Pending merger had to be considered in valuing gifted public stock

Plain-English summary

A corporate co-founder transferred publicly traded shares to a grantor retained annuity trust shortly before the company announced a merger that followed extended negotiations. The stock price rose substantially after the announcement, and transaction records supported the view that a hypothetical buyer could have foreseen the merger on the gift date. Chief Counsel advised that the normal mean trading price did not represent fair market value under these circumstances. A hypothetical willing buyer and seller would have considered the pending merger and other relevant facts when valuing the gift.

Ruling snapshot

• Question: Would hypothetical willing buyers and sellers consider a pending merger when valuing publicly traded stock for gift tax purposes?
• Outcome: advice given, the pending merger had to be considered in determining fair market value
• Key authorities: IRC § 2512; Treas. Reg. §§ 25.2512-1 and 25.2512-2; Bank One; Estate of Kollsman; Silverman; Ferguson

Full text (IRS public release)

           Office of Chief Counsel
           Internal Revenue Service
           Memorandum
           Number: 201939002
           Release Date: 9/27/2019
           CC:PSI:4:HLDamazo                            Third Party Communication: None
           POSTF-111979-17                              Date of Communication: Not Applicable


 UILC:     2512.07-00

  date:    May 28, 2019

     to:   Thomas R. Mackinson
           Associate Area Counsel
           (San Francisco, Group 1)
           (Small Business/Self-Employed)

           Attn: Cameron W. Carr

  from:    Leslie H. Finlow
           Senior Technician Reviewer, Branch 4
           Associate Chief Counsel
           (Passthroughs & Special Industries)


subject:
           Gift Tax Examination

           This Chief Counsel Advice responds to your request for assistance. This advice may
           not be used or cited as precedent.

           LEGEND

           Donor              = --------------------------------------------------------------
           Corporation A      = -------------------------------------------------------------------------
           Corporation B      = ---------------------------------------------------------------------------
           Trust              = --------------------------------------------------------------------------------------
           Shares             = --------------------------------------------------------------------------------
           Date 1             = -----------------------------------------
           Date 2             = ------------------------------------------


           ISSUE

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Whether, under the circumstances described below, the hypothetical willing buyer and
seller of shares in a publicly-traded company would consider a pending merger when
valuing stock for gift tax purposes.

CONCLUSION

Yes. Under the fair market value standard, the hypothetical willing buyer and seller of a
publicly-traded company would consider a pending merger when valuing stock for gift
tax purposes.

FACTS

Donor is a co-founder and Chairman of the Board of Corporation A, a publicly-traded
corporation. On Date 1, Donor transferred Shares to Trust, a newly-formed grantor
retained annuity trust with a ------------ term, with a remainder to his children. -------------
later on Date 2, after the market closed, Corporation A announced a merger with
Corporation B. The merger was the culmination of -------------- negotiations with multiple
parties, and then, -------------------- before the Date 1 transfer, exclusive negotiations with
Corporation B.

On the ----- day of trading after the merger was announced, the value of the
Corporation A stock increased substantially, though less than the agreed merger price.
The merger was consummated more than ----------------- after Date 1.

The Internal Revenue Service has reviewed the underlying transaction documents from
the year preceding the merger. Such documents include the Corporation A and
Corporation B exclusivity agreement, correspondence between Corporation A and
Corporation B, and Board meeting minutes. The record as compiled to date supports
the position that, as of Date 1, the hypothetical willing buyer of the stock could have
reasonably foreseen the merger and anticipated that the price of Corporation A stock
would trade at a premium

LAW

Section 2512(a) of the Code provides that if a gift is made in property, the value thereof
at the date of the gift shall be considered the amount of the gift.

Section 25.2512-1 of the Gift Tax Regulations provides, in part, that if a gift is made in
property, its value at the date of the gift shall be considered the amount of the gift. The
value of the property is the price at which such property would change hands between a
willing buyer and a willing seller, neither being under any compulsion to buy or sell, and
both having reasonable knowledge of relevant facts.

Section 25.2512-2(a) generally provides that the value of stocks and bonds is the fair
market value per share or bond on the date of the gift.

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Section 25.2512-2(b)(1) provides, in relevant part, that if there is a market for stocks or
bonds, on a stock exchange, in an over-the-counter market or otherwise, the mean
between the highest and lowest quoted selling prices on the date of the gift is the fair
market value per share or bond.

Section 25.2512-2(e) provides, in relevant part, that in cases in which it is established
that the value per bond or share of any security determined on the basis of the selling or
bid and asked prices as provided under § 25.2512-2(b) does not represent the fair
market value thereof, then some reasonable modification of the value determined on
that basis or other relevant facts and elements of value shall be considered in
determining fair market value.

The value of property for Federal transfer tax purposes is a factual inquiry wherein the
trier of fact must weigh all relevant evidence and draw appropriate inferences to arrive at
the property’s fair market value. Bank One Corp. v. Commissioner, 120 T.C. 174
(2003), rev’d on other grounds, 458 F3d 564 (7th Cir. 2006) (citing Commissioner v.
Scottish Am. Inv. Co., 323 U.S. 119 (1944)). For this purpose, fair market value is the
price that a hypothetical willing buyer would pay a hypothetical willing seller, neither
being under any compulsion to buy or to sell, and both having reasonable knowledge of
relevant facts. Treas. Reg. § 25.2512-1; Rev. Rul. 59-60, 1959-1 C.B. 237. The
valuation of property is a question of fact. See Redstone v. Commissioner, T.C. Memo.
2015-237.

The willing buyer and willing seller are hypothetical persons, rather than specific
individuals or entities, and their characteristics are not necessarily the same as those of
the donor and the donee. See Estate of McCord v. Commissioner, 120 T.C. 358
(2003), rev’d on other grounds, 461 F3d 614 (5th Cir. 2006); Estate of Newhouse v.
Commissioner, 94 T.C. 193 (1990). The hypothetical willing buyer and willing seller are
presumed to be dedicated to achieving the maximum economic advantage. Newhouse,
94 T.C. at 218.

The principle that the hypothetical willing buyer and seller are presumed to have
“reasonable knowledge of relevant facts” affecting the value of property at issue applies
even if the relevant facts at issue were unknown to the actual owner of the property.
Estate of Kollsman v. Commissioner, T.C. Memo. 2017-40, appeal docketed, No.
18-70565 (9th Cir. Feb. 27, 2018). Moreover, both parties are presumed to have made a
reasonable investigation of the relevant facts. Id. Thus, in addition to facts that are
publicly available, reasonable knowledge includes those facts that a reasonable buyer or
seller would uncover during the course of negotiations over the purchase price of the
property. Id. Moreover, a hypothetical willing buyer is presumed to be “reasonably
informed” and “prudent” and to have asked the hypothetical willing seller for information
that is not publicly available. Estate of Kollsman, supra.

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Generally, a valuation of property for Federal transfer tax purposes is made as of the
valuation date without regard to events happening after that date. Ithaca Trust Co. v.
United States, 279 U.S. 151 (1929). Subsequent events may be considered, however, if
they are relevant to the question of value. Estate of Noble v. Commissioner, T.C. Memo.
2005-2, n.3. Federal law favors the admission of probative evidence, and the test of
relevancy under the Federal Rules of Evidence is designed to achieve that end. Id.
Thus, a post-valuation date event may be considered if the event was reasonably
foreseeable as of the valuation date. Trust Services of America, Inc. v. U.S., 885 F.2d
561, 569 (9th Cir. 1989); Bank One Corp., 120 T.C. 174, 306. Furthermore, a
post-valuation date event, even if unforeseeable as of the valuation date, also may be
probative of the earlier valuation to the extent that it is relevant to establishing the
amount that a hypothetical willing buyer would have paid a hypothetical willing seller for
the subject property as of the valuation date. See Estate of Gilford v. Commissioner, 88
T.C. 38, 52-55 (1987).

In Silverman v. Commissioner, T.C. Memo. 1974-285, aff’d, 538 F.2d 927 (2d Cir.
1976), cert. denied, 431 U.S. 938 (1977), the petitioners gifted shares of preferred stock
while in the process of reorganizing with the intent to go public. The Tax Court rejected
the expert testimony presented by the petitioners because the expert failed to take into
account the circumstances of the future public sale.

In Ferguson v. Commissioner, 174 F.3d 997 (9th Cir. 1999), aff’g 108 T.C. 244 (1997),
the appellate court considered the issue of whether the Tax Court correctly held that
taxpayers were liable for gain in appreciated stock under the anticipatory assignment of
income doctrine. In Ferguson, taxpayers owned 18 percent of AHC and served as
officers and on the board of directors. In late 1987 and early 1988, the AHC board of
directors contacted and eventually authorized Goldman, Sachs & Co. to find a
purchaser of AHC and to assist in the negotiations. By July 1988, Goldman, Sachs had
found four prospective purchasers. Shortly thereafter, AHC entered into a merger
agreement with DCI Holdings, Inc. With the taxpayers abstaining from the vote, the
AHC board unanimously approved the merger agreement. On August 3, 1988, the
tender offer was started. On August 15, taxpayers with the help of their broker
executed a donation-in-kind record with respect to their intention to donate stock to a
charity and two foundations. On September 9, 1988, the charity and the foundations
tendered their stock. On September 12, 1988, the final shares were tendered and on
October 14, 1988, the merger was completed. The court concluded that the transfers to
charity and the foundations occurred after the shares in AHC had ripened from an
interest in a viable corporation into a fixed right to receive cash and the merger was
“practically certain” to go through. In particular, the court noted that “[t]he Tax Court
really only needed to ascertain that as of [the valuation] date, the surrounding
circumstances were sufficient to indicate that the tender offer and the merger were
practically certain to proceed by the time of their actual deadlines - several days in the
future.” Ferguson, 174 F.3d at 1004. Consequently, the assignment of income doctrine
applied and the taxpayers realized gain when the shares were disposed of by charity
and the foundations.

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The current case shares many factual similarities with Ferguson, including the targeted
search by the Board of Directors of Corporation A to find merger candidates, the
exclusive negotiations with Corporation B immediately before the final agreement, the
generous terms of the merger, and an agreement that was “practically certain” to go
through. While the Ferguson opinion deals exclusively with the assignment of income
doctrine, it also relies upon the proposition that the facts and circumstances surrounding
a transaction are relevant to the determination that a merger is likely to go through. See
Bank One and Kollsman, supra. The current case presents an analogous issue, that is,
whether the fair market value of the stock should take into consideration the likelihood
of the merger as of the Date 1 transfer of Shares to Trust. The Ferguson and Silverman
opinions, as considered by the Tax Court and the Second and Ninth Circuit Courts of
Appeal, support the conclusion that the value of stock in Corporation A must take into
consideration the pending merger. Accordingly, a value determined on the basis of the
selling price as provided under § 25.2512-2(b) does not represent the fair market value
of Shares as of the valuation date; pursuant to § 25.2512-2(e), other relevant facts and
elements of value must be considered in determining fair market value. Under the fair
market value standard as articulated in § 25.2512-1, the hypothetical willing buyer and
willing seller, as of Date 1, would be reasonably informed during the course of
negotiations over the purchase and sale of Shares and would have knowledge of all
relevant facts, including the pending merger. Indeed, to ignore the facts and
circumstances of the pending merger would undermine the basic tenets of fair market
value and yield a baseless valuation.

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

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