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Rev. Rul. 59-60
SECTION 2031. - DEFINITION OF GROSS ESTATE
26 CFR 20.2031-2: Valuation of stocks and bonds.
(Also Section 2512.) (Also Part II, Sections 811 (k), 1005, Regulations 105, Section 81.10.)
1959-1 C.B. 237; 1959
In valuing the stock of closely held corporations, or the stock of corporations where market
quotations are not available, all other available financial data, as well as all relevant factors
affecting the fair market value must be considered for estate tax and gift tax purposes. No general
formula may be given that is applicable to the many different valuation situations arising in the
valuation of such stock. However, the general approach, methods, and factors which must be
considered in valuing such securities are outlined.
Revenue Ruling 54-77, C.B. 1954-1, 187, superseded.
SECTION 1. PURPOSE.
The purpose of this Revenue Ruling is to outline and review in general the approach, methods and
factors to be considered in valuing shares of the capital stock of closely held corporations for
estate tax and gift tax purposes. The methods discussed herein will apply likewise to the valuation
of corporate stocks on which market quotations are either unavailable or are of such scarcity that
they do not reflect the fair market value.
SEC. 2. BACKGROUND AND DEFINITIONS.
.01 All valuations must be made in accordance with the applicable provisions of the Internal
Revenue Code of 1954 [*2] and the Federal Estate Tax and Gift Tax Regulations. Sections
2031(a), 2032 and 2512(a) of the 1954 Code (sections 811 and 1005 of the 1939 Code) require
that the property to be included in the gross estate, or made the subject of a gift, shall be taxed
on the basis of the value of the property at the time of death of the decedent, the alternate date
if so elected, or the date of gift.
.02 Section 20.2031-1(b) of the Estate Tax Regulations (section 81.10 of the Estate Tax
Regulations 105) and section 25.2512-1 of the Gift Tax Regulations (section 86.19 of Gift Tax
Regulations 108) define fair market value, in effect, as the price at which the property would
change hands between a willing buyer and a willing seller when the former is not under any
compulsion to buy and the latter is not under any compulsion to sell, both parties having
reasonable knowledge of relevant facts. Court decisions frequently state in addition that the
hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well
informed about the property and concerning the market for such property.
.03 Closely held corporations are those corporations the shares of which are owned [*3] by a
relatively limited number of stockholders. Often the entire stock issue is held by one family. The
result of this situation is that little, if any, trading in the shares takes place. There is, therefore, no
established market for the stock and such sales as occur at irregular intervals seldom reflect all of
the elements of a representative transaction as defined by the term "fair market value." 238
SEC. 3. APPROACH TO VALUATION.
.01 A determination of fair market value, being a question of fact, will depend upon the
circumstances in each case. No formula can be devised that will be generally applicable to the
multitude of different valuation issues arising in estate and gift tax cases. Often, an appraiser will
find wide differences of opinion as to the fair market value of a particular stock. In resolving such
differences, he should maintain a reasonable attitude in recognition of the fact that valuation is not
an exact science. A sound valuation will be based upon all the relevant facts, but the elements of
common sense, informed judgment and reasonableness must enter into the process of weighing
those facts and determining their aggregate significance.
.02 [*4] The fair market value of specific shares of stock will vary as general economic conditions
change from "normal" to "boom" or "depression," that is, according to the degree of optimism or
pessimism with which the investing public regards the future at the required date of appraisal.
Uncertainty as to the stability or continuity of the future income from a property decreases its
value by increasing the risk of loss of earnings and value in the future. The value of shares of stock
of a company with very uncertain future prospects is highly speculative. The appraiser must
exercise his judgment as to the degree of risk attaching to the business of the corporation which
issued the stock, but that judgment must be related to all of the other factors affecting value.
.03 Valuation of securities is, in essence, a prophesy as to the future and must be based on facts
available at the required date of appraisal. As a generalization, the prices of stocks which are
traded in volume in a free and active market by informed persons best reflect the consensus of the
investing public as to what the future holds for the corporations and industries represented. When
a stock is closely held, is traded [*5] infrequently, or is traded in an erratic market, some other
measure of value must be used. In many instances, the next best measure may be found in the
prices at which the stocks of companies engaged in the same or a similar line of business are selling
in a free and open market.
SEC. 4. FACTORS TO CONSIDER.
.01 It is advisable to emphasize that in the valuation of the stock of closely held corporations or
the stock of corporations where market quotations are either lacking or too scarce to be
recognized, all available financial data, as well as all relevant factors affecting the fair market
value, should be considered. The following factors, although not all-inclusive are fundamental and
require careful analysis in each case:
(a) The nature of the business and the history of the enterprise from its inception.
(b) The economic outlook in general and the condition and outlook of the specific industry in
(c) The book value of the stock and the financial condition of the business.
(d) The earning capacity of the company.
(e) The dividend-paying capacity.
(f) Whether or not the enterprise has goodwill or other intangible value. 239
(g) Sales of the [*6] stock and the size of the block of stock to be valued.
(h) The market price of stocks of corporations engaged in the same or a similar line of business
having their stocks actively traded in a free and open market, either on an exchange or
.02 The following is a brief discussion of each of the foregoing factors:
) (a) The history of a corporate enterprise will show its past stability or instability, its growth or
lack of growth, the diversity or lack of diversity of its operations, and other facts needed to form
an opinion of the degree of risk involved in the business. For an enterprise which changed its form
of organization but carried on the same or closely similar operations of its predecessor, the history
of the former enterprise should be considered. The detail to be considered should increase with
approach to the required date of appraisal, since recent events are of greatest help in predicting
the future; but a study of gross and net income, and of dividends covering a long prior period, is
highly desirable. The history to be studied should include, but need not be limited to, the nature of
the business, its products or services, its operating and [*7] investment assets, capital
structure, plant facilities, sales records and management, all of which should be considered as of
the date of the appraisal, with due regard for recent significant changes. Events of the past that
are unlikely to recur in the future should be discounted, since value has a close relation to future
(b) A sound appraisal of a closely held stock must consider current and prospective economic
conditions as of the date of appraisal, both in the national economy and in the industry or
industries with which the corporation is allied. It is important to know that the company is more or
less successful than its competitors in the same industry, or that it is maintaining a stable position
with respect to competitors. Equal or even greater significance may attach to the ability of the
industry with which the company is allied to compete with other industries. Prospective competition
which has not been a factor in prior years should be given careful attention. For example, high
profits due to the novelty of its product and the lack of competition often lead to increasing
competition. The public's appraisal of the future prospects of competitive industries [*8] or of
competitors within an industry may be indicated by price trends in the markets for commodities and
for securities. The loss of the manager of a so-called "one-man" business may have a depressing
effect upon the value of the stock of such business, particularly if there is a lack of trained
personnel capable of succeeding to the management of the enterprise. In valuing the stock of this
type of business, therefore, the effect of the loss of the manager on the future expectancy of the
business, and the absence of management-succession potentialities are pertinent factors to be
taken into consideration. On the other hand, there may be factors which offset, in whole or in part,
the loss of the manager's services. For instance, the nature of the business and of its assets may
be such that they will not be impaired by the loss of the manager. Furthermore, the loss may be
adequately covered by life insurance, or competent management might be employed on the basis
of the consideration paid for the former manager's services. These, or other 240 offsetting factors,
if found to exist, should be carefully weighed against the loss of the manager's services in valuing
the stock [*9] of the enterprise.
(c) Balance sheets should be obtained, preferably in the form of comparative annual statements for
two or more years immediately preceding the date of appraisal, together with a balance sheet at
the end of the month preceding that date, if corporate accounting will permit. Any balance sheet
descriptions that are not self-explanatory, and balance sheet items comprehending diverse assets
or liabilities, should be clarified in essential detail by supporting supplemental schedules. These
statements usually will disclose to the appraiser (1) liquid position (ratio of current assets to
current liabilitites); (2) gross and net book value of principal classes of fixed assets; (3) working
capital; (4) long-term indebtedness; (5) capital structure; and (6) net worth. Consideration also
should be given to any assets not essential to the operation of the business, such as investments
in securities, real estate, etc. In general, such nonoperating assets will command a lower rate of
return than do the operating assets, although in exceptional cases the reverse may be true. In
computing the book value per share of stock, assets of the investment type should be revalued on
[*10] the basis of their market price and the book value adjusted accordingly. Comparison of the
company's balance sheets over several years may reveal, among other facts, such developments
as the acquisition of additional production facilities or subsidiary companies, improvement in
financial position, and details as to recapitalizations and other changes in the capital structure of
the corporation. If the corporation has more than one class of stock outstanding, the charter or
certificate of incorporation should be examined to ascertain the explicit rights and privileges of the
various stock issues including: (1) voting powers, (2) preference as to dividends, and (3)
preference as to assets in the event of liquidation.
(d) Detailed profit-and-loss statements should be obtained and considered for a representative
period immediately prior to the required date of appraisal, preferably five or more years. Such
statements should show (1) gross income by principal items; (2) principal deductions from gross
income including major prior items of operating expenses, interest and other expense on each item
of long-term debt, depreciation and depletion if such deductions are made, officers' [*11]
salaries, in total if they appear to be reasonable or in detail if they seem to be excessive,
contributions (whether or not deductible for tax purposes) that the nature of its business and its
community position require the corporation to make, and taxes by principal items, including income
and excess profits taxes; (3) net income available for dividends; (4) rates and amounts of
dividends paid on each class of stock; (5) remaining amount carried to surplus; and (6)
adjustments to, and reconciliation with, surplus as stated on the balance sheet. With profit and
loss statements of this character available, the appraiser should be able to separate recurrent from
nonrecurrent items of income and expense, to distinguish between operating income and
investment income, and to ascertain whether or not any line of business in which the company is
engaged is operated consistently at a loss and might be abandoned with benefit to the company.
The percentage of earnings retained for business expansion should be 241 noted when
dividend-paying capacity is considered. Potential future income is a major factor in many valuations
of closely-held stocks, and all information concerning past income [*12] which will be helpful in
predicting the future should be secured. Prior earnings records usually are the most reliable guide
as to the future expectancy, but resort to arbitrary five-or-ten-year averages without regard to
current trends or future prospects will not produce a realistic valuation. If, for instance, a record of
progressively increasing or decreasing net income is found, then greater weight may be accorded
the most recent years' profits in estimating earning power. It will be helpful, in judging risk and the
extent to which a business is a marginal operator, to consider deductions from income and net
income in terms of percentage of sales. Major categories of cost and expense to be so analyzed
include the consumption of raw materials and supplies in the case of manufacturers, processors
and fabricators; the cost of purchased merchandise in the case of merchants; utility services;
insurance; taxes; depletion or depreciation; and interest.
(e) Primary consideration should be given to the dividend-paying capacity of the company rather
than to dividends actually paid in the past. Recognition must be given to the necessity of retaining
a reasonable portion of profits [*13] in a company to meet competition. Dividend-paying capacity
is a factor that must be considered in an appraisal, but dividends actually paid in the past may not
have any relation to dividend-paying capacity. Specifically, the dividends paid by a closely held
family company may be measured by the income needs of the stockholders or by their desire to
avoid taxes on dividend receipts, instead of by the ability of the company to pay dividends. Where
an actual or effective controlling interest in a corporation is to be valued, the dividend factor is not
a material element, since the payment of such dividends is discretionary with the controlling
stockholders. The individual or group in control can substitute salaries and bonuses for dividends,
thus reducing net income and understating the dividend-paying capacity of the company. It
follows, therefore, that dividends are less reliable criteria of fair market value than other applicable
(f) In the final analysis, goodwill is based upon earning capacity. The presence of goodwill and its
value, therefore, rests upon the excess of net earnings over and above a fair return on the net
tangible assets. While the element of goodwill [*14] may be based primarily on earnings, such
factors as the prestige and renown of the business, the ownership of a trade or brand name, and a
record of successful operation over a prolonged period in a particular locality, also may furnish
support for the inclusion of intangible value. In some instances it may not be possible to make a
separate appraisal of the tangible and intangible assets of the business. The enterprise has a value
as an entity. Whatever intangible value there is, which is supportable by the facts, may be
measured by the amount by which the appraised value of the tangible assets exceeds the net book
value of such assets.
(g) Sales of stock of a closely held corporation should be carefully investigated to determine
whether they represent transactions at arm's length. Forced or distress sales do not ordinarily
reflect fair market value nor do isolated sales in small amounts necessarily control 242 as the
measure of value. This is especially true in the valuation of a controlling interest in a corporation.
Since, in the case of closely held stocks, no prevailing market prices are available, there is no basis
for making an adjustment for blockage. It follows, [*15] therefore, that such stocks should be
valued upon a consideration of all the evidence affecting the fair market value. The size of the
block of stock itself is a relevant factor to be considered. Although it is true that a minority
interest in an unlisted corporation's stock is more difficult to sell than a similar block of listed stock,
it is equally true that control of a corporation, either actual or in effect, representing as it does an
added element of value, may justify a higher value for a specific block of stock.
(h) Section 2031(b) of the Code states, in effect, that in valuing unlisted securities the value of
stock or securities of corporations engaged in the same or a similar line of business which are listed
on an exchange should be taken into consideration along with all other factors. An important
consideration is that the corporations to be used for comparisons have capital stocks which are
actively traded by the public. In accordance with section 2031(b) of the Code, stocks listed on an
exchange are to be considered first. However, if sufficient comparable companies whose stocks are
listed on an exchange cannot be found, other comparable companies which have [*16] stocks
actively traded in on the over-the-counter market also may be used. The essential factor is that
whether the stocks are sold on an exchange or over-the-counter there is evidence of an active,
free public market for the stock as of the valuation date. In selecting corporations for comparative
purposes, care should be taken to use only comparable companies. Although the only restrictive
requirement as to comparable corporations specified in the statute is that their lines of business be
the same or similar, yet it is obvious that consideration must be given to other relevant factors in
order that the most valid comparison possible will be obtained. For illustration, a corporation having
one or more issues of preferred stock, bonds or debentures in addition to its common stock should
not be considered to be directly comparable to one having only common stock outstanding. In like
manner, a company with a declining business and decreasing markets is not comparable to one with
a record of current progress and market expansion.
SEC. 5. WEIGHT TO BE ACCORDED VARIOUS FACTORS.
The valuation of closely held corporate stock entails the consideration of all relevant factors as
[*17] stated in section 4. Depending upon the circumstances in each case, certain factors may
carry more weight than others because of the nature of the company's business. To illustrate:
(a) Earnings may be the most important criterion of value in some cases whereas asset value will
receive primary consideration in others. In general, the appraiser will accord primary consideration
to earnings when valuing stocks of companies which sell products or services to the public;
conversely, in the investment or holding type of company, the appraiser may accord the greatest
weight to the assets underlying the security to be valued. 243
(b) The value of the stock of a closely held investment or real estate holding company, whether or
not family owned, is closely related to the value of the assets underlying the stock. For companies
of this type the appraiser should determine the fair market values of the assets of the company.
Operating expenses of such a company and the cost of liquidating it, if any, merit consideration
when appraising the relative values of the stock and the underlying assets. The market values of
the underlying assets give due weight to potential earnings and dividends [*18] of the particular
items of property underlying the stock, capitalized at rates deemed proper by the investing public
at the date of appraisal. A current appraisal by the investing public should be superior to the
retrospective opinion of an individual. For these reasons, adjusted net worth should be accorded
greater weight in valuing the stock of a closely held investment or real estate holding company,
whether or not family owned, than any of the other customary yardsticks of appraisal, such as
earnings and dividend paying capacity.
SEC. 6. CAPITALIZATION RATES.
In the application of certain fundamental valuation factors, such as earnings and dividends, it is
necessary to capitalize the average or current results at some appropriate rate. A determination of
the proper capitalization rate presents one of the most difficult problems in valuation. That there is
no ready or simple solution will become apparent by a cursory check of the rates of return and
dividend yields in terms of the selling prices of corporate shares listed on the major exchanges of
the country. Wide variations will be found even for companies in the same industry. Moreover, the
ratio will fluctuate from [*19] year to year depending upon economic conditions. Thus, no
standard tables of capitalization rates applicable to closely held corporations can be formulated.
Among the more important factors to be taken into consideration in deciding upon a capitalization
rate in a particular case are: (1) the nature of the business; (2) the risk involved; and (3) the
stability or irregularity of earnings.
SEC. 7. AVERAGE OF FACTORS.
Because valuations cannot be made on the basis of a prescribed formula, there is no means
whereby the various applicable factors in a particular case can be assigned mathematical weights
in deriving the fair market value. For this reason, no useful purpose is served by taking an average
of several factors (for example, book value, capitalized earnings and capitalized dividends) and
basing the valuation on the result. Such a process excludes active consideration of other pertinent
factors, and the end result cannot be supported by a realistic application of the significant facts in
the case except by mere chance.
SEC. 8. RESTRICTIVE AGREEMENTS.
Frequently, in the valuation of closely held stock for estate and gift tax purposes, it will be found
that the stock [*20] is subject to an agreement restricting its sale or transfer. Where shares of
stock were acquired by a decedent subject to an option reserved by the issuing corporation to
repurchase at a certain price, the option price is usually accepted as the fair market value for
estate tax purposes. See Rev. Rul. 54-76, C.B. 1954-1, 194. However, in such case the option
price is not 244 determinative of fair market value for gift tax purposes. Where the option, or buy
and sell agreement, is the result of voluntary action by the stockholders and is binding during the
life as well as at the death of the stockholders, such agreement may or may not, depending upon
the circumstances of each case, fix the value for estate tax purposes. However, such agreement is
a factor to be considered, with other relevant factors, in determining fair market value. Where the
stockholder is free to dispose of his shares during life and the option is to become effective only
upon his death, the fair market value is not limited to the option price. It is always necessary to
consider the relationship of the parties, the relative number of shares held by the decedent, and
other material facts, to determine [*21] whether the agreement represents a bonafide business
arrangement or is a device to pass the decedent's shares to the natural objects of his bounty for
less than an adequate and full consideration in money or money's worth. In this connection see
Rev. Rul. 157 C.B. 1953-2, 255, and Rev. Rul. 189, C.B. 1953-2, 294.
SEC. 9. EFFECT ON OTHER DOCUMENTS.
Revenue Ruling 54-77, C.B. 1954-1, 187, is hereby superseded.
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