## Facts

- Marjorie deGreeff Litchfield died April 17, 2001; her estate elected the alternate valuation date of October 17, 2001.
- Her late husband’s will placed minority interests in two closely held family corporations into a QTIP trust for Marjorie; the trust-held shares were includible in her gross estate under I.R.C. § 2044 at fair market value.
- The IRS determined a federal estate tax deficiency of $6,223,176; the remaining dispute at trial concerned valuation discounts for the estate’s minority interests in:
  - Litchfield Realty Co. (LRC), and
  - Litchfield Securities Co. (LSC).
- LRC: the estate held 43.1% of 500,000 outstanding shares; LRC’s net asset value (NAV) was about $33.17 million, largely farmland/equipment and marketable securities; built-in capital gains were about $28.76 million (about 86.7% of NAV).
- LRC had converted from C corporation to S corporation status in January 2000; a shareholder agreement restricted transfers to protect S-corporation and related status and provided a right of first refusal.
- LSC: NAV was about $53 million, largely marketable securities; built-in capital gains were about $39 million (about 73.8% of NAV); the estate owned a minority interest.
- The parties used a net-asset-value approach and disputed the appropriate discounts for (i) built-in gains tax exposure, (ii) lack of control, and (iii) lack of marketability.
- The estate’s expert modeled expected holding periods, projected appreciation and dispositions, computed future capital gains taxes, discounted the projected taxes to present value, and derived built-in gains discounts of about 17.4% (LRC) and 23.6% (LSC); for LRC he also applied a 14.8% lack-of-control discount and a 36% lack-of-marketability discount.
- The IRS’s expert discounted only the tax on built-in gain measured as of the valuation date (without modeling additional appreciation), producing smaller built-in gains discounts of about 2% (LRC) and 8% (LSC), and challenged the estate’s minority and marketability discounts.

## Issues

1. What built-in capital gains tax discount should apply under the willing-buyer/willing-seller standard when valuing minority interests in closely held corporations with substantial built-in gains?
2. What lack-of-control and lack-of-marketability discounts were appropriate for the estate’s minority interests in the two closely held corporations?

## Decision

- The Tax Court generally accepted the estate’s approach and allowed substantial built-in gains discounts rather than the IRS’s substantially smaller discounts.
- The court concluded that a hypothetical buyer would account for the present value of expected corporate-level tax costs, including tax attributable to appreciation during anticipated holding periods.
- The court also recognized significant lack-of-control and lack-of-marketability discounts in light of minority ownership, illiquidity, and transfer restrictions (including LRC’s shareholder agreement and the absence of a public market).

## Legal Principles

- Fair market value for estate tax purposes is determined under the willing-buyer/willing-seller standard, assuming fully informed hypothetical parties and no compulsion to buy or sell.
- In valuing minority interests in closely held entities under a net-asset approach, built-in gains tax exposure may be treated as a value-reducing liability reflected through an appropriate discount.
- A built-in gains discount may be based on the present value of expected future taxes, and the analysis may consider tax effects arising from anticipated appreciation and realistic asset-disposition timing.
- The Tax Court, as factfinder, may credit expert testimony that ties assumptions to company-specific facts (including management expectations) and reject models that rely on simplified assumptions inconsistent with how a hypothetical buyer would price the interest.
- Lack-of-control and lack-of-marketability discounts are supported by minority status, inability to control distributions or liquidation, illiquidity, and contractual or structural transfer restrictions.

## Conclusion

The Tax Court upheld significant valuation discounts for the estate’s minority interests in two closely held corporations with large built-in gains, finding that a hypothetical buyer would discount for the present value of expected corporate-level taxes (including taxes tied to holding-period appreciation) and for minority and marketability constraints.


Estate of Litchfield v. Commissioner, T.C. Memo. 2009-21 (2009)