Special Valuation Issue
What is Your Case Worth Today?
What is the value of a contested estate? In this article, the author shares her insight and discusses two leading U.S. Tax Court cases in this area, Estate of Lennon and Estate of Foster.
Consider for a moment, all the plaintiffs you currently represent.Â Now, pick one case.Â If the plaintiff died today, what would the case be worth today? Â Letâ€™s assume the prospects for winning the case are dreary until, after the date of death, you find the â€śsmoking gunâ€ť document and settle the case for $10 million.Â Was the case worth $10 million on the date of death? Â Based on the cumulative understanding at the date of the death, the case had grim prospects and there was no knowledge of the smoking gun document on the date of death; therefore, the case was worth far less than $10 million, but how much less? Â As of January 1, 2018, estate taxes are due on taxable estates of $11.18 million and over.
Letâ€™s look at an example to further illustrate the point.Â (Note that all names have been changed in the following case for confidentiality purposes.)
â€śWhatâ€™s it Worth?â€ť
That was the question posed when Mr. Pat Jones, Jr. (Junior) died in 2012 while he and his siblings were fighting against their stepmother over their fatherâ€™s $77 million estate.Â His father, Pat Jones, Sr. (Senior) had died in 2010.Â Prior to Seniorâ€™s passing, the stepmother asserted that in 2008, Senior had signed a power of attorney to her and created a revocable trust (the Trust) which established two trusts that divided his estate evenly upon his death.Â Trust #1 was for the stepmother and Trust #2 divided 50% of his estate evenly among 23 children and grandchildren.Â Trust #2 included an â€śin terroremâ€ť clause which stated that if any of the children or grandchildren challenged Trust #2 and lost, their share would be reduced from 1/23 to 1/230, effectively cutting them out of an inheritance.
If Junior and his siblings challenged the power of attorney and the Trust and won, Senior would have passed intestate.Â The stepmother would receive one-third of the estate, and the other two-thirds would be divided evenly by Junior and his three siblings, instead of 50% divided between 23 people.Â Therefore, if Junior challenged the Trust and won, he stood to inherit approximately $12.8 million.Â If he challenged the Trust and lost, he would inherit approximately $169,000.Â Junior and his three siblings filed suit against their stepmother in 2010.Â Junior died in 2012, before the case settled.Â The value of the case had to be determined for estate purposes and the range of value at date of death was somewhere between $169,000 and $12.8 million, less legal fees.
After Juniorâ€™s death, the case was narrowed down to two issues.Â The first issue was the validity of the power of attorney and whether Senior was mentally incapacitated when it was executed.Â The second issue was whether the stepmother had exercised â€śundue influenceâ€ť over Senior when he signed the power of attorney and other estate documents.
Senior and the stepmother had been married for approximately 33 years when he passed.Â Regarding the power of attorney, the judge heard testimony from three treating physicians who testified that Senior was cognitively impaired in 2008 when the power of attorney was signed.Â Additionally, the judge heard testimony from Seniorâ€™s lawyer who prepared the power of attorney, stating that Senior signed it of his own volition.Â In 2014, the judge ruled that the power of attorney was valid.Â The judge stayed the ruling on undue influence and advised the parties to settle.
After the ruling in favor of the stepmother for the power of attorney, and because of the â€śin terroremâ€ť clause in Trust #2, it was basically all or nothing for Juniorâ€™s estate and his siblings based on the pending ruling on undue influence.
The stepmother made an offer to settle for $10 million to Juniorâ€™s estate and his three siblings.Â On November 20, 2014, the case settled for $10 million to be divided among Juniorâ€™s estate and his three siblings, structured with an initial payment of four million dollars and the balance to be paid within seven years.
A settlement offer made prior to Juniorâ€™s death for $100,000 to each of the siblings was declined.Â The siblingsâ€™ counter offer to settle for 55% of the estate, was not acknowledged by the stepmother.
To determine the fair market value of the case at date of death, the ultimate settlement amount was used as a starting point, discounting Juniorâ€™s portion of the four million dollars down payment, less legal fees, and adding the future interest payments and the final payment back to the present value, which resulted in a total value of $1.7 million.
Two cases were examined for precedent on the discount for lack of control and the discount for lack of marketability, comparing the facts in the case law to the facts of the case.
The first case was Estate of Ann Marie Lennon v. Commissioner of Internal Revenue, T.C. Memo 1991-360.Â The facts considered were as follows:
- The estate had won a final judgement before the date of death for $7.75 million
- The defendant had filed a motion for a new trial before the date of death
- After the date of death, the defendant filed an appeal
- After the date of death, the defendant offered two million dollars to settle
- The parties settled after the date of death and four days before the start of oral arguments on appeal for $5.25 million
- After costs and fees, the defendantâ€™s estateâ€™s personal representative received $2,456,131
- The Tax Court found that the date of death fair market value was $1.75 million, for a 29% discount from settlement proceeds received
- A discount for lack of control was not considered, as the estate was the sole entity controlling the litigation/settlement
In comparing the Lennon case to the case at issue, the following was noted:
- No final hearing had been conducted with a verdict at date of death
- The ruling on the validity of the power of attorney was still pending
- The amount received in Lennon was cash. In the case at issue, Juniorâ€™s estate would have received a non-controlling interest in an estate (Seniorâ€™s) that was primarily comprised of real estate
- There was an additional risk that Juniorâ€™s estate would not receive the final settlement payment
- A discount for lack of control was warranted as Juniorâ€™s estate was one of four parties who jointly controlled the case/settlement
The second case cited was Estate of Ellen D. Foster v. Commissioner of Internal Revenue, T.C. Memo 2011-95.Â The facts considered were as follows:
- The settlement was received approximately four years after the date of death
- After the date of death, the Plaintiff found a document described as a â€śsmoking gunâ€ť that greatly increased their probability of success in the case
- The judge determined a ten percent probability of a successful preliminary investigation, and a 50% probability of a successful comprehensive investigation
- The judge increased the Plaintiffâ€™s expertâ€™s discount for lack of marketability from 25% to 39.5%
- A discount for lack of control was not considered, as the estate was the sole entity controlling the litigation
In comparing the Foster case to the case at issue, the following was noted:
- In this case, the initial payment was received approximately four years after the date of death and the second payment is scheduled to be received approximately eight years after the date of death
- No â€śsmoking gunâ€ť was available for the Plaintiff
Additionally, counsel for the siblings estimated that the probability of a successful outcome of the case at the date of death was 25%.Â This translates to a value of $2.56 million to Juniorâ€™s estate, based on Seniorâ€™s estate which was valued at $77 million.Â Other correspondence during the course of the litigation put Seniorâ€™s gross estate at $50 million.Â Under this assumption, and using a 25% probability of success, Juniorâ€™s estateâ€™s share would have been $1.66 million.Â Both calculations are prior to any attorney fees that would have been due, which would lower the amount received.Â Based on these factors, the financial experts ultimately determined a value of $1.7 million before discounts, using the present value of future proceeds.Â This is a reasonable approximation of the estateâ€™s interest at Juniorâ€™s date of death, before discounts for lack of marketability and lack of control.
Based on all the above considerations, a combined discount of 55% for lack of marketability and lack of control was determined.
Ultimately, the value of the case at the date of death was determined to be $771,000, or 45% of the final amount received of $1.7 million.
The valuation consideration of an estate when a portion of the estate is in litigation can be a complicated path based on present value, future payments, marketability, and control.Â Financial consultants with valuation expertise can help determine what your case is ultimately worth.
Libby J. Smith is a Manager at RGL Forensics where she focuses her work on business valuation and forensic accounting. She has been a CPA for 28 years and has over 20 years of experience in business valuation for estate and gift tax matters, marital dissolution and shareholder disputes.
Ms. Smith can be contacted at (813) 915-5639 or by e-mail to firstname.lastname@example.org.