The Current State of Marketability Discounts
ACTEC Journal, Vol. 30, p. 137, Fall 2004
Posted: 29 Oct 2004
The marketability discount is the major source of controversy in tax valuation disputes, particularly in estate and gift tax matters. Four recent cases, Gross, Heck, McCord, and Lappo, shed particular light on the most current Tax Court thinking on this issue. The article explains how the Service's arguments represent a radical departure from past practice and how tax practitioners can more effectively respond to the Service's arguments. Valuation discounts for both FLPs and operating entities are discussed, along with lack of marketability discounts for lottery prizes (Shackleford, Gribauskas, and Cook), structured settlements, other annuities, and notes (Luton, Smith, and Hoffman), plus stock options and other derivatives. Discount increments for rights of first refusal (Borgatello and Jones), assignee interests, and lack of voting rights (Barnes, Kosman, and Hillgren) are also covered.
The Service's appraisal techniques in McCord and Lappo are analyzed and rejected. The Service's argument that only a 7.4 percent marketability discount should apply to FLPs holding real estate or marketable securities is analyzed. This argument failed in both Lappo and McCord due to inconsistencies in expert testimony on cross, among other reasons. However, certain elements of the analysis were accepted. The two cases represent partial victories for the IRS in that a more up-to-date set of empirical data showing lower discounts was accepted.
Most importantly, the Service's argument that no discount increment should apply to private equity (privately held company stock) over restricted stock is scrutinized. This argument must be rejected because it assumes that the restricted stock of a public company is as difficult to sell as fully private equity. Since restricted stock is only temporarily restricted for resale (for as little as one year), private equity is clearly less liquid. The Service relied on faulty assumptions and weak evidence in McCord. The research cited by the Service's expert is found to be irrelevant. The Tax Court has not yet ruled specifically on the issue. The author's own research indicates that the increment for private equity over restricted stock could be 20 percentage-points or more.
Note: This is a description of the paper and not the actual abstract.
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