reversed the Commissioner’s determination.

    Issue(s)

    Whether the value of the McCann-Erickson, Inc. Class B stock, subject to restrictions requiring its sale back to the corporation at a defined book value, should be valued at that book value for gift tax purposes, or at a higher value based on the corporation’s net worth, earning power, and dividend-paying capacity.

    Holding

    No, because the restrictions on the stock effectively fixed its value at the defined book value, as the shareholder had no market in which to sell the shares at a higher price.

    Court’s Reasoning

    The court reasoned that the value of the Class B shares was controlled by the bylaw restrictions. The employee-shareholder could not sell the shares at their own price because there were no available buyers other than the corporation. The corporation was required to buy the shares at book value, and the shareholder was prevented from asking for more. The court distinguished this situation from cases involving options where the corporation had the right, but not the duty, to purchase the shares. The court stated, “The employee-shareholder had no market in which he could sell at his own price, for there were no available buyers, no matter how willing…There was but one market, comprised of one buyer, the corporation, and the bylaw fixed the price in that market at the prescribed book value and prevented the seller from asking or agreeing upon any more and required the buyer to pay that price.” Therefore, the court held that the customary methods of stock valuation were not applicable, and the value was fixed at the book value.

    Practical Implications

    This case establishes that for gift tax purposes, stock subject to a binding agreement requiring its sale back to the corporation at a defined book value is valued at that book value, regardless of other valuation factors such as the corporation’s net worth or earning potential. This ruling has significant implications for closely held corporations that utilize such stock restrictions as part of their employee incentive programs. Attorneys should advise clients that if such restrictions are in place, the stock’s value for gift or estate tax purposes will likely be limited to the book value defined in the agreement. Subsequent cases have cited McCann to support the principle that restrictions on the transferability of stock can significantly impact its value for tax purposes. It emphasizes the importance of carefully considering and documenting stock restrictions when planning for gifts or estate taxes involving closely held businesses.