October 22, 2014
A complex valuation case concerning the estate of the owner of a cable uplink company for the urban ministries network The Word has been decided in favor of the estate.
The US Tax Court in August accepted the original $9.3 million valuation entered by the estate of Franklin Z. Adell rather than the original IRS valuation of nearly 10 times that much – $92.3 million (Estate of Frank Z. Adell, et al. v. Commissioner, TCM 2014-155).
The IRS had also asked for a significant understatement penalty of more than $15 million.
Michigan resident Franklin Adell owned 100 percent of STN.Com, a cable uplink company whose sole client was The Word Ministries. He established the Adell Trust in 2002 to hold the business for his two daughters and one son.
Adell and his son, Kevin, formed STN, with Kevin handling the day-to-day operations and developing The Word network.
The Word was organized exclusively for charitable purposes and received tax-exemption from the IRS under Section 501(c)(3).
The Word agreed to pay STN “the lesser of actual cost or 95 percent of net programming revenue” to broadcast The Word nationally via satellite. STN employed 30 to 35 employees.
Somewhere along the way, “actual cost” seemed to drop off the radar, and STN collected at least 95 percent of revenues each month, according to court papers.
Adell received between $2 million and $7.3 million in compensation each year from 2002 to 2006, and Kevin Adell received between $223,000 and $1.29 million each year. STN leased Bentleys and Rolls-Royces, bought second homes and other real estate, and the Adells even had a fully staffed yacht.
After Adell’s death, STN continued to generate gross receipts of approximately $18 million a year in both 2007 and 2008.
The Tax Court said it would not speak to the tax-exempt status of The Word network but would deal only with the fair market value of Adell’s 100 percent interest in STN and whether the estate was liable for the tax valuation understatement penalty.
Both sides had dropped the amount of their valuation in more recent appraisals – the estate to $4.3 million and the IRS to $26.3 million.
The court said the value of the taxable estate should be the fair market value – the price at which the property would change hands between a willing buyer and a willing seller. The fair market value of stock of a closely held corporation is best determined by considering actual sales at arm’s length in the normal course of business, the court said.
In the absence of an arm’s-length transaction – in which buyers and sellers act independently to determine value – the fair market value is generally determined by using three approaches: market, income and asset-based, according to the court.
- Market Approach: Values a company’s nonpublicly traded stock by comparing that stock to the same or comparable stock that has sold in arm’s-length transactions in the same timeframe.
- Income Approach: Values a company’s nonpublicly traded stock by converting anticipated economic benefits into a single present amount.
- Asset-based Approach: Values stock by looking to the company’s assets net of its liabilities.
Experts in the case used different methods to determine the value. The estate’s expert used the discounted cash flow analysis of the income approach in 2007, shortly after Adell’s death, to come up with the $9.3 million value. Later, the estate’s expert did another valuation using the asset approach and came up with a value of $4.3 million.
The court found that a willing seller and a willing buyer could not ignore the historical performance of STN’s profits at the time of Adell’s death, and that STN was a profitable company despite the risk that The Word could begin paying expenses only or use another cable provider.
Thus, the court said, the income approach was most appropriate and found for the $9.3 million value.
The biggest difference between the estate’s valuation and that of the IRS involved the value of Kevin Adell’s goodwill in working with the various ministries. But the court found that the ministries worked with Kevin Adell because they trusted him personally, not because he was a representative of STN.
Because $9.3 million was the amount that STN had valued the estate on its original Form 706, there was no liability for an understatement penalty.
This article was originally posted on October 22, 2014 and the information may no longer be current. For questions, please contact GRF CPAs & Advisors at email@example.com.