Holman vs. Commissioner and Valuation Discounts

Holman vs. Commissioner, 130 T.C. No.12 (May 12, 2008), is an interesting case chock full of issues. The court considers whether the transfer of assets constitutes a direct or indirect gift, whether the LP should be treated as analogous to a trust, whether the LP passes the tests of 2703(a) and whether the valuation presented is appropriate. Some issues are addressed in more creative ways than others. One of the most creative is the analysis of the valuation discounts applied.

Expert vs. Expert

It appears the court is simply weighing the testimony of one expert against another and, in many ways, that is true. The result is that the court calculated and applied its own discounts, apparently rejecting the idea of the holding period affecting the discount. In addition, the court’s comment regarding some of the expert testimony may have more merit than intended.

In the world of “Fair Market Value” discounts for lack of control and marketability are included as standard discussions when considering the value of privately held entities. Those discounts dictate a number of factors to consider. The type of entity, the assets held by the entity, the implications of lack of control, the likely holding period of the investment in the entity and the existence of a market for the interest are all key issues. In Holman, the court seems to credit the testimony of one expert because the opposition failed to convince the court his estimation of the discount for lack of marketability was “anything but a guess,” based upon certain widely publicized restricted stock studies. The other expert, to whom the court deferred, based his discount upon the same studies but disregarded anything other than an analysis of the change in discounts for restricted stock over time, based on the change in Rule 144 restriction periods.

Something Different

Two interesting and novel statements emerged. Both the court and the expert, to whom the court deferred, ignored the likely holding period of the actual interest while basing their conclusions on the holding period of publicly traded restricted shares (that analysis in itself is a confirmation that holding period is an important factor). In fact, restricted stock studies depend almost entirely upon the anticipated holding period as the basis for the application of discounts. It is very interesting to base a discount on these studies and then declare there should be no upward adjustment due to the anticipated holding period because it had “little, if any, influence,” presumably because of a buy-back provision in the partnership agreement.

The second novel statement contends that the expert upon whom the court does not rely “could only draw the conclusion that an LP interest is simply not salable, which is not the conclusion that he draws. We do not reject per se (his) reliance on restricted stock studies. We simply lack confidence in the result he reaches given the assumptions he makes.” This implies that, had the expert followed his assumptions to the logical conclusion, the lack of marketability discount is 100% because there will never be a ready market for the interests, which might have given his testimony more weight. Alternatively, had he calculated a discount based upon a holding period dictated by the term of the partnership agreement, which would have been much higher than the discount presented, the court might have taken a different position. Instead, it was the lack of support for the discount that doomed the expert and the taxpayer.


Partnership drafting aside, (there were certain provisions of this partnership that precipitated the problems in the first place) it is clear how important substantiation of the application of discounts is to a valuation analysis. Perhaps the result would have been different if the experts had focused their analyses on the proper required rates of return for investments in private investment companies, rather than simply focusing on the correct discounts to apply. As it is, we can only say that the court seems to have missed the point pertaining to the impact of holding period.

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Robert Buchanan

Valuation | ESOP
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