The Anatomy of Valuing Stock in Closely Held Corporations: Pursuing the Phantom of Objectivity into the New Millenium

Monday, January 1st, 2001 at 12:00 am by Stephen J. Leacock
Stephen J. Leacock, The Anatomy of Valuing Stock in Closely Held Corporations: Pursuing the Phantom of Objectivity into the New Millenium, 2001 Colum. Bus. L. Rev. 161

Valuing stock in closely-held corporations is one of the most perplexing problems facing the courts. Valuation techniques are complex. Furthermore, the courts may not be sufficiently familiar with accounting and financial theory to effectively resolve the intractable details in a manner satisfactory to all constituents.

In fact, valuation of stock in close corporations is required, inter alia, in order to assess income taxes when buying or selling such stock , and also when such corporations are being reorganized. Moreover, when someone dies and bequeaths shares in a closely held corporation, for estate tax purposes, the IRS is required to assess the value of such shares in determining how much the decedent’s estate is worth. Similarly, gifts of shares in a closely-held corporation – the value of which exceed the annual gift tax exclusion – are subject to taxation. Clarity is therefore critical.

In these contexts, the IRS has defined ‘value‘ as connoting ‘the price at which the property would change hands between a willing buyer and a willing seller – when the former is not under any compulsion to buy; and the latter is not under any compulsion to sell – both parties having reasonable knowledge of relevant facts.‘ However, the concept of value is relative and dependent upon the goals of the particular valuer. There is no objective standard on which judges, academic commentators and practitioners agree.

For instance, with respect to utilizing fair market value, two commentators have concluded that it is appropriate to construct a fair market value, rationally and justifiably, only in circumstances where there exists a market in which the stock to be valued is traded. In contrast, a closely held corporation has no definable market and expert testimony is of necessity required in order to generate hypothetical sales transaction prices based upon financial valuation theory.

The problem is that, although both the IRS and the courts strive to conform to meaningful financial theories and adhere to legal precedents, the resulting valuations differ depending upon the type of tax that is imposed and whether the tax law has provided for exceptions to the general valuation approach set out in Rev. Rul. 59-60, 1959-1 C.B. 237. Furthermore, determinations of value with respect to shares in closely-held corporations may differ, depending upon the purposes for which the taxpayer is asserting the particular valuation.

This paper discusses a number of different valuation approaches that the courts have followed, particularly with respect to contested valuations in income, estate, and gift taxation cases.

Author Information

Professor of Law, Barry University, School of Law (on leave from DePaul University, College of Law 1998-2000). Committee Member of the American Bar Association Committee on Corporate Laws, Section of Business Law 1990-1996.