LACK OF CONTROL AND LACK OF MARKETABILITY DISCOUNTS
A recent Tax Court (the Court) case which would be interesting to review is the Estate of Miriam M. Warne, deceased, William R. Warne and Thomas H. Warne, Co-Executors v. Commissioner, TC Memo 2021-17, February 18, 2021. As I am not an attorney, it is from a business appaiser’s point of view. A complete description of the issues is discussed in the Memo but briefly a Family Trust owned majority interests in several limited liability companies (LLC). The majority of the Trust was owned by the decedent (Miriam) who also managed the Trust, In 2012, some small minority gifts of LLC interests were made to various family members and in 2014 Miriam passed away. The LLCs were essentially investment firms owning various interests in real estate. The IRS disputed the values shown on the gift tax return as well as on the estate tax return. It is important to remember that for an estate, the value of what the decedent owned on the date of death is the required value. However, for gifts, it is the value to the recipient on the date of the gift which is to be determined.
The opinion goes into great detail on the determination of real estate interests held by the various LLCs for both the 2012 gifts and the 2014 estate. This discussion can be viewed in the opinioin.
Then the Court discusses discounts for Lack of Control (LOC) and for Lack of Marketability (DLOM) as of the date of death. Two experts were used: Philip Schwab, ASA, by the Estate and Espen Robak, CFA, by the IRS. While the IRS does not require [but the Tax Court can and does take notice] and the CFA is not required to follow adherence to the Uniform Standards of Professional Appraisal Practice (USPAP), the ASA is required by the American Society of Appraisers for certified appraisers. The Opinion is not clear about the appraisal reports, it indicates that both parties used only the Adjusted Net Asset Value (ANAV) approach. While USPAP (and ASA) requires consideration of all methods [Asset, Income, and Market], the interest being valued (as well as the quality and quantity of data) determines the weight given to each method. That is, does the interest have the ability to access the underlying assets and realize the values of those assets. The value of the majority interests as of the date of death would be heavily dependent on the ANAV method as the interest being valued had the ability to dissolve the LLCs and gain access to the assets.
The opinion goes into great detail about the determination of the LOC and the DLOM to apply to the majority positions in the LLCs as of the date of death. The final conclusion is consistent with the literature which indicates that even controlling interests such as determined in the ANAV method should have a lack of marketability discount for time horizon risk, price risk, and transaction costs [see articles by Ronald D. DiMattia, CPA, ABV, CMA (“Controlling Interests-Discount for Lack of Marketability: The Empirical Evidence,” CPA Expert, Summer 2008, and “Controlling Interests-Discount for Lack of Marketability: The Empirical Evidence,” CPA Expert, Spring, 2009)] . The findings in the opinion are consistent with the findings of Albuquerque and Schroth [(Rui Albuqerque and Enrique Schroth, “The Value of Control and the Costs of Illiquidity,” Journal of Finance, LXX, No.4, August 2015, pp. 1405-1455) and Bolton and von Thadden (Patrick Bolton and Ernst-Ludwig von Thadden, “Blocks, Liquidity, and Corporate Control,” Journal of Finance, 53, February, 1998, pp. 1-26)].
But what about the minority (noncontrolling nonmarketable) positions in the LLCs which were the subject of the 2012 gifts. Not only is the use of only the ANAV method questionable but also the size of the discounts would be expected to be considerably different. That is, an article by Timothy J. Meinhart (“The Consideration of Projected Income in the Valuation of Noncontrolling Ownership Interests,” Insights, Autumn, 2010, pp. 43-52) indicates that it is critical that projected income valuation be determined as well as the balance sheet when valuing nonmarketable, noncontrolling ownership interests in asset holding companies. A recent webinar by William H. Frazier, ASA, through Business Valuation Resources on January 19, 2021, discusses the necessity to examine the income approach when valuing minority interests in asset holding companies. No where in this Opinion, is the issue of using the income approach to value the minority noncontrolling nonliquid inteests in the LLCs which were the subject of the 2012 gifts.
