In Action on Decision 2008-001, the Service said it would not acquiesce in the Tax Court’s allowance of a taxpayer’s contested valuation of the stock of a closely held corporation following a post-death, tax-free reorganization. The court’s 2006 decision represented a $100 million victory for family owners of privately held Kohler Co., the well-known manufacturer of small engines and plumbing fixtures. The Wisconsin-based company reorganized in 1998, partly to reconsolidate family control by buying out its approximately 4% nonfamily ownership.
The IRS issued deficiency notices and 20% accuracy-related penalties on the two gift returns and one estate return for 1998 of three grandchildren of the 137-year-old company’s founder: Herbert V. Kohler Jr.; the estate of his late brother, Frederic; and their sister, Ruth Kohler. Another deficiency was issued against the gift return of Herbert Kohler’s wife, Natalie Black (who also was the personal representative of Frederic Kohler’s estate). Frederic Kohler died in 1997. His estate chose an alternate valuation date in September 1998 and filed the estate tax return showing a stock value of approximately $47 million. The government valued the stock at $144.5 million.
During the alternate valuation period, the company issued new stock with transfer restrictions and a purchase option in exchange for its old stock. Nonfamily shareholders could not swap their shares but could accept $52,700 cash per share or litigate for a higher price, which some successfully did.
The government contended that the date of Frederic’s death was the proper valuation date but was blocked on procedural grounds from so arguing. It then argued that the valuation should be based on the pre-reorganization stock, citing Treas. Reg. § 20.2032-1(d), which provides that certain property interests that change form during an alternate valuation period by being actually received or disposed of by the estate are to be valued as of the date of death. However, the Tax Court noted that the regulation does not address tax-free reorganizations and found no authority to treat one as a change in form or exchange to be disregarded.
Alternately, the government argued the post-reorganization stock should be valued without regard to the transfer restrictions and purchase option. It pointed to IRC § 2032, which provides that property is valued as of the date it is “distributed, sold, exchanged or otherwise disposed of” during an alternate valuation period. But the Tax Court pointed out that Treas. Reg. § 20.2032-1(c), defining “otherwise disposed of,” specifically excludes tax-free reorganizations.
The court also found fault with the credentials, methods and conclusions of the government’s valuation expert witness, Scott Hakala. On the other hand, the court approved the probity and diligence of the plaintiffs’ two experts, Robert Schweihs and Roger Grabowski.
Not only was the plaintiffs’ valuation more reliable, but they were entitled to shift the burden of proof to the government to show that its valuation was the proper one, the court said. The government said the estate had been uncooperative toward its reasonable requests for documents. But on the whole, the estate did cooperate in good faith, the court said. Although the estate moved to quash a government summons of documents, it readily complied once that motion was denied. Moreover, the motion reflected legitimate concerns by the estate about the relevance of documents sought, given Kohler Co.’s interest in confidentiality of its proprietary information, the court said.
Besides nonacquiescing, the Service also issued proposed regulations (REG- 112196-07) to restrict to “market conditions” post-death events that cause a reduction in estate value during an alternate valuation period.
Herbert V. Kohler Jr. et al. v. Commissioner , TC Memo 2006-152
Prepared by Edward J. Schnee , CPA, Ph.D., Hugh Culverhouse Professor of Accountancy and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.