Tax Court Accepts Buy-Sell Agreement For Gift/Estate Valuation
Business Valuations Advisor, Fall 2006
Estate of Pearl I. Amlie, 2006 Tax Ct. Memo LEXIS 76 (April 17, 2006)
Sometimes the squeaky wheel does get more out of the will. Rod Amlie was one of several prospective heirs to his mother’s assets, which consisted primarily of a 13.6% common stock interest in a bank. In 1986, his mother had struck Rod from her will—but established a spendthrift trust for him. A couple of years later, she voluntarily accepted a court-appointed conservator, who spent the next decade attempting to secure a guaranteed buy-sell option for Mrs. Amlie’s minority stake in the bank, his efforts largely thwarted by Rod’s legal objections.
Key factor is hiring valuator
Concerned that such a substantial portion of the Amlie assets were tied up in a minority interest, the conservator negotiated a 1991 agreement that fixed a price and buyer for the stock as well as a guarantee that her minority shares would receive the same price as those of the controlling interest, in the event the majority stakeholder sold.
In 1994, the majority owner (David Hill) sold his interest to First American Bank Group, Ltd. (FABG), receiving shares in FABG as determined by certain book value ratios of the merged banks. Per the 1991 guarantee, the conservator negotiated an exchange of Amlie’s interest for FABG common stock at the same ratios received by Mr. Hill, which turned out to be close to $118 per share; and—in a move that turned out to be critical later on—retained a valuation consultant to determine whether this was a fair price for the FABG stock together with the price guarantee, or what became known as the “Hill Rights.”
To reach this opinion, the valuation specialist reviewed merger multiples for appropriate M&A comparables in the banking industry, and concluded that Mrs. Amlie’s minority interest, coupled with the Hill Rights as well as the right to defer capital gains taxes until after death, was fairly priced at $118 per share. The conservator submitted this 1994 agreement for court approval, contending that it established a further hedge against the risks of Mrs. Amlie’s post-merger, minority interests.
Rod Amlie was the sole heir who objected, claiming that the $118 price failed to compensate for the Hill Rights by up to $500,000, as determined by his valuation expert. For various reasons, the district court rejected the 1994 agreement, which sent the parties back to negotiating a fair price for the FABG stock.
The squeaky wheel could have been right
The family negotiations culminated in a 1995 agreement whereby all of Mrs. Amlie’s bank stock would be sold to Rod’s trust at the $118 price. The trust could then pursue whatever price it could obtain, while the remaining heirs would have received a fixed price without incurring the risks of continued litigation and lack of liquidity.
Within two years, the trust had negotiated with FABG to redeem all of the stock at $217.50 per share plus 4% per year compounded semiannually until Mrs. Amlie’s death, thus securing a premium for the Hill Rights. When she died a year later, her bank interests sold at the negotiated price, and Rod (as executor) received $993,757 for the estate’s share at the $118 price, plus an additional $495,968, which then passed to his trust at the premium value.
Estate valuation turns on “arms length” aspect
On its tax returns, the estate valued the minority bank interests at $993,757; while on its fiduciary income tax return, Rod’s trust reported the $495,968 as capital gains. Not surprisingly, the IRS assessed a deficiency of $495,968 against the estate’s return, claiming that the value of the bank stock should equal the price that FABG paid for it following Mrs. Amlie’s death. The estate claimed that the buy-sell agreement fixing the price at $118 should be controlling.
To prevail, the estate would have to show that the buy-sell agreement was binding on all parties during life and after death; the restrictions had a bona fide business purpose, and were not substitutes for a testamentary disposition. In addition, the Tax Court said that under Section 2703(b)(3), a 1990 amendment to the Code, the agreement must be comparable to similar “arms length” arrangements.
In reviewing whether the buy-sell agreement complied with each of the requirements of §2703(b)(3), the Court found:
- Fixed price. The 1995 agreement fixed the $118 price as a ceiling (and floor) on the value of Mrs. Amlie’s FABG stock, thereby passing all the risk of subsequent loss (or gain) to Rod’s trust; it was irrelevant that the precise portions of the trust’s bequest wouldn’t be known until after Mrs. Amlie died and the rest of her estate valued.
- Bona fide business purpose. “We are persuaded that the conservator, in securing the [buy-sell agreement], was seeking to exercise prudent management of decedent’s assets by mitigating the very salient risks of holding a minority interest in a closely held bank, consistent with the conservator’s fiduciary obligations.”
- Not a testamentary device. This finding turned on the fairness of the consideration received, which was “significant,” given the risks of “substantial litigation hazards.” Notably, the conservator had only agreed to the $118 price “after receiving professional advice that it was a fair price.”
- Comparable arms-length terms. Here, too, the estate’s valuation specialist’s opinion that the interest was fairly priced was persuasive in the Court’s finding that the terms were comparable to similar arrangements entered into by persons in an arms’ length transaction.
The fact that Rod Amlie later secured a $217 price per share “raises questions” whether the $118 was comparable to similar, arms-length arrangements. But in the end, the agreement by his siblings to a lower price simply convinced the Court that the parties disagreed over the potential risks and rewards:
In the circumstances, the other prospective heirs struck a bargain for the proverbial ‘bird in the hand’ of a guaranteed price, transferring to Rod the benefits and burdens of the pursuit of the possible ‘two in the bush.’ It may have been a bad bargain in hindsight, but we are persuaded it was arm’s-length when made.
