Estate of Shurtz (T.C. Memo 2010-21) was filed in February 2010, or almost two years ago.
On February 24, 2010, the BV Wire, published by Business Valuation Resources, reported on the case in a short article entitled “Mercer Capital (and QMDM) wins discounts in new FLP case.”
According to the decision, written by Judge Jacobs, the IRS determined a deficiency in Federal estate tax of $4,737,934 and an addition to tax pursuant to section 6651(a)(1) of $1,184,484 against the Estate of Charlene B. Shurtz (the estate). It was a serious matter for the estate.
Charlene B. Shurtz (Mrs. Shurtz) died January 21, 2002 at the age of 76 in California. She was one of three children of Charles A. Barge and Bonnie Inez Barge (the Barges). The Barges and their descendants (the Barge family) owned and managed, first directly and then indirectly through family partnerships, more than 45 thousand acres of timberland in the State of Mississippi (the Barge timberland).
The Barge timberland was actively managed by the family. The Barge family felt that the land was given to them by providence, and hence they were stewards of the land and should use its bounty to do God’s work.
To shorten a long and interesting story, the Barge family expanded over the years and by the early 1990s, 14 individual family members held undivided interests in the Barge timberland. The family was advised that rolling the family’s timberland ownership into a family limited partnership would facilitate management of the assets as well as gift and estate planning for individual family members.
C.A. Barge Timberlands, L.P. (Timberlands) was formed in 1993. Following the formation of Timberlands, Mrs. Shurtz owned a 16% limited partnership interest in the entity.
Over time, Mrs. Shurtz and her husband (Reverend Shurtz) worked on their own estate planning. They were advised that the creation of a limited partnership for their family would be a helpful estate planning and family wealth management vehicle.
In 1996, the Shurtzes formed Doulos as their family’s limited partnership. Its primary assets were the 16% limited partnership interest in Timberlands and about 748 acres of Mississippi timberland that the couple owned.
The timberlands of both Timberlands and Doulos were jointly managed. Annual meetings were held each year for both entities. The family was actively involved in important management decisions.
In 1998 the Shurtzes decided to review their estate plan. They were referred to Lewis Wall, an attorney who focuses on estate planning. Mr. Wall drafted a revocable trust agreement (entitled the Shurtz Family Trust Agreement) to take effect upon the death of either Mrs. Shurtz or Reverend Shurtz. The Shurtz Family Trust was intended to achieve the following goals:
- Assure to the extent possible that there was no Federal tax payable at the death of the first spouse
- Minimize Federal estate taxes at the surviving spouse’s death through proper use of the available unified credit (exemption) amount, coupled with use of each of the survivor’s remaining generation-skipping exemption amounts to the extent possible
- Assure that the decedent’s interest in Doulos remained in the family
- Provide for the remainder of the estate (upon the death of the survivor spouse) to pass into a charitable lead annuity trust which would provide for a 12-percent-per-year annuity to charity for a term sufficient that the remainder interest to the family members would be valued at zero or as close to zero as possible
As noted above, Mr. Shurtz died testate on January 21, 2002.
Issues in the Case
According to Harris H. (“Trip”) Barnes III, a Mississippi estate tax attorney who represented the estate at trial, there were a large number of issues in the Shurtz case. The Court’s decision did not touch on them all, and some of them essentially became non-issues (or were not necessary to address) given the conclusions reached by Judge Jacobs.
The key issues for decision in this case were summarized by the Court:
- Whether the values of assets transferred by Charlene B. Shurtz (hereinafter referred to as Mrs. Shurtz or decedent) six years before her death to her family limited partnership (Doulos) are included in the value of her gross estate pursuant to section 2036(a) and/or 2035(a).
- If the values of the assets transferred to Doulos are includable in the value of decedent’s gross estate, then: (a) the values of the assets transferred, and (b) whether the values of assets that are included in the value of decedent’s gross estate under section 2036(a) qualify for the marital deduction under section 2056(a) as property included in the gross estate.
- Whether the estate is liable for an addition to tax under section 6651(a)(1).
There were significant valuation issues in this case. The IRS was asking for $4.7 million in additional estate tax plus penalties of $1.2 million. However, the valuation battle is not discussed in the decision.
The Value of the Shurtz Estate
Mrs. Shurtz’s gross estate was valued at $8,768,059.03 per the Form 706. The assets having the greatest values making up the gross estate were:
- An 87.6% limited partnership interest in Doulos valued at $6,116,670. The underlying asset of Doulos, its 16-percent limited partnership interest in Timberlands, was valued by the estate at $9,993,280
- A 1% general partnership interest in Doulos valued at $73,500
- 100 shares of BTM valued at $383,700
- One-third of the residue of the Estate of Bonnie Barge valued at $1,126,190
The values of the Shurtz estate’s assets as provided by the Court were based on real estate and business appraisals prepared on behalf of the estate.
The Contentions of the Parties
Respondent (the IRS) contended that:
- The values of the assets contributed to Doulos should be includable in the value of Mrs. Shurtz’s gross estate by reason of her retention of the control, use, and benefit of the transferred assets within the meaning of sections 2036 and/or 2035(a).
- For purposes of section 2056(a), the value of Mrs. Shurtz’s interest in Doulos should be used to determine the amount of the marital deduction.
The estate’s position was that:
- Mrs. Shurtz left no taxable estate because her entire estate was left first to a unified credit trust (formed to use the unified (exemption) credit) and then to various marital trusts.
- Section 2036(a) does not apply because Mrs. Shurtz’s transfer of assets to Doulos constituted a “bona fide sale for an adequate and full consideration” within the meaning of that provision.
The Court’s Findings
The Court concluded that the 1996 transfer of property to Doulos was made for “adequate and full consideration” in a “bonafide sale.” This conclusion neutered the argument from the IRS that questioned the legitimacy of the family’s limited partnership, Doulos.
The Court also concluded that “the marital deduction to which the estate is entitled under section 2056 is to be computed according to the value of the partnership interest that actually passed to Reverend Shurtz.” The Court’s valuation conclusion was, in effect, the estate’s Form 706 values as filed. With this background, we can take a look at the valuation questions in the case.
Discussion of the Appraisals
A typical valuation duel occurred regarding the fair market value of Mr. Shurtz’s interest in Doulos.
- The appraiser for the IRS was subjected to a Daubert challenge prior to his being accepted as an expert. He was admitted as an expert by the Court and his report was admitted as his direct testimony. He was cross-examined.
- Matt Crow, as noted above, was the appraiser for the estate. He was admitted as an expert and his report was admitted as his direct testimony. He was cross-examined, and Judge Jacobs personally directed questions to him some length.
- In addition, Matt prepared a rebuttal report that was also introduced and accepted by the Court.
Matt’s report used the net asset value method to determine the fair market value of limited partner interests of Doulos. In developing conclusions of fair market value, Matt’s report:
- Developed an appraisal of the fair market value of the 16% interest in Timberlands owned by Doulos. A minority interest discount of 10% was applied, which was followed by a marketability discount of 50%. This interest was then placed into the market-value balance sheet of Doulos, together with its other assets.
- Developed an appraisal of the fair market value of the 87.6% limited partnership interest of Doulos held by the estate. At this level, a minority interest discount of 10% was applied followed by a marketability discount of 30%.
- Employed the Quantitative Marketability Discount Model (the QMDM) in developing appropriate marketability discounts at each level of ownership (i.e., Timberlands and Doulos).
The IRS appraiser’s report referenced the Bajaj Study of restricted stocks as well as the FMV Opinions Study. According to Matt’s rebuttal report, the applications of these two methods were flawed in the IRS appraiser’s report.
In addition, there was conflicting discussion in the IRS appraiser’s report regarding what minority interest and marketability discounts should be appropriate. The text appeared to indicate (per Matt’s rebuttal) that a somewhat lower minority interest discount and a considerably higher marketability discount should be appropriate. Matt’s rebuttal report illustrated the impact of these issues in relationship to the appraisals developed in his report.
The valuation issues are summarized in the following table.
A quick review of the table above indicates:
- There was minimal difference of opinion regarding the net asset value of C.A. Barge Timberlands
- The other differences are accounted for by the math error and differences regarding the appropriate minority interest and marketability discounts.
- The biggest difference in concluded values was the result of differing marketability discount applied by the two appraisers.
After receiving the reports of both experts and hearing their testimony, Judge Jacobs mentioned neither of the experts nor their reports in his decision. The Court accepted the appraisals filed with the Form 706 without exception.
From the previously mentioned article in the BV Wire quoting Matt Crow:
“It wouldn’t surprise you to learn we used the Quantitative Marketability Discount Model (QMDM),” Crow adds, “modeling the partner level cash flows over a reasonable holding period and discounting them at a premium rate of return to compensate for lack of marketability—the same shareholder-level, discounted cash flow modeling we’ve done thousands of times.” The IRS expert relied on the Bajaj studies along with the “usual” restricted stock and pre-IPO studies, with primary support from FMV Opinions data, focusing on comparing the subject interests with the FMV data on market-to-book ratios and dividends per share. “I rebutted the Service’s expert report and he rebutted mine,” Crow reports. “In the end, the judge accepted the estate’s return, and thus our valuation, as submitted.”
I tell this story because you wouldn’t know it by reading the case.