Estate of Simplot: the Tax Court applies a significant premium to voting privileges.

• Author: Pratt, David

Transferring minority stock positions and limited partnership interests to obtain valuation discounts has always been an estate and gift tax reduction technique. Naturally, the Internal Revenue Service and taxpayers have argued over the valuation of interests in closely held corporations and partnerships. Fortunately, the courts have consistently held that a minority discount should be applied to the transfer of noncontrolling blocks of stock in closely held corporations.[1] While most of the valuation cases have addressed the minority interest discount, a recent Tax Court case, Estate of Richard R. Simplot v. Commissioner, 12 T.C. 13 (1999), has applied a "premium" on the transfer of a minority block of voting stock. In addition, the court held that the premium on such stock should be applied as a percentage of the entire equity value of the company, as opposed to a percentage of the value of the shares of stock whose value was at issue. Even more disturbing was the Tax Court's statement, in dicta, that the premium for a controlling interest in voting stock would be "substantially greater" than the premium applied to a noncontrolling interest.

This article discusses the "premium" applied in Simplot[2] and the ramifications that the decision could have on estate and gift tax reduction strategies involving closely held corporations and family limited partnerships.[3] While the case is on appeal to the Ninth Circuit Court of Appeals, practitioners must be mindful of the decision.

Facts of Simplot

Richard R. Simplot was the son of the founder of J.R. Simplot Co. (the "company"), a privately held major frozen food processing and agribusiness chemical company. At the time of his death, Mr. Simplot owned 18 of the 76.445 outstanding class A voting shares (approximately 23.55 percent) and 3,942.048 of the 141,288.584 outstanding class B nonvoting shares (approximately 2.79 percent) in the company. The remainder of the voting shares were owned by Mr. Simplot's three siblings; the remainder of the nonvoting shares were owned by other Simplot family members, including Mr. Simplot's siblings, and the company's ESOP.

With the exception of the voting rights attached to the class A shares, the two classes of stock were substantially similar. Each class had an equal right to receive the same dividends (without preference), but the class B shares had a liquidation preference and the class A shareholders had a right of first refusal on the sale of any class A shares. On Mr. Simplot's federal estate tax return, each of the class A voting shares and class B nonvoting shares were valued at $2,650.[4] The IRS issued a notice of deficiency, in which it determined the fair market value of each class A voting share to be $801,994.83 and the fair market value of each class B nonvoting share to be $3,585.50.

Estate's Position

The estate's position was that the class A voting shares should have the same value as the class B nonvoting shares. The estate argued that the class A voting shares and the class B nonvoting shares were "functionally equivalent" because neither Mr. Simplot's minority block of voting shares nor his minority block of nonvoting shares could result in the power to control the company.[5] Thus, the voting shares could not be entitled to a premium for voting privileges. The estate further asserted that any element of control that attached to the class A voting shares was negated by the restriction on the transferability of the class A voting shares, coupled with the liquidation preference attached to the class B nonvoting shares.

IRS' Position

The IRS contended that a premium should be applied to the class A voting shares and that "because of the disparate ratio (or skewed distribution) between the number of shares of voting stock outstanding and the number of shares of nonvoting stock outstanding (1 to 1,848), the premium should be expressed as a percentage of(or in relation to) the equity value of [the company]."[6] One IRS expert indicated that an appropriate premium for the class A voting shares would be 10 percent of the total equity value of the company; a second expert suggested that an appropriate premium for such shares would be three to seven percent of the total equity value of the company.

Tax Court's Opinion

The Tax Court agreed with the IRS that...