Stephanie Osborne-Rodgers

Law & Valuation
Professor Palmiter
Spring, 1999


Text of Paper

Property that is transferred upon death is taxed through the federal estate tax.  The gross estate includes all property owned and any death bed transfers.  In order to determine the amount of the tax, the value of the gross estate must be determined.  The estate is either valued at the date of death or at an alternative date of six months later, if there is a decrease in the value of the gross estate not due to the passage of time.  The value of the estate is to be determined by the fair market value of the property involved.  This can be difficult to determine for certain types of property, such as closely held business interests.

How are interests in a closely held business to be valued for estate tax purposes?
The Internal Revenue Code and regulations promulgated pursuant to the Code set forth factors that should be examined when valuing these interests, such as the value of traded stock of similar business, net worth, outlook of the industry, good will, and numerous other factors.
As determining the value of closely held business interests can be difficult, the Internal Revenue Code and regulations promulgated pursuant to the Code help to determine the way to do this.  According to the Code, the starting point for valuing nontraded stocks and securities is to examine stocks of similar or comparable businesses that are actively traded.  The regulations expand on this by providing other factors, such as the company’s net worth, prospective earning power, dividend paying capacity, good will, economic outlook of the industry, and several other factors.  The formula used, incorporating these factors, will vary on a case by case basis.  Premiums and discounts may also be applied to a stock value.  One example is a control premium, which may be added because controlling interests are worth more than other interests.  Conversely, a minority interest may receive a discount, because buyers are not willing to pay as much for a noncontrolling interest, unless it has the attribute of being a swing vote, in which case it will not be discounted.  Several other conditions may lead to premiums and discounts affecting the value of the interest.  Another condition that factors into the valuation is a buy-sell restrictive agreement  These agreements are only given valuation effect if it is a bona fide business arrangement, if its not a testamentary devicde, and if it is comparable to an arms’ length transaction.
In Estate of Lauder, the United States Tax Court chose not to include a restrictive buy-sell agreement in the valuation of shares of a closely held corporation.  This agreement was created because the Lauders wished to keep Estee Lauder (ELI), the company, in the family.  When Joseph Lauder died, several thousand of his shares of ELI common stock were sold, and the estate and the IRS had a disagreement as to the value of the shares of stock.  During the trial, the Lauders used two business valuation experts to determine the value of the stock at the time the shareholder agreement was put into effect.  Shearson Lehman, the first expert used comparative market valuation, which involves comparing ELI with similar companies whose stock is publicly traded.  The second expert, Dillon, Read, provided an opinion as to what the property discount for lack of marketability should be, using the dividend discount model. This compares the present value of a dividend stream paid by publicly traded cosmetic companies with the present value of a dividend stream paid by private companies.  Several factors were used in this formula, such as the fact that Estee and Leonard are key person and that ELI had lower operating margins than its competitors.  The IRS used two experts as well, Management Planning and Willamette Management Associates.  Management Planning used a comparative valuation method.  Willamette used four valuation methods, the capital market approach, the market data transactional approach, the adjusted net worth approach and the discounted net cash flow approach. The court concluded that the shareholder agreements were enforceable and met the bona fide business purpose required in the Regulations, but found that it was testamentary in nature, and therefore should not be included in the valuation.  The court chose to accept the Shearson Lehman earnings-based approach, but rejected its multiples and all of the lack of marketability evidence and supplied its own figures.  Then the case was remanded in order to determine the fair market value of the stock at Joseph’s death.
In Estate of Hall, the value of stock in the closely held corporation Hallmark in the gross estate needed to be valued.  Hallmark stock ownership was limited to the Hall family, Hallmark employees, and charities. There was an agreement containing stock transfer restrictions, which set the price of the stock as the adjusted book value. This figure also represented the value of employee participation in the profit sharing plan.  Upon Hall’s death, the estate hired two business valuation experts to present evidence as to the value of the stock.  First Boston Corp. chose to compare publicly traded companies who were industry leaders like Hallmark.  Each stock price was discounted in order to produce an approximate private company stock value.  Shearson Lehman was the second expert, and also compared Hallmark to other industry leaders and examined several factors.  The IRS used one expert, PCA.  This expert used a market comparison approach and the income capitalization approach.  However, the market comparison was restricted to the only publicly traded company in the same industry as Hallmark, American Greetings.  The income capitalization approach was used to measure fair market value by  projecting future cash flow tha the asset will generate.  In this case, the court found that the buy-sell agreement was enforceable and binding, and that therefore the fair market value of the stock could not exceed adjusted book value.  The court criticized the IRS’ expert for refusing to consider the buy-sell agreement and for restricting the comparison to American Greetings.  The court chose to adopt First Boston’s valuation analysis of the stock.
Thus, two cases involving the estate of founding members of companies who were industry leaders who owned stock restricted by buy-sell agreements had very different outcomes, showing that stock valuation of closely held companies can be a very difficult and tricky process.



This paper will examine the methodology and techniques used in valuation of closely held business interests in the federal estate tax context.  As a way of introduction, the paper begins with a description of the estate taxation framework.[1] Next the paper will examine the treatment of closely held business assets by the Internal Revenue Code and Regulations.[2]  Lastly, a comparison of two estate tax cases where valuation was disputed are compared and examined.[3]

The Federal Estate Tax System

The federal estate tax is a wealth transfer tax. The tax is measured by the amount/value of the property transferred. It is not a direct tax on the property itself, it is rather a tax on the act of transferring property.[4]  Many taxpayers escape the estate tax, it is imposed only on those estates whose tax base exceeds $650,000.[5] This exemption is scaled to increase annually to a maximum exemption in 2006 of $1,000,000.[6]
The estate tax base consists of the decedent’s gross estate and the taxable gifts made by the decedent after 1976.[7] The gross estate consists of property in which the decedent had an interest in at the time of his death. This includes property owned by the decedent at the time of his death.[8] The Internal Revenue Code takes a expansive view of what constitutes ownership. Included in the gross estate under “property owned” is life insurance policies, future interests, and causes of action for wrongful death as well as real estate and investment property.[9] In essence any type of property is includable in the gross estate if the decedent held a beneficial ownership in the property.[10]
A second element of the gross estate includes Also included are so called “death bed transfers” gifts made by the decedent in contemplation of death.  Designed to combat tax avoidance, Congress has included in the “gross estate” all transfers by the decedent which occur within three years of death.[11]
Because the estate tax is an excise tax on the privilege of transferring property, only the value of the property that is transferred is taxed.[12] Moreover, the statutory framework does not contemplate consideration of the destination of the property.[13]

Valuation Consideration in the Internal Revenue Code and Regulations

The estate tax attaches at the moment of death. Therefore, the value of assets included in the “gross estate” is that of the date of the decedent’s death.[14] The Internal Revenue Code also allows for an alternative valuation date.[15]  Under I.R.C. §2032 an executor can elect to value the all the assets in the estate six months after the date of death. The purpose of this alternative valuation date is to protect estates from sudden declines in market value of the decedent’s assets.[16] Two special rules apply to the election of the alternative valuation date.  First, the alternative valuation date may only be elected if the election actually produces a decrease in both the value of the gross estate and the amount of the estate tax payable.[17] Secondly, changed in value during the six months which are attributable to the “mere lapse of time” will be disregarded.[18] For example, property such as a patent which has a limited life and inevitably loses value with the passage of time.  For such assets the alternative valuation election is not available; these assets are valued as of the date of death.[19]
The valuation process is critical to the estate tax process; it is the value of the property determines the tax rate the estate will be subject to. While the estate tax statutes are not clear on what “value” means or how it is determined. The Regulations are somewhat more helpful.  The Regulations equate “value” with “fair market value.”[20]  “Fair market value” is defined as: “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”[21]  While “fair market value” is seen as the controlling guideline for valuation, the Regulations also contain special rules concerning the valuation of specific types of property--among them: stocks and bonds[22], household effects[23], life estates and future interests[24] and life insurance contracts.[25]

Despite the promulgation of regulations detailing how certain types of property should be valued, very often there is no obvious way to arrive at a “fair market value” for an asset. In this context this paper will examine the methodology used in valuing closely held business interests.
Actively traded business interests represent little challenge in the valuation context. The “willing seller-willing buyer” framework actually works in reality to determine prices every day on financial markets. For example, an estate with 1000 shares of Microsoft stock will value that stock at the mean of the highest and lowest quoted selling prices on the valuation date.[26] This is the easy case because identical property is easily identified and it is routinely traded.
Closely held business interests are vastly more complicated to value.  Because the stock is nontraded using the willing buyer-willing seller analysis is more hypothetical. I.R.C. §2031(b) mandates that the starting point for valuing nontraded stocks and securities is by reference to stocks of similar or comparable businesses that are actively traded. Because this too is a speculative measure, the Regulations expand the aspects of a closely held business that warrant the greatest attention in valuation.
Where stock in a closely held business is being valued, considerations include: the company’s net worth, prospective earning power and dividend paying capacity and “other relevant factors”.[27]  “Other relevant factors” include:
The good will of the business; the economic outlook in the particular industry; the company’s position in the particular industry and its management; the degree of control of the business represented by the block of stock to be valued; and the values of securities of corporations engaged in the same or similar lines of business which are listed on a stock exchange. . . . In addition to the relevant factors described above, consideration shall also be given to nonoperating assets, including proceeds of life insurance policies payable to or for the benefit of the company, to the extent such nonoperating assets have not been taken into account in the determination of net worth, prospective earning power and dividend-earning capacity.[28]
Given the broad array of considerations the Regulations propose when valuing closely held business interests the Internal Revenue Service issued Revenue Ruling 59-60 to act as a guide for the valuation of these assets.[29] As a primary matter the Service recognizes that valuation of closely held business interests is an inexact science and a case-by-case approach is warranted.  Therefore, there is no single formula for accurate valuation.[30]

Premiums and Discounts

In addition to the above factors considered in valuation, there are a number of premiums and discounts that are often applied to a stock value. A “control premium” may be added to the value of the stock. A block of stock which represents a controlling interest in a company has a greater value than the value derived above.[31]  Similarly, a block of stock which represents a noncontrolling minority interest may call for a discount in value.[32]  The rationale behind the discount is that a buyer in the real world would take into account this minority interest when determining a price to pay for the stock.[33] Indeed, the Tax Court has recognized that while the sum of the parts cannot equal more than the whole- that is the majority block with the control premium and the minority block with the discount, should not equal more than 100 percent, the sum of the parts can equal less than 100 percent.[34]
Even where a block of stock represents a minority interest a discount is not always warranted. Consideration must be given to “swing vote” attributes. The value of a minority interest may be increased where it can be coupled with another minority block to create control of the business. In this case a “swing vote” attribute can effectively offset an otherwise allowable minority discount.[35]

The Internal Revenue Service and Courts recognize that often the willing buyer- willing seller approach can lead to unrealistically high values, as such a lack of marketability discount is often applied.[36]  Reasoning that investors seek out assets which are easy to sell and which have a ready or existing market. Accordingly, interests which would be difficult to sell are given a discount.[37]  The purpose behind this discount is to equalize an investment in closely held stock with stock that is publicly traded.[38]

In certain situations, a “key person” discount will be allowed. The IRS defines a “key person” as an individual whose contribution to a business is so significant that there is certainty that future earning levels will be adversely affected by the loss of the individual.[39] The loss of a “key person” can have a depressing effect on stock values. Such a discount will be applied only when: 1) whether the claimed individual was actually responsible for the company’s profit levels; and 2) if there is a key person, whether the individual can be adequately replaced.[40]

Buy-Sell Agreements

Often, especially with family controlled businesses, restrictive buy-sell agreements are entered into with regard to the disposition of stock. Such agreements typically give existing shareholders, the corporation and or the board of directors the “right of first refusal” on the sale of securities. Along with this “right of first refusal” the agreements typically have a fixed price for the stock or a formula used to derived the selling price. The idea behind this arrangement is that it replicates what a willing-buyer would spend—that is, a willing buyer would never pay more than the restriction price.[41] Because Congress sees this arrangement as inherently suspect, an restrictive agreement will not be given valuation effect unless:
a)the restriction must be a “bona fide business arrangement.”
b)the restriction must not be a testamentary device designed to transfer property to the decedent’s family
c)the terms of the restriction must be comparable to the arrangements that would be entered into in an arms’ length transaction.[42]
Real World Examples of Buy-Sell Agreements and Valuation
Given the factors considered by courts in valuation of closely held businesses, including discounts and premiums the next section of the paper will examine how and when buy-sell agreements will be given valuation effect. Two cases have been chosen as examples, both represent closely held businesses which at the time of valuation were leaders in their respective industries.

A.  Estate of Lauder

In Estate of Lauder,[43] the United States Tax Court refused to give valuation effect to a restrictive buy-sell agreement of shares of a closely held corporation. At the time of his death in 1983, Joseph H. Lauder was the executive chairman of the board of directors and treasurer of Estee Lauder, Inc.(ELI)[44] Cofounded with his wife Estee, after World War II, the company was incorporated in 1958.  ELI created a niche by selling cosmetics and skin care products exclusively to high-end department and specialty stores. Sons Ronald and Leonard joined the business in the 1960’s. The company at the time of the case had three major operating divisions, Estee Lauder U.S.A, Clinque, and Estee Lauder International. The Lauders shared the belief that ELI should remain in the family.[45]
On May 28, 1974 the Lauders and ELI executed a “Shareholder Agreement”[46] The agreement outlined a right of first refusal to the ELI or other shareholders if a shareholder intended to sell any shares. The agreement also covered the death of any shareholder- the shares would be offered first to ELI and other shareholders.  The Agreement further, outlined the purchase price for the shares as the “net per share book value of such shares (excluding any value for all intangible assets, such as goodwill, etc.).”[47] The book value was to be determined by the last audited annual statement of ELI preceding the date of sale or the date of death. The Agreement also stipulated that the book value should be reduced by the amount of any dividends paid subsequent to the last financial statement and before the stock sale, and adjusted for unrecorded tax refunds or deficiencies.[48] Leonard arrived at the book value formula and did not consult a professional business appraiser. The Agreement was amended in 1976, but did not significantly change the agreement. Again the Lauders did not consult a valuation expert.
At Joseph’s death, his estate sold 6756 shares of ELI common stock to ELI at $4111 per share. On the estate tax filing the date of death value of all stock was fixed at $29,050,800 ($4300/share).  The Internal Revenue Service determined that the date of death value of the stock was $89,517,000 ($13,250/share) and issued a notice of deficiency.
Expert Valuation Testimony
The Lauders employed two experts in business valuation at the subsequent trial each were tasked with valuing the stock at the time of the two shareholder agreements. Shearson Lehman relied on the comparative market valuation method to value the ELI stock. This method involves comparing ELI’s financial and operating performance with that of similar companies whose stock is publicly traded. In making the comparison to other companies Shearson Lehman used the Price/Earnings ratio (the current market price per share divided by earnings per share).[49]  Shearson Lehman selected several companies for comparison among them: Avon, Del Laboratories, Faberge, Helene-Curtis, La Maur, Mary Kay, Noxell and Revlon.  Based on the company comparisons, Shearson Lehman concluded that had ELI been publicly traded at the time of the agreements, it would have been valued at multiples of 9 and 9.5 times it most recent earnings. With these multiples the stock would have traded at $2,025.18 and $2727.15 per share respectively.  These share prices were discounted by 50 percent due to lack of marketability yielding prices per share of $1,012.59 and $1363.58 as of 1974 and 1976.[50]
A second expert used by the estate was Dillon, Read. Dillon, Read provided to the court an opinion as to the proper discount for lack of marketability. In concluding that the stock would trade on the public market at a discount of 60 to 70 percent, the expert used the dividend discount model.   This model compared the present value of a dividend stream normally paid by publicly traded cosmetics companies with the present value of a dividend stream paid by a private company (assumed to be 25 to 30 percent). This formula is thought to represent what level of return is demanded by investors. Dillon Read took into consideration several factors in reaching its conclusion: 1) Estee and Leonard are considered “key persons”; 2) ELI had lower operating margins than its competitors 4) ELI limited is distribution to high end stores; and 5) ELI was highly leveraged in comparison to the cosmetics industry as a whole.[51]
The IRS also employed two experts, Management Planning and Willamette Management Associates.  Management Planning’s valuation analyst used a comparative valuation method to determine the multiples to use in valuing the ELI stock. Among the ratios used were: price to book value, price to latest 4-year weighted average earnings, price to latest 4-year weighted cash flow, price to latest year earnings, price to latest year cash flow, price to latest year dividends, and dividends to latest 4-yar weighted average earnings. Criteria used to select the companies included the availability of financial information and those with common stock publicly traded at at least $5/share.
Dillon, Read concluded that ELI was not dependent on a key person, company size was not a significant factor and that ELI had a superior rate of return on equity which offset any negative effect from its relatively lower profit margins. The public market value for the ELI common stock was arrived at by “subtracting the value of ELI preferred stock from the figure representing ELI’s aggregate equity value.”[52] This formula produced stock prices in 1974 of $4,014 (voting)and $3,823(non-voting); in 1976 $4,661 (voting) and $4,439 (non-voting). After applying a 25 percent discount for marketability the share prices were: 1974 $3,000 (voting) and $2,900 (non-voting); in 1976 $3,500 (voting); and $3,300 (non-voting).
The IRS also employed another expert, Willamette Management Associates. This firm valued the stock using four valuation methods: the capital market approach, the market data transactional approach, the adjusted net worth approach and the discounted net cash flow approach. The figures from each formula produced the value of a controlling equity interest in ELI.  These figures were averaged. To arrive at a stock value the expert applied a 10 percent discount for lack of marketability and a 5 percent “key person” discount. Additionally a 30 percent discount for the descendant’s minority interest was applied. The resulting values were $2,632 (voting) and $2,393 (nonvoting) in 1974. In 1976, the expert concluded that the values would have been $3,261 (voting) and $2,964 (non-voting).

Court’s Treatment of the Valuation Evidence

The Court concluded that the agreements were enforceable against the decedent during his life and upon his death.  Further the court concluded that a desire to maintain family control of a business through buy-sell restrictions may serve the bona fide business purpose required in I.R.C. §2703(b)[53]

The Court concluded that the agreements did serve a legitimate business purpose but the agreements were testamentary in nature. In arriving at the conclusion the court focused on the arbitrary nature of the book value formula and the lack of an independent valuation or appraisal at the time of the shareholder’s agreements.
As for the valuation method, the court embraced the Sherson Lehman earnings-based approach. It accepted the comparative valuation formula with its emphasis on price/earnings ratios of competitors. However, the Court rejected the multiples of 9 and 9.5. The court noted that the distribution strategy of marketing exclusively to high-end department stores was not a negative factor and that the company was a leader in that portion of the market. The court reasoned that the price/earning multiples should be 11 and 12.5 for 1974 and 1976 respectively. As a further matter, the court rejected all of the lack of marketability evidence and concludes that a 40 percent discount is appropriate.[54] The court concludes that the ELI stock would have sold for $1,485.13 and $2,153.02 in 1974 and 1976 respectively.  This is in contrast with the estate’s values of $614.70 and $1,212.70.  The court held that further proceedings were in order to determine the fair market value of the stock at the decedent’s death, the case was therefore remanded.
B.  Estate of Hall
Founded in 1910 by Joyce C. Hall, Hallmark Cards was incorporated in 1923.[55]  Hall served as the chairman of the board of the industry leader in greeting cards.[56]  Hall died in 1982.  His executor filed an estate tax return.  The gross estate included 70,083,000 shares of class C common stock and 1,797,000 certificates of participating interest in a voting trust of Hallmark class B common stock. The class B stock was valued at $187835/share for a total of $131,640,403.05. The certificates for the class C common stock were valued at $reported In addition to various greeting card lines and gift 98157/share for a total of $3,560,881.29.  The Internal Revenue Service issued a notice of deficiency in the amount of $201,776,276.84; the IRS determined that the class C common stock was undervalued by $167,614,006.95and the interests in the class B stock were also undervalued by $4,507,648.71.[57]

In addition to greeting cards and gift wrap the company had in the 1970’s began a course of diversification acquiring a costume jewelry company, a picture frame manufacturer. There was also a retail division and a real estate development project in Kansas City, the Crown Center.[58]
For Hall keeping Hallmark a private corporation was a top priority. Stock ownership was limited to the Hall family, Hallmark employees and charities.[59] As of the valuation date Hallmark had three classes of outstanding stock: class A preferred stock, class B common stock and class C common stock. Class A preferred stock, a non-voting stock, was held by the Hallmark Employee Profit Sharing Plan and participating employees.[60]  Class B common stock was the only voting class of common stock. Class C common stock was a non-voting common stock. [61]

Stock Transfer Restrictions

In 1963, certificates representing all the shares of class B common stock were deposited in a trust indenture. Beneficial owners of the class B common stock continued to have all the economic benefits of stock ownership including the right to receive dividend payments and the right to vote the shares. [62] The indenture also restricted who the stock could be transferred to. No shareholder could transfer stock to a person not deemed a “permitted transferee” (Hallmark, members of the Hall family) without first being offered to Hallmark and other class B shareholders.[63] The purchase price for class B stock was set forth in the indenture.  The prevailing adjusted book value would be the purchase price and the agreement allowed for an installment purchase of the stock.[64]
In 1974 the decedent and U.S. Trust Company, trustee for the Hallmark Employee Profit Sharing Plan, entered into an agreement which mandated that on Hall’s death U.S. Trust would purchase 2/3 of the decedent’s Hallmark stock.[65]

Adjusted Book Value

In addition to being the purchase price for stock under the restrictive agreements, the adjusted book value represented the value of employee participation in the profit sharing plan.[66] The indenture created the book value formula. Beginning with Hallmark’s book value per share, an adjustment was made for goodwill. Using an average 10 percent return on equity as a benchmark, the goodwill adjustment looked at five year intervals. If the average was above 10 percent a goodwill premium was added; a lower return resulted in a discount.[67] Premiums were added to class B stock because of its voting status and to Class A stock because of its liquidation and dividend preferences.[68]

Expert Valuation Opinions

The Hall estate hired two experts in business valuation to present evidence as to the value of the stock. First Boston Corp. valued all classes of Hallmark stock for the estate at the time of the tax filing, in 1982.[69] First Boston as a preliminary matter identified only one company in the greeting card industry, American Greetings as a comparable company.  Despite the fact that American Greetings was Hallmark’s chief competitor, the expert felt that a comparison with only one company would be insufficient.  As such he selected six other companies for comparison, A.T.Cross Co., a leading manufacturer of writing instruments; Avon Products, the world’s largest manufacturer of cosmetics; Coca-Cola; Lenox Inc., a leading producer of china; and Papercraft, a leader in the manufacture of gift wrap.  The expert choose publicly traded companies who, like Hallmark, were industry leaders. Stock prices (high and low) for each of the comparable companies were complied for the years 1973 to 1982.[70] The stock prices of the comparable companies were discounted by 35 percent to produce an approximate private company stock value.[71]  The expert concluded that the Hallmark formula was a “reasonable estimate of the fair market value of Hallmark stock at the valuation date.”[72]
Shearson Lehman was also employed by the estate. The expert (incidentally the same expert who prepared the Lauder estate values for Shearson Lehman above) also chose to compare Hallmark to other industry leaders including McDonald’s, Annheuser Busch, IBM and Coca-Cola. The expert’s rationale was that such companies were highly regarded in the investment community for management, financial position and leading market position. In assessing value, the expert used a price- to-earnings ratio (the current market price per share divided by earnings per share). Reasoning that the price-to earnings ratio is typically the figure used by investment bankers and investors the expert regarded it as the best reflection of the market’s judgement about future earnings potential.[73] In addition to historical earnings data, the expert considered the state of the national economy, the greeting card industry and Hallmark’s respective place within the industry, and also weighed the possibility of large legal liability for Hallmark (there were numerous legal claims associated with the collapse of concrete walkways in the Hyatt Regency in Crown Center, 114 people were killed and dozens seriously injured[74]).

The price-to-earnings ration arrived at by Shearson was adjusted by 20 percent to account for the negative effects of the Crown Center litigation. The expert arrived at a value of $3.16 per share for all classes of Hallmark common stock. This value was discounted by 36 percent for lack of liquidity, to $2.02 per share.[75] The share value was further reduced because of the restrictions on sale to $1.60 share.[76]

The IRS employed one expert in business valuation, Philadelphia Capital Advisors(PCA). The expert used both a market comparison approach and the income capitalization approach.[77]

Reasoning that American Greeting Cards was the only publicly traded company that had a similar product line and served the same markets, the expert restricted his market comparison to American. Further the expert presumed that there was a functional relationship between price-to-earnings ratios and earnings growth. Based on this “functional relationship” the expert concluded that Hallmark would hold a “market premium” over American Greeting of not less than 118 percent.[78]  The expert further applied a control premium and concluded that based on the market comparison approach the stock would have a value of $8.05 per share.[79]

The income capitalization approach measures fair market value by projecting future cash flow that the asset will generate.[80]  Here the PCA expert added noncash depreciation charges Hallmark’s net income. No adjustments were made for noncash charges for deferred taxes or estimated cash needed for future capital expenditures.[81] Combining an equity discount rate and a debt discount rate, the expert arrived at a cost of capital discount which was applied to the projected cash-flow.

Given these figures PCA arrived at a “weighted average business value” by weighing the market comparison approach by 65 percent; the income capitalization figure by 35 percent.[82] As of the valuation date Hallmark stock was valued at $7.62/share.[83]

The same formulas were used in a separate analysis by PCA to calculate the minority share valuation of the Hallmark shares. This appraisal arrived at a value per share of $4.49. This per share value was discounted by 5 percent to reflect lack of voting rights (for the class A and class C stock) and an additional 5 percent discount was applied to reflect the costs of taking Hallmark public.[84] Arriving at values of$4.27 for minority class C, and 44.49 for class B stock, the PCA expert gave no consideration to the transfer restrictions.[85]

Court’s Discussion of the Valuation Testimony

As a primary matter, the Court rejected the IRS contention that the buy-sell agreement was an estate-planning tool, and the purchase price to set aside the buy-sell agreement did not serve a bone fide business purpose.  Indeed the Court finds that the agreement was enforceable and binding.[86]  While the court refused to hold that the agreement fixed the share price for estate tax purposes, it did conclude that the fair market value of the stock could not exceed the adjusted book value.[87]
While noting that all the experts were qualified, the Court noted that the nature of valuation was inherently imprecise.[88]  The Court criticized the IRS for refusing to allow its expert (PCA) to consider the impact of the buy-sell agreement.  Especially harsh was the Court’s criticism of PCA’s decision to only use one company, American Greetings as a comparable company to Hallmark.[89]  Concluding that a potential investor would never limit his consideration of a stock purchase to only one alternative, the Court rejected the IRS argument that as a matter of law the comparison must be made of companies within the same industry.[90]
In addition to this fatal flaw in the PCA valuation, the Court notes that the “functional relationship” between price-to-earnings ratios and earnings growth, which allowed PCA to arrive at a 118 percent “market premium” was without empirical evidence. Moreover, the Court takes issue with PCA’s income capitalization valuation. The Court notes that PCA used an incorrect definition of cash flow.
PCA used a cash-flow definition that included net income plus depreciation, but did not consider capital expeditures, increases in working capital or deferred taxes. The court also took issue with PCA’s use of a weighted average cost of capital, one that combined equity and debt discount rates, as opposed to using a pure equity discount rate to arrive at the expected returns for an equity investor.[91] Lastly, the Court finds the marketability discount of 5 percent too low, given that a minority shareholder would not be able to force Hallmark to “go public”.  Here the court finds the estate’s marketability discounts more appropriate.[92]
In general approves the valuation techniques of both of the estate’s experts.  The court rejects the discount for the transfer restriction used by Shearson Lehman.  The court concludes that the valuation by First Boston was reasonable and adopts the expert’s valuation analysis of the stock.[93]


Estate of Hall  and Estate of Lauder represent two contemporaneous estate tax valuation cases. The cases bear a number of similarities: both were of decedent’s who founded and took and active role in management of industry leading companies, companies, which were controlled by the decedent’s families, in both cases the restrictive buy-sell agreements and book value played a key role in the valuation debate. However, the cases are markedly dissimilar in their outcome.
The court in Lauder, paid a focused on the testamentary nature of the buy-sell agreements arising from arbitrary book value formulas arrived at by the family.  This arbitrary formula colored the court’s perception of the valuation testimony offered by the estate.  The lesson learned from Lauder is the importance of an independent valuation/appraisal at the time of a restrictive agreement.  This avoids concerns about the agreement being a disguised testamentary device. Moreover, in Lauder the court was confident in rejecting valuation testimony concerning price/earnings multiples and arriving at its own figures.
As a concluding note, Estee Lauder, Inc. did go public in 1992. The company has also acquired a number of cosmetic related companies and remains an industry leader.
In Estate of Hall,  the court focused much less on the testamentary nature of the restrictive stock agreements. Perhaps this is due to the fact that the agreement also governed employee participation in the profit sharing program.  The court was well versed in valuation techniques and was openly critical of the valuation expert hired by the IRS.  Here the lesson is for the IRS, valuation must the court noted include all relevant considerations. The Tax Court noted a number of errors in the IRS valuation analysis. Here the estate was able to avoid a large tax deficiency judgement because it had consulted with experts in valuation, and the conclusions of those experts were deemed by the court to be reasonable.
Hallmark, Inc. remains controlled a closely held corporation.  It is controlled by the Hall family in accordance with the founder’s wishes.


[1]  See infra  notes 4-13.
[2]  See infra notes 13-42.
[3]  See infra notes 42-93.
[4] Regis W. Campfield et al., Taxation of Estates, Gifts and Trusts ¶1049 (20th ed. 1997).  See also , I.R.C. §2001 (1998).
[5]  I.R.C.  s.  6018(a)(1)[6] I.R.C. § 2010 (c)[7] I.R.C. § 6018(a)(4)[8] I.R.C. §2033, §2034[9] Id.
[10]  Treas. Reg. §20.2033-1 (1963).
[11] I.R.C. §2035 (1983).
[12]  Estate of Harrison, T.C. Memo 1987-88.
[13]  Estate of Chenoweth, 88 T.C. 1577 (1987).
[14] Goodman v. Granger, 243 F. 2d 264 (3d Cir. 1957).
[15] I.R.C. §2032
[16] Campfield, supra  note 4 at ¶9013.
[17] I.R.C. §2032 (c)
[18] I.R.C. §2032 (a)(3)
[19] Treas. Reg. §20.2032-1(a)(3) (1994).
[20] Treas. Reg. §20.2031-1(a) (1965)
[21]  Id.
[22] Treas. Reg. §20.2031-2 (1992).
[23] Treas. Reg. §20.2031-6 (1994).
[24] Treas. Reg. §20.2031-7(1994).
[25] Treas. Reg. §20.2031-8 (1974).
[26] Treas. Reg. §20-2031-2(b) (1992). ).
[27] Treas. Reg. §20-2031-2(f) (2) (1992).
[28]  Id.
[29] Rev. Rul. 59-60, 1959-1C.B.237.
[30]  Id. at §3 ¶1.
[31]  Estate of Chenoweth, 88 T.C. 1577 (1987).
[32]  Id. See also, Ward v. Commissioner, 87 T.C. 78, 106 (1986).
[33] campfield, supra note 4 at ¶11,065.
[34]  Estate of Chenoweth, 88 T.C. 1577 (1987).
[35] Tech. Adv. Mem. 9436005 (May 26, 1994). Citing Estate of Bright v. United States, 658 F.2d 999 (5th Cir. 1981).
[36]  Campfield supra note 4 at ¶11,071.
[37]  Central Trust Co. v. United States, 305 F. 2d 292 (Ct. Cl. 1962).
[38]  Estate of Adams, 79 T.C.M. 938, 958 (1979).
[39] Department of the Treasury, Irs valuation Training for appeals officers coursebook, §9-11 (1998).
[40], Id. at §9-12.
[41]  Campfield, supra note 4, ¶11,091.
[42] I.R.C. §2703(b)
[43]  64 T.C.M 1643 (1992).
[44]  I d.
[45]  Id.
[46]  Id.
[47]  Id.
[48]  Id.
[49]  Id.
[50]  Id.
[51]  Id.
[52]  Id.
[53]  Id. Citing Estate of Bischoff, 69 T.C. 32 (1977).
[54]  Id.
[55]  Estate of Hall, 92 T.C. 312, 313 (1989).
[56]  Id. at 314.
[57]  Id at 315.
[58]  Id.
[59]  Id. at 315-6.
[60]  Id. at 315.
[61]  Id.
[62]  Id. at 316.
[63]  Id. at 317.
[64]  Id.
[65]  Id. at 319.
[66]  Id at 320.
[67]  Id.
[68]  Id at 321.
[69]  Id at 324.
[70]  Id at 325.
[71]  Id at 326.
[72]  Id.
[73]  Id. at 328.
[74]  Id. at 315.
[75]  Id. at 330.
[76]  Id. at 331.
[77]  Id.
[78]  Id.
[79]  Id. at 332.
[80]  Id.
[81]  Id.
[82]  Id., at 333.
[83]  Id.
[84]  Id.
[85]  Id.
[86] Id. at 334-5.
[87]  Id. at 335.
[88]  Id. at 338.
[89]  Id. at 339.
[90]  Id . at 340.
[91]  Id. at 341.
[92]  Id.
[93]  Id. at 342.