In the February 18, 2021, decision in the Estate of Warne v. Commissioner, the U.S. Tax Court (T.C. Memo 2021-17) allowed discounts for lack of control and lack of marketability for majority controlling interests in five real estate holding entities, preferring the approach and analyses presented by the Estate’s expert in rendering its opinion.
When Miriam Warne died on February 20, 2014, she held majority interests, ranging from 72.5% to 100%, in five LLCs holding real estate. Most of the properties held by the companies were subject to long-term ground leases. Warne served as the manager of all of the companies, and the operating agreements of the LLCs gave the majority owner significant powers over the operations of the companies, including the sole right to remove and replace the manager, sell the assets of the company, and dissolve the companies. The remaining owners of the companies consisted of family members.
The trust agreement for the trust holding a 100% interest in one of the LLCs (Royal Gardens, LLC) provided that upon Warne’s death, a 75%-member interest be transferred to a family foundation and the remaining 25% be transferred to a church.
On the estate tax return, the estate listed appraised values of the majority interests (72.5% to 87.432% interests) in four of the companies using a net asset approach and reflecting discounts for lack of full control and lack of marketability. The estate reported the value of its 100% interest in Royal Gardens, LLC, at its net asset value with no discounts. On the return, the estate also listed the charitable donations for the 75% interest donation to the foundation and the 25% interest donation to the church with no discounts.
In its notice of deficiency, the IRS increased the values of the four fractional interests by reducing the discounts and decreased the values of the charitable contributions by applying discounts for lack of control and marketability to the 75% and 25% interests in Royal Gardens, LLC.
For the discounts for lack of control for the majority controlling interest, the experts hired by the taxpayer and the Internal Revenue Service (IRS) used different approaches and data but arrived at similar reduced discounts of 5% and 2%, respectively.
The taxpayer hired a Stout expert, who examined data published in the Mergerstat Control Premium Study. The Mergerstat Study measures control premiums on transactions of publicly traded companies. The expert’s appraisal report compared premiums paid to acquire 50.1% to 89.9% controlling interests with those paid to acquire 90% to 100% interests. Since most publicly traded companies are Delaware corporations, 90% was considered most relevant for the analysis as it represents the threshold necessary to “force” or “freeze” out minority shareholders in Delaware. Therefore, the difference in premiums between these two blocks indicates a discount for controlling interests that lack full control. After considering factors specific to the LLCs such as the nature of their assets and operations and the potential for any dispute from the remaining members, Stout selected a lack of full control discount of 5%.
The IRS’ expert used closed-end funds to calculate the discount for lack of control finding a range of 3.5% to 15.7%, and concluding at the bottom of the range at 2%.
For the discount for lack of marketability, the experts relied on very similar restricted stock data but applied slightly different approaches. Stout examined the data comparing each of the companies to the dataset based on their financial characteristics using a weighted quintile analysis. Due to the ability of the majority interests to dissolve the companies and sell the properties, Stout then further broke down the data to examine the most liquid interests, looking at those transactions with holding periods of six months or less to conclude at a discount of 5% for lack of marketability. In contrast, the IRS expert examined his restricted stock database to determine an average discount of 14.5% and then concluded at 2% discount.
The Tax Court, noting that it had previous ruled no discounts for lack of control should be applied for similar majority controlling interests, stated it would accept a “slight” discount in this case since the experts present such discounts. The Tax Court favored the “sound” data and analysis presented by Stout, finding that the limited number of closed-end fund data holding securities was inappropriate and therefore not applicable. Agreeing with the data presented by Stout, the Tax Court decided on a discount of 4%, slightly below the taxpayer expert’s selected discount of 5%.
The Tax Court also adopted the taxpayer expert’s 5% discount for lack of marketability, noting that it found Stout’s analysis more creditable and that the report was more thorough.
With regard to the charitable transfer, the Tax Court ruled that discounts should be applied to the 75% and 25% interest in the Royal Gardens LLC, even though the entire LLC was contributed by the estate to two charities, stating that “when valuing charitable contributions, we do not value what an estate contributed; we value what the charitable organizations received.”
Several recent cases that have supported significant discounts for lack of marketability for a controlling or a majority interest, but this is the first case with a detailed analysis for the lack of control discount for a majority interest. The case (and this part is not as novel or new) also presents another strong example of how the correct use of the data and a thorough report that tells the appropriate narrative will win the battle of the experts.