In the Estate of Adell v. Comm'r, T.C. Memo. 2014-155 (8/4/14), the IRS rejected an estate's $9.3 million business valuation of its closely held stock and instead determined a date-of-death value of over $92 million. As a result, the IRS assessed an estate tax deficiency of almost $40 million and assessed millions more in penalties for substantial estate tax valuation understatements.

The estate initially filed a business valuation with a value of $9.3 million using discounted cash flows which accounted for personal goodwill attributable to a key person.  The IRS in its initial response valued the estate at over $92.2 million. Subsequently, both the estate and the IRS obtained additional valuations. The estate shifted to an adjusted net book value methodology where the assets and liabilities were stated at their liquidation value and determined that the value of the stock was $4.3 million (confirmed by the original and a second valuation expert). . The IRS countered with a business valuation also using discounted cash flows but came up with a value of approximately $26.3 million… primarily due to differences in accounting for the personal goodwill in the income approach.

In a defeat for the IRS, the Tax Court rejected the opinion of the IRS's business valuation expert; however, it also rejected the estates second business valuations stating that they were based on erroneous assumptions over the subject company’s ability to make a profit. In rejecting the IRS position, the Tax Court noted that the IRS’ appraiser did not properly account for the very significant personal goodwill of the Company’s key employee.

Lessons learned: Perhaps the estate felt they had nothing to lose by submitting new valuation reports; however they risked credibility by shifting positions and not addressing why historical earnings were not relevant. It appeared to the Tax Court that they ignored historical earnings in their subsequent business valuations. The IRS erred in not adequately addressing personal goodwill… the estate’s expert appears to have done a good job laying out the importance of the personal goodwill in their business valuation report.

https://www.ustaxcourt.gov/InOpHistoric/EstateofAdellMemo.Paris.TCM.WPD.pdf