The key to this case is the premise of value concept.  Premise of value poses the question, “Is the business an ongoing business or is it one in which the business will go into dissolution?” The Tax Court’s valuation failed to adequately consider the premise of value, resulting in an appeals decision in favor of the taxpayer.


Details of the Case

For fifteen years, an Oregon family had continuously operated the Giustina Land and Timber Company, a timber business involving 47,939 acres of timberland.  The company, employing from 12 to 15 people throughout this time, derived income from growing trees, cutting them down and selling the logs.  The company had two general partners and eight limited partners, all members of the same extended family.


The company had a dissolution provision in the partnership agreement stating that if two-thirds of the limited partners agreed, the partnership could be dissolved.   This would result in selling the assets and dividing the proceeds among the partners.  When Natale Giustina died in 2005, he owned a 41% limited-partner interest in the company.  The transfer of Natale’s interest to his heirs required a valuation of the business for tax purposes.


Using two methods to value the limited partners interest, the U.S. Tax Court gave 75% weight to the discounted cash flow (DCF) value and 25% to the net asset value (NAV).  This meant the court assumed a 75% likelihood that the company would continue to operate. The Tax Court determined that if the partnership were to liquidate and sell off its timberlands, the partnership would receive almost $143 million.   Adding in non-timberland assets increased the company’s potential value to $150,680,000.  The IRS valuator gave a 60% weight to the value of the partnership’s assets, in the event that the company were to liquidate.  The valuator also assumed a 25% chance that a hypothetical buyer of Natale Giustina’s limited partner interest would actually try to get the other partners to agree to liquidate.


The business valuation processes used by the estate, the IRS and the Tax Court varied significantly in their projections of the valuation of Natale’s interest.  The estate estimated the value at just under $13 million.  The IRS set it at $33,515,000 and the Tax Court estimated it at $27,454,115, basing their number on a 72/25 mix of cash flow and asset valuations.   The IRS valuation and the Tax Court’s valuation each would double the taxable value to the estate and its heirs compared to the estate’s estimate.  The estate challenged the higher levels by appealing to the U.S. Court of Appeals for the Ninth Circuit, arguing that the assets should not be included in the estimate because the business would almost certainly continue to operate.


The appeals court agreed with the plaintiffs, remanding the case to the Tax Court to provide a more realistic valuation, totally removing the asset valuation and focusing on the cash flow value of the company.  The resulting valuation by the Tax Court settled at $13,954,730 for the shares owned by Natale Giustina.


The Court Initially Failed to Realistically Consider Premise of Value

Premise of Value must be properly assessed at the beginning of the valuation. The premise of value is an assumption regarding the most likely set of transactional circumstances that will affect the subject valuation.  For example, is it a going concern or will the company be liquidated? In other words, the business valuator needs to consider what will most likely happen in the business after the valuation.  Basing an assumption in whole or in part on the dissolution of assets might not make any sense with a company that is very unlikely to dissolve.


The Tax Court initially said that the company could be liquidated.  A minority owner cannot force liquidation of a company.  A more realistic valuation could have avoided this situation, saving years of litigation.  When business changes require business valuation, selecting a certified business valuator can save time, money and in some cases taxes for the parties involved.  TD&T has Accredited in Business Valuation (ABV) professionals who can help you in preventing this kind of situation from happening.