My good friend Peter Kawulia, 78, is a distinguished member of the Manitoba Sports Hall of Fame, and the third-ranked featherweight boxer in the history of the British Empire(1). In that Pete was never knocked out, and was cut only once in 115 bouts, he knows his way around the ring. If Pete were to share his thoughts he would undoubtedly say that regardless of his awe-inspiring talent, whom he had in his corner was crucial to his success. The heirs of Helen Richardson(2) recently learned the importance of this choice, as clearly they could have avoided a knockout and the resulting “medical bills” with the right professionals in their corner.
Ms. Richardson owned a minority interest in a family-owned personal holding company (PHC) that held approximately $52.2MM of publicly-traded securities, with a potential liability for built in capital gains (BIG) of $18.1MM. The estate reported the value of the interest as $3.1MM (a 74% discount) based on an opinion from a CPA that held a Master of Science in Taxation, and no valuation credentials.
The CPA used a Dividend Discounting Model, a form of the income approach, to value the holdings. He applied a 100% discount for BIG in arriving at the $3.1 million value. Importantly, the holdings of the PHC turned over (were sold and replaced) only every 70 years on average, which is very unusual; this was a function of the PHC’s investment strategy.
The IRS engaged a valuation expert that valued the interest at $7.3MM. As to the choice of methodology, the expert argued that in valuing an asset holding entity the Discounted Net Asset Value (NAV) Method should be employed. He also came down against the use of a 100% discount for BIG, arguing that the acquirer of the interest would turn over the holdings of the entity more frequently, thus triggering the BIG over a period of 20 to 30 years. Subsequently, the Estate engaged a rebuttal expert, and changed its proposed value to $5.0MM; however, the damage was done. In establishing the value at $6.5MM the Tax Court held, amongst other things, that:
- Most importantly, in the valuation of complex assets it is necessary to engage the services of a qualified and accredited appraisal professional;
- The Dividend Discount Model is not appropriate in valuing a holding company; and
- A 100% discount for BIG is generally incorrect, an assumed holding period being the preferred approach.
In support of its imposition of substantial penalties for understatement, the Court said:
“While we do not disagree with the estate’s assertion that the decedent’s interest in PHC may be difficult to value, we believe that this further supports the importance of hiring a qualified appraiser. In order to be able to invoke ‘reasonable cause’ in a case of this difficulty and magnitude, the estate needed to have the decedent’s interest in PHC appraised by a certified appraiser. It did not.”
So, the next time you have an appraisal issue, think carefully about who you want in your corner and the value of hiring a true expert.
(1) Amazingly, this superb athlete went on to play six years of professional hockey for the IHL’s Reed’s Comets, later Blackhawks after retiring from the ring.