Reasonably Certain Foreseeable Future Events and the Standard of Value
In Berquist v. Commissioner, Judge Swift Finds a Company‚Äôs Pending Liquidation is Relevant and Foreseeable.
The Tax Court valued closely-held stock in an anesthesiology practice donated to a hospital for charitable contribution purposes at its liquidation value since the anesthesiology practice would no longer exist after the physician-stockholders were consolidated into a newly-formed umbrella physician management company.¬† The donors valued the practice at $401.79 per share under the going concern premise of value.¬† The respondent determined a fair market value of $37.00 per share under the liquidation premise of value.¬† The Judge cited one key factor that determined his ruling.¬† Find out what it was.
Bergquist v. Commissioner
131 T.C. No. 2
July 22, 2008
The primary issue before the United States Tax Court was to determine the fair market value of the stock in an anesthesiology practice donated to a hospital for charitable contribution purposes.¬†
The Tax Court valued closely held stock in an anesthesiology practice donated to a hospital for charitable contribution purposes at its liquidation value since the anesthesiology practice would no longer exist after the physician-stockholders were consolidated into a newly-formed umbrella physician management company.¬† The donors valued the practice at $401.79 per share under the going concern premise of value while the respondent determined a fair market value of $37.00 per share under the liquidation premise of value.¬†
The Court ruled in favor of the respondent, ruling that a reasonably informed willing buyer and willing seller would have taken into account the fact that the practice would not be in existence less than three months after the valuation date.¬† The Court further imposed a Section 6662(h) accuracy related penalty of 40 percent to each of the petitioners.¬†¬†
From 1994 to 2001, petitioners practiced medicine as employees of and as stockholders in University Anesthesiologists, P.C. (‚ÄúUA‚ÄĚ).¬† Through UA, petitioners provided medical services to patients of the Oregon Health & Science University Hospital (‚ÄúOHSU‚ÄĚ), a public teaching and research hospital in Portland, Oregon.¬† UA was led by its chief executive officer John Gunn.¬† Gunn was also a CPA.¬†
In the late 1990s, and after careful consideration and discussion, because of perceived risks and management concerns associated with the many separate medical practice specialty groups that were providing (through their respective professional service corporations) medical services to OHSU hospitals and clinics, OHSU‚Äôs executive management concluded that the consolidation into a single medical practice group, controlled and managed by a single professional service corporation, which, in turn, would be under OHSU‚Äôs direct management and administration, would be required of all the different medical practice specialty groups that wished to continue to be affiliated with OHSU.¬†
Under the consolidation, medical doctors practicing at OHSU hospitals and clinics, including petitioners, were to leave their separate medical practice specialty groups and¬† professional service corporations and were to become employees of a newly formed single, consolidated medical practice group operating and providing medical services through a newly formed tax-exempt professional service corporation.¬†
In 1999, Gunn attended a conference sponsored by the Medical Group Management Association.¬† During a roundtable discussion at the conference, Gunn learned that for federal income tax purposes, some doctors throughout the country apparently were claiming substantial charitable contribution deductions relating to donations to academic-affiliated institutions of stock in their medical professional service corporations.¬†
Upon returning from the conference and in view of the planned consolidation, Gunn discussed with UA‚Äôs attorney, UA‚Äôs accountant, and OHSUMG‚Äôs (newly-formed consolidated entity) CEO the possible tax benefits and other ramifications if, as a step associated with the consolidation, petitioners and the other UA anesthesiologists were to donate their UA stock to OHSUMG and to claim charitable contribution deductions with regard thereto.¬†
On June 7, 1999, UA held a stockholders meeting at which the potential tax benefits of donating UA stock to OHSUMG were described as offering a ‚Äúhuge tax windfall of $150,000 to each UA stockholder.‚ÄĚ¬† In April 2001, an attorney for UA informed each UA stockholder of the steps to be taken to make the donation to OHSUMG of his or her UA stock and to claim a charitable contribution deduction.¬†
Once the consolidation was completed, UA would have no doctors or patients and UA would not operate and would continue in existence for a period of time simply to collect accounts receivable outstanding as of the date of the consolidation.¬† It was expected that after the consolidation, UA‚Äôs winding-down expenses would reduce UA‚Äôs taxable income to zero.¬†
On June 6, 2001, UA retained a valuation firm to value the UA stock to be donated.¬† The UA attorney advised the appraisers of the upcoming consolidation in a letter and stated that OHSUMG would ‚Äúbe the employer of all the physicians, including the UA anesthesiologists, after the reorganization is completed.‚ÄĚ¬†
On September 14, 2001, all of the UA stockholders donated their stock.¬† At the time of the donation, each of the UA stockholders had a basis of 20 cents per share in his or her UA stock.¬† The appraisers found a fair market value of the stock of $401.79 as of August 31, 2001.¬†
On January 1, 2002, the UA anesthesiologists, consolidated into OHSUMG, and the doctors became employees of OHSUMG.¬† After the consolidation, UA no longer operated as a provider of anesthesiology services but continued in existence only to collect accounts receivable.¬† After consolidation, any proceeds UA received as a result of collecting accounts receivable were, after payment of expenses, distributed to the UA anesthesiologists in the form of bonus and severance pay.¬† The UA anesthesiologists were the only physician group part of OHSUMG who donated to OHSUMG stock or any other interest in their preconsolidation professional service corporation.¬†
OHSUMG‚Äôs president notified UA that on its books OHSUMG would enter a value of $0 for the UA stock it received, since UA‚Äôs projected cash disbursements would approximated total projected cash receipts, thus leaving no unencumbered residual value for the benefit of OHSUMG.¬†
In preparation for a UA January 29, 2002 stockholders meeting, a letter was sent to UA stockholders on January 8, 2002 by UA‚Äôs president.¬† In advance of the meeting, each UA stockholder was advised by UA‚Äôs attorney and accountant not to bring to the meeting his or her own tax advisor.¬† At the meeting, several of the UA stockholders expressed that they would like to claim donations below the appraised value.¬† UA‚Äôs attorney and accountant advised the UA stockholders not to attract the IRS‚Äô attention by deviating from the amounts reported on the Forms 8283 and not to discuss the donations with the IRS if contacted.¬† The attorney and accountant further advised the UA stockholders not to show their own tax advisors the minutes from the UA stockholders‚Äô meeting.
Before trial and on the basis of an expert appraisal, respondent agreed that the UA stock had a fair market value of $37 per voting share and $35 per non-voting share and that charitable contribution deductions were allowable to petitioners to that extent.¬†
A Dramatic Difference in Perceived Value
The dramatic difference between petitioners‚Äô experts‚Äô and respondent‚Äôs expert‚Äôs appraised value for the UA stock stems largely from the experts‚Äô respective conclusions as to the proper valuation premise‚ÄĒwhether to value UA as a going concern.¬†
Petitioners‚Äô experts valued UA as of September 14, 2001 as a going concern because they viewed the scheduled January 1, 2002 consolidation of UA into OHSUMG as uncertain.¬† It should be noted that neither of petitioners‚Äô experts‚Äô reports explain how or why they selected a going concern premise of value.¬† Further neither expert report makes any mention of the January 1, 2002 consolidation.¬†
The court reviewed the evidence including letters, e-mails, minutes of meetings, financial statements, and handwritten notes) and concluded that as of September 14, 2001, UA should not be valued as a going concern.¬† The donation of the UA stock was driven by the imminent consolidation of UA (along with the other medical groups) into OHSUMG.¬† On the evidence, it is beyond any reasonable question that petitioners would not have donated their UA stock to OHSUMG had there existed any realistic possibility that the consolidation would not occur by yearend 2001, or soon thereafter.¬†
The court further noted that, ‚ÄúWhile the January 1, 2002 consolidation date may not have been set in stone, by September 2001 there was tremendous commitment by UA, by OHSU, and by OHSMUG management to ensure that by January 2002 the consolidation would occur.¬† On the facts before us, a reasonably informed willing buyer or seller certainly would have known about and would have taken into account the fact that as of September 13, 2001, there was an extremely high likelihood that by early 2002 UA would no longer be an operating entity.‚ÄĚ
The respondent‚Äôs expert determined an equity fair market value for UA of $521,373.¬† In calculating the fair market value, the expert applied a 35 percent lack of control discount and a 45 percent lack of marketability discount.¬†
Respondent‚Äôs expert derived the 35 percent lack of control discount from a study of mergers and acquisitions of publicly traded companies in the health care industry.¬† Respondent‚Äôs expert derived his 45 percent lack of marketability discount from a study of restricted stock health care companies and from a study of initial public offerings.
Under Section 662(h), a taxpayer may be liable for a 40 percent accuracy-related penalty on the portion of an underpayment of tax attributable to a gross valuation misstatement.¬† Section 6662(h)(2)(A) provides that there is a gross valuation misstatement if the value of property as claimed on a tax return is 400 percent or more of the amount determined to be the correct value.¬† However, no valuation misstatement penalty is imposed unless the portion of the underpayment attributable to the valuation misstatement exceeds $5,000 (see Sec. 6662(e)(2).¬†
Respondent argued at trial that petitioners did not act in good faith and did not make a good faith investigation of the value of the donated UA stock.¬† The court agreed with the respondent‚Äôs argument, noting ‚ÄúFrom the beginning, the plan to donate UA stock on the brink of the January 1, 2002 consolidation was presented to UA stockholders as a way to reap a potential ‚Äė150K‚Äô windfall.¬† Petitioners are well educated and surely were cognizant of the imprudence of valuing the UA stock at such a high value given the likelihood that by 2002 UA would no longer be an operating entity.‚ÄĚ¬†
The court further noted that the petitioners were aware of the January 8, 2002 letter from OHSUMG‚Äôs president stating that OHSUMG had decided to book the donated stock at zero.¬† While the value of property in the hands of the donee is generally not determinative of fair market value (see Estate of Robinson v. Commissioner, 69 T.C. 222, 225 (1977)), petitioner should have at least questioned the difference in reporting by OHSUM and by themselves.¬†
The court was critical of the fact that petitioners were advised not to bring their own tax advisors to the January 29, 2002 UA stockholders meeting and were directed to withhold information from their own tax advisors.¬† The court noted that this should have put petitioners on notice as to the inaccuracy of the claimed donations.
Given the aforementioned, the court ruled that the petitioners were also liable for the 40 percent accuracy-related penalty under Section 6662(h).¬†
Peter H. Agrapides, MBA, AVA
Peter H. Agrapides, MBA, AVA, is a Principal at Western Valuation Advisors, which has offices in Salt Lake City, Utah, and Las Vegas, Nevada. Mr. Agrapides‚Äô practice focuses primarily on valuations for gift and estate tax reporting. He has experience valuing companies in a diverse array of industries. These engagements have ranged from small family owned businesses to companies over $1billion. Reach him as email@example.com.