The U.S. Tax Court recently opined on the matter Estate of Aaron U. Jones v. Commissioner of Internal Revenue. Judge Carey Pugh, in the approximately $45 million gift tax case of Jones (the “Estate”) versus the Commissioner of the Internal Revenue (“Commissioner”), sided with the Estate in an apparent repeat of the Estate of Giustina v. Commissioner  (Giustina) decisions. The dispute involved the valuation of minority intertest gifts in two companies, Seneca Sawmill Company (SSC) and Seneca Jones Timber Company, L.P. (SJTC) as of May 28, 2009. SSC was a lumber manufacturer operating technologically advanced dimension and sawmills. SJTC held approximately 1.45 billion board feet of timber over 166,000 acres in western Oregon with an appraised value of $424 million and was subject to $32 million in loans from SSC. SSC, an S corporation, owned a 10% interest in SJTC and served as its general partner. SSC purchased 32% of its logs from SJTC. SJTC practiced sustained yield harvesting and sold, through trading arrangements, approximately 90% of its logs to SSC. SJTC and SSC were joint parties to a third-party credit agreement, and SSC and SJTC transferred money to and from each other in the form of loans/receivables. As of the valuation date, the U.S. was experiencing a severe economic recession, especially in the housing market, which required SSC to reduce production and SJTC to reduce timber harvests to minimize the sale of logs at depressed prices between 2007 and 2009.
In the valuation of SJTC, the Estate’s expert relied on both the Income Approach and Market Approach to value, ultimately concluding on a value of $21 million on a non-controlling, non-marketable basis. Furthermore, the expert concluded on a value of $20 million for SSC, also on a non-controlling, non-marketable basis. The Commissioner’s expert valued SJTC as a going concern using both an Asset Approach and a Market Approach, ultimately concluding on a value of $140 million on a non-controlling, non-marketable basis. The Commissioner did not present an appraisal of SSC. The Commissioner did provide rebuttal testimony to the Estate’s valuation of SSC.
The Court concluded that SJTC had aspects of both an operating company and an investment/holding company, and that an Income Approach may be appropriate. However, citing Giustina, the Court stated that the relative weight to give an Asset Approach should be based on the likelihood that SJTC would sell its timberlands. Furthermore, the Court concluded that SSC and SJTC were so closely aligned and interdependent that in valuing SJTC it is appropriate to take into account its relationship with SSC and vice versa. Thus, the Court concluded that the Income Approach was more appropriate. The Court further ruled in favor of tax-affecting the earnings of SJTC in a dispute that did not involve the experts. The Court noted that the difference between the facts of this case and those presented in Gross v. Commissioner and Gallagher v. Commissioner is that the Estate’s expert more accurately took into account the tax consequences of SJTC’s flow-through status and found that approach more convincing and complete than the zero-tax rate proffered by the Commisioner.
This complex valuation case involved appraisals of minority interests in two unique interrelated companies, one of which owned substantial timber assets generating limited income during a severe downturn in the economy. The facts of this case presented the court with a valuation dilemma that the Court may have felt was already settled in the prior Giustina cases which had similar facts. Therefore, the Court decided to go with the expert that followed the road paved by Giustina and presented appraisals of both of the companies.