                              T.C. Memo. 2014-155



                         UNITED STATES TAX COURT



     ESTATE OF FRANKLIN Z. ADELL, DECEASED, KEVIN R. ADELL,
       TEMPORARY CO-PERSONAL REPRESENTATIVE, Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 1188-11.                          Filed August 4, 2014.



      Steven Spencer Brown, Denis John Conlon, Royal B. Martin, Jr., and

William Gibbs Sullivan, for petitioner.

      John W. Stevens and Angela B. Reynolds, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      PARIS, Judge: In a notice of deficiency, respondent determined a Federal

estate tax deficiency of $39,673,096 with respect to the Estate of Franklin Z. Adell
                                        -2-

[*2] (estate). Respondent also determined a section 66621 substantial estate tax

valuation understatement penalty of $15,267,768 due to a gross valuation

misstatement as defined by section 6662(h)(2)(C). After concessions, the issue

remaining for decision is the fair market value of Franklin Z. Adell’s (Mr. Adell)

100% interest in STN.Com, Inc. (STN.Com), on August 13, 2006, the date of his

death.2 The Court must also decide whether the substantial estate tax valuation

understatement penalty applies.

                               FINDINGS OF FACT

      Some of the facts are stipulated and are so found. The stipulation of facts,

the supplemental stipulation of facts, the second supplemental stipulation of facts,

the exhibits attached thereto, and the exhibits admitted at trial or admitted by order

are incorporated herein by this reference.


      1
       Unless otherwise indicated, section references are to the Internal Revenue
Code in effect for the date of Franklin Z. Adell’s death, and Rule references are to
the Tax Court Rules of Practice and Procedure.
      2
        In addition to making concessions, the parties have further adjusted the
valuation issue for purposes of trial. On its Form 706, United States Estate (and
Generation-Skipping Transfer) Tax Return, filed on November 13, 2007, the estate
initially reported the value of Mr. Adell’s interest in STN.Com as $9.3 million. At
trial and on brief petitioner argues that the value of Mr. Adell’s STN.Com interest
on his date of death was $4.3 million. In the notice of deficiency, respondent
proposed a value of $92,277,000, for a purported adjustment of $85,937,657, but
now respondent argues that the value of Mr. Adell’s interest in STN.Com was
$26,341,030.
                                        -3-

[*3] Mr. Adell died on August 13, 2006, when he was a legal resident of

Michigan. Mr. Adell’s estate is being probated under the laws of the State of

Michigan. Kevin R. Adell (Kevin), Mr. Adell’s son and the estate’s co-personal

representative, resided in Michigan when the petition was filed.3

      Mr. Adell was married to Sharon Adell, who died before him. They had

three children, Kevin, Julie Verona, and Laurie Fischgrund. On July 17, 2002, Mr.

Adell created the Franklin Z. Adell Trust (Adell Trust). The trust instrument was

amended and restated on October 31, 2003. Mr. Adell’s three children were equal

beneficiaries of the Adell Trust. The values of the Adell Trust’s assets are

included in the value of Mr. Adell’s gross estate. One of the assets, and the




      3
       In 2009 Mr. Adell’s daughters, Julie Verona and Laurie Fischgrund, filed a
lawsuit against Kevin as the personal representative of the estate in the probate
court of Oakland County, Michigan. On April 26, 2010, the Oakland County
probate court appointed Joseph Ehrlich as the successor temporary personal
representative of the estate. On August 11, 2010, the Oakland County probate
court appointed Ms. Verona and Ms. Fischgrund as successor co-personal
representatives of the estate. After reaching a settlement with Kevin regarding the
probate of the estate, Ms. Verona and Ms. Fischgrund were discharged as co-
personal representatives of the estate by a court order dated February 22, 2012.
Kevin was appointed as the temporary co-personal representative of the estate on
January 13, 2011, in part, to petition this Court concerning the value of STN.Com.
                                        -4-

[*4] subject of the dispute herein, is Mr. Adell’s 100% interest in STN.Com, Inc.

(STN.Com), a cable uplinking company.4

I. Background of STN.Com

      Before Mr. Adell became involved with cable uplinking, he invented a car

door edge guard in 1952 and ran a door guard manufacturing business with his

brothers. In 1978 Mr. Adell decided to pursue an opportunity in television

broadcasting. He applied for a television license, which he received 10 years later

in 1988. At that time Mr. Adell’s son, Kevin, was finishing his degree in

communications at Arizona State University. Mr. Adell, who continued to work

for his family’s automotive company during the day, convinced his son to return

home to Michigan and help him build a television station. With loans and money

from his parents, Kevin built the television station WADL for his father, Mr.

Adell.5 WADL went on the air in 1989 and initially broadcasted infomercials.


      4
        In addition to his interest in STN.Com, Mr. Adell transferred the following
property to the Adell Trust during his lifetime: Treasury bills and accrued interest
with a date-of-death value of $4,504,529; a $3.2 million home; Mr. Adell’s 100%
interest in Birmingham Properties, Inc. (Birmingham Properties), with a date-of-
death value of $960,166; and Mr. Adell’s 86% interest in Adell Broadcasting
Corp., Inc. (Adell Broadcasting), with a date-of-death value of $6 million.
      5
       Adell Broadcasting, a C corporation, owned and operated WADL. Mr.
Adell owned an 86% interest in Adell Broadcasting that he transferred to the Adell
Trust during his life. Mr. Adell’s interest in Adell Broadcasting had a date-of-
                                                                       (continued...)
                                          -5-

[*5] Several years later, after a competitor lost its affiliation with a local channel,

WADL was able to contract all of the religious programming that was previously

broadcasted on the other channel.

      In 1994 Mr. Adell formed STN Satellite Television Network, Inc. (STN

Satellite), a Nevada corporation that provided satellite uplinking services. Mr.

Adell purchased a building for his uplinking business that was separate from the

WADL location.6 Kevin hired a company to apply for an uplink license and the

uplink license was issued to “STN”.7 Kevin handled the day-to-day operations

and began to learn about the uplinking business by providing satellite uplinking

services on a contract basis for various customers, including Hughes Electronics

Corp., a subsidiary of General Motors. STN Satellite’s contract with Hughes



      5
       (...continued)
death value of $6 million. See supra note 4.
      6
       Birmingham Properties, an S corporation wholly owned by Mr. Adell,
owned the building. STN.Com paid Birmingham Properties $20,000 a month in
rent. Mr. Adell transferred his interest in Birmingham Properties to the Adell
Trust during his life, and as of his date of death, Birmingham Properties had a
value of $960,166. See supra note 4.
      7
        At trial Kevin testified that the name on the uplink license was “STN”,
referring to STN Satellite, but he could not remember whether he had changed the
name on the license to “STN.Com”. After STN.Com’s incorporation in 1999, Mr.
Adell and Kevin used the names STN, STN.Com, and Satellite Television
Network, Inc., interchangeably.
                                       -6-

[*6] Electronics Corp. lasted for two years, from 1997 through 1999, and was

terminated around the time Kevin saw an opportunity to create STN.Com, a new

entity to operate Mr. Adell’s uplinking business.

      Mr. Adell incorporated STN.Com on June 29, 1999, as a C corporation in

the State of Michigan. Mr. Adell was STN.Com’s sole shareholder until July 17,

2002, when he transferred his 100% interest in STN.Com consisting of 1,000

shares of common stock to the Adell Trust. From the date of incorporation

through the date of Mr. Adell’s death, STN.Com’s board of directors included Mr.

Adell, Kevin, and Ralph G. Lameti.8 Kevin served as STN.Com’s president, but

he never had an employment agreement or a noncompete agreement with

STN.Com. STN.Com’s sole business purpose was to broadcast an urban religious

program9 channel that Kevin named “The Word Network” (The Word).




      8
        Mr. Lameti, who is a certified public accountant and has a law degree, did
all of the accounting work for Mr. Adell and his family. Mr. Lameti’s firm
provided accounting services for STN.Com.
      9
      On Form 990, Return of Organization Exempt From Income Tax, Mr. Adell
and Kevin specified the broadcasting of “urban religious programs” as The Word’s
exempt purpose. For consistency, the Court will adopt the term from the Form
990 when describing the programming of STN.Com.
                                       -7-

[*7] II. STN.Com and The Word

      Before The Word, Kevin was looking for programming content to create an

entertainment channel. He pitched various ideas for a channel, such as a 24-hour

channel documenting General Motors cars and manufacturing since the company

was headquartered in Michigan, but those ideas never got off the ground. Kevin

was familiar with religious programming so he decided to create a 24-hour station

broadcasting urban religious ministries and gospel music, which he called The

Word. To gain support for The Word, Kevin met with religious leaders in the

Detroit area, including Bishop Charles Haywood Ellis, and Reverend Jesse

Jackson, Sr., in Chicago. They agreed to help Kevin launch The Word.

      In October 1999 Mr. Adell, Kevin, Mr. Lameti, Rev. Jackson, and Bishop

Ellis went to Los Angeles to meet with the president of DirecTV about The Word.

Kevin presented his idea for a 24-hour urban religious program channel, and Rev.

Jackson and Bishop Ellis explained the need for urban ministries to reach a

national audience. The DirecTV representatives were interested in broadcasting

The Word and asked Kevin to prepare a business plan. They also gave Kevin a

deadline for creating The Word, which had to be a nonprofit entity in order to use

the available broadcast space.
                                          -8-

[*8] On October 27, 1999, Kevin and Mr. Adell incorporated World Religious

Relief as a Michigan nonprofit to operate as The Word. According to its articles

of incorporation, The Word was organized exclusively for charitable, educational,

and scientific purposes as described in section 501(c)(3), and no part of its assets

or net earnings could inure to the benefit of or be distributable to its directors,

officers, or other private persons.10 Mr. Adell was the president and a director of

The Word, and Kevin was the treasurer, secretary, and a director of The Word.11

      STN.Com purchased and operated the equipment used to uplink The Word’s

urban religious programming and provided 30 to 35 employees to broadcast The

Word. On November 24, 1999, The Word and STN.Com signed a Services and

Facilities Agreement (services agreement) in which STN.Com agreed to provide

“such executive, management, legal, technical, supervisory, administrative,



      10
         When Kevin contacted ministers about programming content and cable
companies for broadcasting opportunities, he was often asked whether ownership
in The Word was available. Kevin indicated that because The Word was a
nonprofit, the ministers and cable companies could not receive an ownership
interest.
      11
        Until Mr. Adell’s date of death in August 2006, Mr. Adell and Kevin were
the only employees of The Word. According to its Form 1023, Application for
Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,
The Word represented that it would not provide compensation to its officers and
directors. However, The Word’s articles of incorporation provide that it may pay
reasonable compensation for services.
                                         -9-

[*9] accounting, clerical, and other services and such facilities as * * * [The

Word] may reasonably require in order to effectively run its operations, as

requested from time to time by the Board of Directors or the President of * * *

[The Word]”. In consideration, The Word agreed to pay STN.Com a monthly

programming fee equal to “the lesser of actual cost or ninety-five percent of net

programming revenue received by * * * [The Word] in a one month period”. The

parties agreed that the programming fee would not exceed STN.Com’s “actual

direct costs and allowable indirect costs”.12

      The services agreement was scheduled to take effect on February 1, 2000,

and terminated upon the earliest of: (1) mutual written consent of the parties; (2)

termination of The Word’s right to use the DirecTV channel; (3) The Word’s

failure to pay the monthly programming fee within five business days after the due

date; or (4) The Word’s exercise of an option to terminate the agreement if

STN.Com failed to transmit The Word’s programming to the DirecTV channel for




      12
        According to the services agreement, the costs must be reasonable and
include: “(a) Reasonable amounts paid to all independent contractors * * * (b)
Reasonable direct costs * * * (c) A reasonable allocation of salaries, wages,
employee benefits, and the employer’s share of payroll taxes * * *; and (d) A
reasonable allocation of overhead costs”.
                                        - 10 -

[*10] a specified length of time.13 Mr. Adell signed the services agreement as

president of The Word, and Kevin signed the agreement as president of STN

Satellite.14

       On or around November 26, 1999, Kevin and Mr. Adell filed The Word’s

Form 1023. According to the Form 1023, The Word received an oral commitment

from DirecTV to broadcast its nonprofit programming, and it intended to offer its

programming to other large cable companies. According to the oral agreement,

The Word was responsible for arranging all programming content, including

contacting ministers, clergy, and other religious leaders who had local television

programs and offering to broadcast their programs for a reduced fee. STN.Com

was responsible for sending The Word’s signal to a satellite, and DirecTV agreed

to take the programs off the satellite and broadcast them nationally.

       Also on the Form 1023, The Word represented that its programming would

be strictly noncommercial and would include educational and theological



       13
       The service contract gives The Word an option to terminate the agreement
if STN.Com fails to transmit programming to the DirecTV channel for “more than
48 hours for seven (7) or more consecutive days, during the term of this
Agreement”, which the Court finds ambiguous.
       14
         At trial Kevin testified that it was a clerical mistake that STN Satellite was
listed instead of STN.Com. From 2000 through Mr. Adell’s date of death in 2006,
Mr. Adell was president of The Word and Kevin was president of STN.Com.
                                       - 11 -

[*11] broadcasts. The Word also disclosed that Mr. Adell and Kevin, who were

officers and directors of The Word, were principals of two entities, Adell

Broadcasting and STN.Com, that agreed to fund The Word’s startup costs. The

Word represented that any financial transactions with Adell Broadcasting and

STN.Com would be at arm’s length and below cost to prevent any private

inurement, and any unreimbursed expense incurred by STN.Com would be treated

as a donation. Broadcasts of The Word began on February 14, 2000; and on May

11, 2000, The Word received its section 501(c)(3) tax-exempt status.

      Pursuant to the services agreement, and continuing through Mr. Adell’s date

of death, The Word paid STN.Com at least 95% of its revenue each month.15 The

Word’s primary source of revenue was from broadcasting contracts that Kevin, as

a representative of The Word, negotiated and entered into with ministers and their

religious affiliates. STN.Com’s primary source of income came from the program

fees it received from The Word, STN.Com’s only customer.16


      15
        In 2002 and 2003 The Word’s programming payment to STN.Com
exceeded 100% of its reported programming revenues. At trial Mr. Lameti
indicated that the one-month difference in tax yearends for The Word and
STN.Com--The Word’s ended in May and STN.Com’s ended in June--could have
caused the excess payments to STN.Com in 2002 and 2003.
      16
       According to the notes to its financial statements for the tax years ending
(TYE) June 30, 2002 through 2006, STN.Com derived its entire broadcast revenue
                                                                       (continued...)
                                      - 12 -

[*12] The Word and STN.Com filed returns for the years leading up to Mr.

Adell’s death. The Word filed Forms 990 for its tax years ending (TYE)17 May 31,

2002 through 2006, and reported the following amounts in broadcasting revenue

and programming fees paid to STN.Com:

 TYE       The Word’s revenue     STN.Com’s fee       STN.Com’s gross receipts
 2002          $7,639,772           $7,668,016               $7,894,164
 2003           9,307,532             9,490,923                9,079,734
 2004          10,767,473           10,229,099                10,462,062
 2005          14,099,195           13,394,235               13,627,870
 2006          16,770,985           15,932,436               15,866,995

      In addition to paying STN.Com’s fee, The Word also reported compensation

paid to its officers listed on its Forms 990 as: Mr. Adell, CEO; 15 hours/week

devoted to position and Kevin, president; 10 hours/week devoted to position.




      16
        (...continued)
from The Word, which “pays 95% of its broadcasting revenue to * * *
[STN.Com]”. The notes do not mention that STN.Com’s broadcasting revenue is
limited to the lesser of its costs or 95% of The Word’s broadcasting revenue, as
provided in the services agreement.
      17
      The parties sometimes use the term “fiscal year ending” instead of TYE.
The Court will use TYE for consistency.
                                             - 13 -

 [*13]                          Compensation from The Word
                    Mr. Adell, CEO                            Kevin, president1
  TYE       15 hrs./wk. devoted to position            10 hrs./wk. devoted to position
 2002                   $45,833                                   $45,833
 2003                      50,000                                  50,000
 2004                      50,000                                  50,000
 2005                      50,000                                  50,000
 2006                      50,000                                  50,000

      1
       The discrepancy in Form 990 officer titles, i.e., Mr. Adell, CEO, and Kevin,
president, was not addressed in testimony or other exhibits. The original Form
1023 listed Mr. Adell as president and Kevin as treasurer and secretary. See
supra pp. 8-10 and note 11 for discussion on Form 1023 application and service
agreement.

      STN.Com filed Forms 1120, U.S. Corporation Income Tax Return, for its

TYE June 30, 2002 through 2006, based on financial statements prepared by Mr.

Lameti’s accounting firms. According to its corporate returns and financial

statements, STN.Com reported the following amounts in gross receipts, retained

earnings, shareholder equity, and assets:

 TYE      Gross receipts     Retained earnings        Shareholder equity            Assets
                                    1                                       1
 2002      $7,894,164                   $557,642          $558,643              $2,242,052
 2003       9,079,734               1,416,587             1,417,587                 3,068,332
                                1                                               1
 2004      10,462,062               2,720,937             2,721,936                 3,623,778
                                       - 14 -

 [*14]
                                                                       1
 2005      13,627,870          3,521,199             3,522,199             5,631,223
 2006      15,866,995          3,842,488             3,843,488          4,922,732

      1
       The Court will assume that minor differences between these numbers as
they appear on the tax returns and on the financial statements are due to rounding.

      STN.Com used the program fees it received from The Word to pay its

expenses. STN.Com’s expenses included a monthly $20,000 rent payment to Mr.

Adell’s wholly owned S corporation, Birmingham Properties, and compensation to

its officers and employees. STN.Com’s largest expense was compensation for Mr.

Adell and Kevin.18 During its TYE in June 2002 through 2006, STN.Com paid

Mr. Adell and Kevin the following amounts in compensation:

                                        Compensation from STN.Com
           TYE                       Mr. Adell                     Kevin
           2002                     $2,050,000                   $1,115,000
           2003                      2,373,507                    1,207,155
           2004                      3,978,143                     223,488
           2005                      6,751,948                     241,336
           2006                      7,354,594                    1,292,758




      18
       These amounts do not include notes receivable from Kevin to STN.Com,
more specifically described infra note 22.
                                      - 15 -

[*15] Mr. Adell’s date of death was August 13, 2006, so for its TYE June 2007

STN.Com paid Mr. Adell’s compensation of $1,157,976 to the Adell Trust. In

TYE June 2007 and 2008 STN.Com paid Kevin compensation of $9,734,643 and

$8,204,066, respectively.19

      In addition to rent and compensation, STN.Com made several miscellaneous

payments that were primarily for the personal benefit of Mr. Adell and Kevin.

STN.Com leased luxury cars, including Bentleys and Rolls-Royces, used for

personal and work purposes by Mr. Adell, Kevin, and its other employees.20

STN.Com also helped Mr. Adell and Kevin purchase and maintain real estate. For




      19
        STN.Com amended its corporate returns for 2007 and 2008 to increase
deductions on its original returns to recharacterize dividend payments as
compensation to Kevin, thereby increasing his compensation for those tax years.
See infra note 30.
      20
         During TYE June 2003 through 2007 STN.Com had prepaid auto lease
expenses of $27,145, $103,042, $114,895, $118,001, and $48,969, respectively.
According to the estate’s return, Mr. Adell owned a Bentley Continental GT that
had a date-of-death value of $130,000 and two Rolls-Royces with date-of-death
values of $225,000 for the Phantom and $130,000 for the Corniche. As of June
2009 Kevin received use of one company owned or leased luxury car that was not
included as wage income and nine other luxury cars that were included as part of
his compensation from STN.Com. The estate objected to this evidence on the
basis of relevancy. The Court reserved ruling on this objection, and now overrules
it to the extent that the evidence is relevant to show that STN.Com was indeed a
profitable corporation during and immediately after Mr. Adell’s life.
                                       - 16 -

[*16] example, STN.Com gave money to Mr. Adell and Kevin to purchase a

condominium in Los Angeles, California, and guaranteed the mortgage.21

STN.Com purchased high-end furnishings for the condominium and for Mr.

Adell’s home in Michigan and paid all expenses, including the mortgage, interest,

and insurance, related to Kevin’s second home in Florida. In 2002 STN.Com paid

$300,000 toward Kevin’s home in Florida. From July 2002 through June 2003

STN.Com paid between $300,000 and $400,000 of Kevin’s personal legal fees for

litigation involving a dispute with a home contractor.22 In 2006 Mr. Adell paid a

$6 million judgment entered against Kevin using funds from Mr. Adell’s salary at




      21
        Kevin claimed that the money received from STN.Com was reported as
wage income to Mr. Adell and Kevin. The estate did not provide evidence
supporting Kevin’s claims and instead objected on the grounds of relevancy. The
Court overrules the estate’s objection and finds the evidence relevant to show that
STN.Com was indeed a profitable corporation. As of Mr. Adell’s date of death,
the condominium had a reported value of $1,675,579.
      22
        These payments were later recharacterized as loans from STN.Com to
Kevin which the financial statements show were substantially repaid after Mr.
Adell’s death. These loans to Kevin were represented by demand promissary
notes. The maximum cumulative balance of the notes was $985,010, and
STN.Com’s financial statements showed yearend balances due from Kevin in the
following amounts for TYE June 2003 through 2007: $430,085, $941,939,
$955,858, $969,778 and $264,662, respectively.
                                       - 17 -

[*17] STN.Com.23 Kevin filed for bankruptcy and moved to Florida in 2003,

where he continues to maintain a residence.24

      Mr. Adell’s daughters also personally benefited from STN.Com. During

2006 through 2008 the Adell Trust made payments to Ms. Verona and Ms.

Fischgrund which were funded by dividend payments made from STN.Com to the

Adell Trust.25 In addition, although STN.Com never employed Ms. Verona, Mr.

Adell, individually and as trustee of the Adell Trust, directed STN.Com to pay Ms.

Verona’s health insurance coverage from approximately 2001 until Mr. Adell’s

death in 2006. STN.Com continued the payments until 2007.

      After Mr. Adell’s death in 2006 Kevin was appointed chief executive

officer, in addition to already being president of STN.Com, and Mr. Lameti was



      23
        On the estate’s original Form 706, the judgment was reported under
Schedule F, Other Miscellaneous Property, as a loan receivable and asset of the
estate with a value of $6,667,018. On the estate’s first amended Form 706, the
judgment was recharacterized as a gift from Mr. Adell to Kevin in the amount of
$6,655,018 and reported under Schedule G, Transfers During Decedent’s Life.
The parties have agreed to treat the $6.6 million payment as a gift. See infra p. 21;
see also Estate of Adell v. Commissioner, T.C. Memo. 2014-89.
      24
        In subsequent gift tax litigation, Kevin claimed Florida as the then-current
residence of the personal representative. The Court recognizes that the related
cases now lie in different appellate jurisdictions.
      25
      In 2008 these payments were recharacterized as compensation paid by
STN.Com to Kevin, who then loaned the funds to the Adell Trust.
                                       - 18 -

[*18] named the chief financial officer of STN.Com. Kevin continued to operate

STN.Com in the same manner as before Mr. Adell died.26 In fact, STN.Com

continued to generate significant gross receipts for its TYE June 2007 and 2008

and reported gross receipts of $18,510,969 and $17,987,701, respectively.

      In September 2008 Ms. Verona and Ms. Fischgrund filed a lawsuit in the

probate court of Oakland County, Michigan, against Kevin as trustee of the Adell

Trust. In 2009 they filed a second lawsuit in the probate court against Kevin as

personal representative in administration of the estate. Because the probate court

litigation affected STN.Com, Kevin testified that he created a new company,

International Broadcasting Services, Inc. (International Broadcasting), to provide

the uplinking services The Word needed to continue its business.

      Kevin filed articles of incorporation for International Broadcasting on June

30, 2010. He is the sole owner. On or around July 10, 2010, almost four years

after Mr. Adell’s death, Kevin resigned from STN.Com, and all of STN.Com’s

employees except for one resigned and became employees of International

      26
        Notably, Kevin continued to use STN.Com for his personal benefit. In
September 2007, using a $2.2 million bank loan, STN.Com purchased an 85-foot
yacht, which Kevin kept at his home in Florida and used for personal purposes.
STN.Com also paid for the captain and crew of the yacht. In 2008 STN.Com
advanced $701,000 to Kevin to set up his company, Novi Trade Center, LLC.
STN.Com advanced a total of $1,491,626.48 to Novi Trade Center, LLC, from
January 2007 through June 2008.
                                         - 19 -

[*19] Broadcasting. Beginning in July 2010 The Word changed its uplinking

provider from STN.Com to International Broadcasting. On July 20, 2010, The

Word and International Broadcasting signed a new Services and Facilities

Agreement that was identical to the one between STN.Com and The Word. Mr.

Lameti signed the new agreement on behalf of The Word, and Kevin signed on

behalf of International Broadcasting. At this time, all of the uplinking equipment

owned by STN.Com was transferred to The Word without consideration, and

STN.Com ceased operations as of 2010.

III. Estate Tax Return

      Mr. Adell died on August 13, 2006. Kevin was appointed personal

representative of the estate and trustee of the Adell Trust.27 On April 26, 2007,

respondent received the estate’s Form 4768, Application for Extension of Time to

File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes,

requesting a six-month extension to pay its estate tax liability.28


      27
        Mr. Lameti was the appointed trustee of the Adell Trust on August 13,
2006, but he resigned and appointed Kevin as trustee on August 14, 2006. Kevin
served as trustee of the Adell Trust until September 1, 2009.
      28
        The estate expected to make a sec. 6166 election computing the deferred
and nondeferred portions of the estate tax on the basis of the portion attributable to
the closely held businesses and was waiting for the valuations of Mr. Adell’s
closely held businesses, Adell Broadcasting, Birmingham Properties, and
                                                                        (continued...)
                                        - 20 -

[*20] On November 13, 2007, the estate filed a Form 706 reporting an estate tax

due of $15,288,517. Included with the Form 706 was a statement in which the

estate elected under section 6166 to defer $7,193,960 of the total estate tax

attributable to the closely held businesses’ assets for five years and then pay the

deferred estate tax in 10 annual installments.29 The estate paid the nondeferred

estate tax of $8,094,557 when it filed the Form 706 on November 13, 2007.30

      Attached to the estate’s return was, inter alia, a Schedule G showing Mr.

Adell’s transfers to the Adell Trust during his life. Among the transfers were Mr.



      28
         (...continued)
STN.Com. The parties have not addressed whether any estate tax lien provisions
required under secs. 6166 and 6324A were violated when STN.Com transferred all
of its uplinking equipment without consideration.
      29
        For a discussion of the estate’s sec. 6166 election and its petition to the
Court regarding the same, see Estate of Adell v. Commissioner, T.C. Memo. 2013-
228.
      30
         STN.Com executed a $3,040,000 capital stock redemption to pay the
nondeferred portion of the estate tax. In addition, on or around November 9,
2007, STN.Com loaned the Adell Trust $1.8 million to pay the estate’s income tax
liability. The payment was originally intended to be a stock redemption, but in
2008 it was recharacterized as compensation paid by STN.Com to Kevin, which
Kevin then loaned to the Adell Trust. The parties have not addressed the tax
consequences under sec. 303 in regard to distributions in redemption of stock to
pay death taxes versus recharacterizing the amount as compensation. The original
estate tax return reflected a $9,300-per-unit value of STN.Com. The trust owned
1,000 shares for a $9.3 million value. The shareholder equity reflected on
STN.Com’s 2006 financial statement was $3.8 million.
                                        - 21 -

[*21] Adell’s shares of stock in: Birmingham Properties, with a reported date-of-

death value of $960,166; Adell Broadcasting, with a reported date-of-death value

of $6 million; and STN.Com, with a reported date-of-death value of $9.3 million.

The STN.Com stock’s reported value was based on a valuation report prepared by

Stout Risius Ross, Inc. (Stout Risius Ross), and certified by Jeffrey M. Risius, one

of the estate’s expert witnesses.31

      The estate amended its estate tax return twice. The estate’s Form 706 was

amended for the first time on November 17, 2008, over a year after the filing of its

original return. On the first amended return, the $6.6 million payment Mr. Adell

made on behalf of Kevin to discharge a judgment in 2006 was recharacterized by

the estate from a note payable to Mr. Adell or a loan receivable to the estate to a

taxable gift from Mr. Adell to Kevin. By recharacterizing the receivable as a gift,

the estate reduced its total transfer taxes from $15,288,517, as originally reported,




      31
        For a discussion of Mr. Risius’ valuation report attached to the estate’s
original Form 706, see infra pp. 23-29.
                                        - 22 -

[*22] to $12,393,889.32 The first amended estate return did not adjust the

STN.Com stocks’s date-of-death value from the originally reported $9.3 million.

      Respondent received the estate’s second amended Form 706 on August 10,

2010, almost four years after Mr. Adell died. On the second amended return, the

estate changed its original return position and reported that the STN.Com stocks’s

date-of-death value was zero instead of $9.3 million. The estate’s total transfer

taxes were reduced to $8,115,889, and the value attributable to the closely held

business assets was reduced from $16,263,166 to $6,960,166.

      On November 9, 2010, respondent issued a notice of deficiency to the estate

in which respondent determined an estate tax deficiency of $39,673,096. In the

notice, respondent determined, inter alia, that the date-of-death value of the

STN.Com stock that Mr. Adell had transferred to the Adell Trust was over $92.2

million, instead of $9.3 million reported on the original Form 706 filed on




      32
          The first amended estate tax return requested that the previously remitted
estate tax payment of $8,094,557, paid in November 2007, be reallocated to apply
$5,205,449 to the amended return balance of $12,393,889. The first amended
return also indicated that the remaining $2,889,108 of the $8,094,557 payment
made with the original return should be applied to Mr. Adell’s taxable gifts. The
Court previously decided that because there was not an available overpayment of
estate tax, the $2,889,108 previously remitted as estate tax could not be applied to
the gift tax liability. See Estate of Adell v. Commissioner, T.C. Memo. 2014-89;
see also supra notes 23 and 29.
                                         - 23 -

[*23] November 13, 2007.33 Kevin, as the estate’s representative, timely filed a

petition with the Court.

IV. Valuation Reports

      A. Mr. Risius’ June 15, 2007, Valuation Report

      Mr. Risius was primarily responsible for preparing the first valuation report

of the STN.Com stock that was attached to the estate’s original return. In

preparing the report, Mr. Risius considered the factors listed in Rev. Rul. 59-60,

1959-1 C.B. 237. He relied on STN.Com’s financial statements for the TYE June

30, 2002 through 2006, the services agreement between The Word and STN.Com,

The Word’s bylaws, and a schedule of compensation paid to STN.Com’s officers

for the TYE June 30, 2002 through 2006. Mr. Risius also spoke with STN.Com’s

management regarding its business, industry, history, and prospects.




      33
         The notice of deficiency did not reference the estate’s second amended
return in which it reported a zero value for the STN.Com stock and it does not
appear from the record that the second amended Form 706 was accepted, although
it does reflect the estate’s original position taken on the petition. The notice of
deficiency, however, included a $2,960,657 gross-up to the estate to account for
the additional gift tax payable with respect to Mr. Adell’s corrected taxable gifts
for 2006 reflected on the first amended return. The estate received a separate
notice of deficiency for the delinquent gift tax return and subsequent gift tax
liability accrued as a result of the recharacterization. The estate’s gift tax petition
is the subject of Estate of Adell v. Commissioner, T.C. Memo. 2014-89.
                                          - 24 -

[*24] Using this information, Mr. Risius described STN.Com as a company that

generates revenue by uplinking network television broadcasting for its sole

customer, The Word, pursuant to a services and facilities agreement. Mr. Risius

reported that STN.Com received 95% of the revenue generated by The Word as

consideration.34 Although Mr. Risius acknowledged that STN.Com’s single

contract with its single customer posed significant risks, he concluded that the risk

could be accounted for by adding a company risk adjustment of 3%.

      Mr. Risius’ financial statement analysis began with a balance sheet analysis

that included consideration of STN.Com’s net working capital, property and

equipment, interest-bearing debt, and stockholders equity. Because STN.Com’s

historical working capital, which included accounts receivable and accounts

payable, demonstrated an upward trend except for 2005, Mr. Risius projected that

STN.Com’s net working capital (current assets less current liabilities) was

expected to gradually increase from approximately $1.2 million to $1.6 million,

remaining constant at approximately 6.3% of sales.35 STN.Com’s overall assets,


      34
        As noted supra pp. 11-13 and note 16, STN.Com’s financial statements for
its TYE 2002 through 2006, and upon which Mr. Risius relied to prepare his
valuation report, also described STN.Com’s consideration as 95% of the revenue
generated by The Word.
      35
           Mr. Risius defined the historical period as the five TYE June 30, 2002
                                                                         (continued...)
                                      - 25 -

[*25] including gross fixed assets of leasehold improvements, uplinking and

broadcasting equipment, office furniture, and one or more vehicles, increased from

$2.2 million in 2002 to $5.6 million in 2005 and then decreased to $4.9 million as

of 2006.36 STN.Com had approximately $854,000 of interest-bearing debt and

stockholders equity that increased from approximately $559,000 to $3.8 million

during the historical period.

      In his income statement analysis, Mr. Risius noted that sales increased

rapidly during the historical period from approximately $7.9 million in 2002 to

$15.9 million in 2006 and were projected to increase from approximately $18.5

million to $26 million during the projection period. “Due to several unusual or

nonrecurring expense items”, however, Mr. Risius made a number of adjustments

to STN.Com’s reported financial results to more accurately reflect STN.Com’s




      35
       (...continued)
through 2006, and the projection period as the five TYE August 13, 2007 through
2011, and the residual period ending August 13, 2012.
      36
        On the basis of his conversations with management, Mr. Risius projected
net capital expenditures to range from approximately $200,000 to $2 million over
five years. According to management, STN.Com budgeted significant capital
expenditures in the future to purchase a tour bus in 2007 and equipment upgrades
in 2009. In 2006 or 2007 STN.Com purchased a bus that cost about $800,000.
                                        - 26 -

[*26] normalized ongoing operating performance. Among the adjustments was a

reduction in officers salaries and wages to reflect market rates.37

      Mr. Risius also adjusted STN.Com’s operating expenses to include an

economic charge for Kevin’s personal goodwill. Mr. Risius explained that the

adjustment was appropriate because the success of STN.Com depended heavily on

Kevin’s personal relationships with the board of directors of The Word.

Moreover, Kevin did not have a noncompete agreement with STN.Com, and as a

result a potential buyer would acquire STN.Com only to the extent that the

company retained Kevin. The economic charge for Kevin’s personal goodwill

ranged from 37.2% to 43.4% of sales over the historical period and from 43.7% to

44.1% of sales over the projection period. Mr. Risius added the economic charge

to STN.Com’s projected operating expenses, thereby increasing the expenses to




      37
        Mr. Adell and Kevin’s combined compensation increased from
approximately $3.2 million to $8.6 million. Because Mr. Adell was the owner of
STN.Com in addition to being an employee, and Kevin was his son, Mr. Risius
explained that only the market rate that would be paid to a third party to perform
their duties should be considered as officers salary. As adjusted, Mr. Risius
estimated STN.Com’s annual base market compensation for management to be
$480,000. Because Mr. Risius described STN.Com’s revenue as 95% of The
Word’s revenue without being capped at STN.Com’s cost of services provided,
Mr. Risius did not address whether any reduction in STN.Com compensation
would mean a reduced programming fee paid by The Word.
                                        - 27 -

[*27] approximately $8 million for the TYE 2007 to $11 million for the residual

period ending in 2012.

      STN.Com’s other operating expenses, which included programming

expenses, satellite fees, legal and professional fees, and other administrative

expenses, increased during the historical period from approximately $2 million to

$4.2 million, in line with STN.Com’s overall growth. As adjusted, STN.Com’s

earnings before interest, taxes, depreciation and amortization generally increased

over the historical period in line with overall sales and was projected to reflect

12.1% of sales, or approximately $2.2 million in the first year of the projection

period to $3.1 million in the residual period.

      On the basis of the foregoing, Mr. Risius determined that STN.Com was an

operating entity that was expected to produce positive cashflows in the future.38 In

other words, the value of STN.Com as a going concern exceeded the value of its

underlying assets in liquidation.39 Accordingly, Mr. Risius used a discounted


      38
        Mr. Risius explained that the highest and best use of a company is either
as a going concern or in liquidation depending on which generates the higher
value; and with respect to STN.Com, its highest and best use was as a going
concern.
      39
        The asset approach in valuing an entity may be used in the valuation of
operating companies where the value of the underlying assets in liquidation--as
reduced to reflect associated tax liabilities--exceeds the value of the business as a
                                                                         (continued...)
                                       - 28 -

[*28] cashflow analysis of the income approach when valuing the STN.Com

stock.40

      First Mr. Risius calculated the total weighted average rate of return, which

he noted is the combination of the return on both debt and equity. The rate of

return was based on an assumed capital structure of 30% debt and 70% equity.

Mr. Risius determined that the required rate of return on equity was 26.9%, which

includes a company risk adjustment of 3% to account for the risk associated with

losing STN.Com’s only customer, The Word. He then calculated that the

estimated after-tax required rate of return on debt was 4.4% by adjusting a known

pretax return on debt rate of 6.7% to reflect an effective Federal income tax rate of

34%. Mr. Risius calculated the total weighted average rate of return--around




      39
         (...continued)
going concern. See Estate of Smith v. Commissioner, T.C. Memo. 1999-368. In
his first valuation report, Mr. Risius determined that the income approach, as
opposed to the asset approach, was appropriate to value the STN.Com stock.
      40
         The discounted cashflow method is one valuation method under the
income approach, which values a company on the basis of its earning capacity.
Estate of True v. Commissioner, T.C. Memo. 2001-167, aff’d, 390 F.3d 1210
(10th Cir. 2004). The estimated value of a company is based on the present value
of its expected future economic benefits, i.e., its distributable cashflow. The
method evaluates a company’s earnings and dividend-paying capacity available to
investors and may consider reinvestment required for the company’s growth.
                                        - 29 -

[*29] 20%--by summing the products of each portion of the capital structure with

its respective rate of return.41

       Mr. Risius applied the rounded 20% rate of return to a stream of annual net

cash projected for STN.Com to calculate an enterprise value of $7.7 million. The

enterprise value includes the present value of STN.Com’s residual cashflow,

$4,284,800, plus the present value of its cashflows for the projection period,

$3,434,000. After making adjustments to the enterprise value to account for

STN.Com’s cash and cash equivalents, interest-bearing debt, and nonoperating

assets, Mr. Risius concluded that the fair market value of the STN.Com stock on

Mr. Adell’s date of death was approximately $9.3 million. This valuation was

included in the original estate tax return filed in November 2007.

       B. Mr. Risius’ October 29, 2012, Valuation Report

       More than five years after his first valuation report, Mr. Risius, on behalf of

Stout Risius Ross, prepared a second valuation report for the STN.Com stock

which the estate submitted at trial. In the second valuation report, Mr. Risius

valued the STN.Com stock using the adjusted book value method reflecting

liquidation or sale of assets instead of a discounted cashflow method. He



       41
                                        - 30 -

[*30] determined that the fair market value on Mr. Adell’s date of death was $4.3

million.

      Mr. Risius’ valuation of the STN.Com stock decreased primarily because he

used the asset approach instead of the income approach. Mr. Risius changed his

valuation approach because of a new understanding of the services agreement. In

his first valuation report, Mr. Risius did not account for the limitation imposed on

STN.Com’s programming fee to the lesser of its cost or 95% of The Word’s

revenue whereas in his second valuation report he accounted for the limitation.

Mr. Risius testified that he realized his mistake when testifying for a hearing

during the Oakland County probate litigation in 2009.

      On the basis of his new understanding of the services agreement, Mr. Risius

explained that the income approach, which requires positive cashflow to be

available for distribution to shareholders, was not appropriate for valuing the

STN.Com stock because the services agreement did not allow STN.Com to

generate a profit.42 According to Mr. Risius: “Although STN has generated

      42
         In making his determination, Mr. Risius relied in part on an expert opinion
prepared by Kenneth Kolmin regarding the terms of the services agreement. On
November 6, 2012, respondent filed a motion in limine to exclude Mr. Kolmin’s
expert report from evidence and to exclude any portion of the other expert reports
that relied on Mr. Kolmin’s report. In an order dated December 6, 2012, the Court
granted respondent’s motion to the extent that it sought to exclude Mr. Kolmin’s
                                                                       (continued...)
                                       - 31 -

[*31] profits in the historical period a hypothetical buyer of a company would not

place any weight on the historical performance of the company given the terms of

the agreement with * * * [The Word].”

      Under the asset approach Mr. Risius accounted for STN.Com’s lack of

ability to generate a profit from its sole customer and the fact that STN.Com did

not have any other source of revenue or other customers from which STN.Com

could generate income. Accordingly, Mr. Risius valued the STN.Com stock using

the adjusted book value method of the asset approach. Using the adjusted book

value, Mr. Risius determined the STN.Com stock was worth $4.3 million on Mr.

Adell’s date of death.43




      42
         (...continued)
report from evidence, but it denied respondent’s motion with respect to the expert
reports that relies on, adopts, or references Mr. Kolmin’s report. Notwithstanding
the foregoing, to the extent Mr. Risius’ conclusion that STN.Com lacked any legal
right to earnings under the services agreement is based on Mr. Kolmin’s report, he
is in error. As described in Mr. Risius’ first valuation report, STN.Com
historically earned a profit under the terms of the services agreement and
continued to do so well after Mr. Adell’s death.
      43
         Mr. Risius’ second valuation report relied on an independent valuation
report by Accuval Associates, Inc. (Accuval Associates), dated October 12, 2012,
for his estimation of the Fair Market Value-Installed of STN.Com’s tangible
personal property assets as of August 13, 2006. The Accuval Associates report
used the term “Fair Market Value-Installed”.
                                        - 32 -

[*32] C. Alex W. Howard’s October 29, 2012, Valuation Report

      The estate’s second expert witness, Mr. Howard, used the net asset value

method of the asset approach to value the STN.Com stock and concluded that its

fair market value on Mr. Adell’s date of death was $4.3 million.44 Like Mr. Risius,

Mr. Howard was also an employee of Stout Risius Ross when he prepared his

valuation report, but he did not work on his report with Mr. Risius.

      In his valuation analysis, Mr. Howard concluded that the income approach

was not appropriate in determining the STN.Com stock’s fair market value “due to

the lack of earnings that could be generated by * * * [STN.Com] under the

provisions of the * * * [services agreement].” While Mr. Howard acknowledged

that STN.Com generated net income historically, he determined that a hypothetical

buyer would not reasonably expect to generate profits because under the services

agreement, STN.Com “should have been only reimbursed for costs incurred,

effectively making it a zero profit situation.”

      Another reason Mr. Howard determined that the income approach was

inappropriate was that STN.Com’s executive compensation model restricted the


      44
        Unlike Mr. Risius, Mr. Howard did not rely on Mr. Kolmin’s expert report
and testified that he did not know it existed. Although an employee of Stout
Risius Ross when he prepared his report, Mr. Howard had left Stout Risius Ross
and had his own firm when he testified.
                                       - 33 -

[*33] company’s earning potential. Mr. Howard explained that analysts and

buyers typically adjust historical and projected cashflows to account for high

salaries paid to executives when determining the fair market value of a controlling

interest in a company. He cited the provision of the services agreement that

defined reimbursable costs to include a “reasonable allocation of salaries, wages,

employee benefits, and the employer’s share of payroll taxes of all employees

employed by STN in providing services under the Agreement”. According to the

terms of the services agreement, however, “any reduction in salaries would result

in a dollar for dollar reduction in revenue for * * * [STN.Com], preventing a

hypothetical purchaser of the Shares from generating profits by reducing salaries

to market levels.” Further, Mr. Howard determined that an unrelated party would

find STN.Com’s executive compensation unreasonable, preventing a hypothetical

purchaser from increasing earnings by increasing executive compensation.

Accordingly, Mr. Howard found the income method was inappropriate because the

services agreement would restrict a hypothetical buyer from increasing profits by

cutting executive compensation, and the hypothetical buyer could not increase

profits by giving himself a high salary because STN.Com’s already unreasonable

executive compensation would not be approved by a third party.
                                       - 34 -

[*34] In addition to lacking a contractual guaranty of a specific return, Mr.

Howard noted that STN.Com’s projected cashflow streams from its only customer,

The Word, were uncertain because Kevin did not have a noncompete agreement

with STN.Com and could create a new company to replace STN.Com. He

explained that the goodwill associated with the relationship between Kevin and

The Word was personal to Kevin. Without an employment agreement with Kevin,

Mr. Howard concluded that an income approach was not appropriate to determine

the fair market value of the STN.Com stock.

      Mr. Howard determined that the net asset value method was the appropriate

valuation method because STN.Com had assets with values that could be

determined.45 Using this valuation method, Mr. Howard determined that on Mr.

Adell’s date of death, the fair market value of 100% of the STN.Com stock was

$4.3 million.

      D. Francis X. Burns’ October 31, 2012, Valuation Report

      Respondent’s expert witness, Mr. Burns, valued the STN.Com stock using

the discounted cashflow method of the income approach and determined that the




      45
        Mr. Howard’s valuation report relied on the independent valuation report
of Accuval Associates dated October 12, 2012, for his valuation of the fair market
value of STN.Com’s fixed assets.
                                        - 35 -

[*35] value on Mr. Adell’s date of death was $26,341,030.46 In his valuation he

reviewed STN.Com’s business operations, ownership structure, and financial

performance between TYE 2002 and 2006. He also reviewed the services

agreement and, like Mr. Risius and Mr. Howard, noted that the monthly program

fee payable from The Word, STN.Com’s only customer, to STN.Com was limited

to “the lesser of actual cost or * * * [95%] of net programming revenue received

by * * * [The Word] in a one month period.”

      On the basis of his analysis of the foregoing, Mr. Burns determined that the

appropriate valuation method for the STN.Com stock on Mr. Adell’s date of death

in 2006 was the discounted cashflow method of the income approach. In support

of his conclusion, Mr. Burns explained that STN.Com was a fairly young company

as of the valuation date that had been profitable in each of the fiscal years

preceding the valuation date. As a source for his projected cashflow assumptions,

Mr. Burns used the management discussions cited in Mr. Risius’ first valuation

report.

      Mr. Burns adopted Mr. Risius’ projected sales for STN.Com for the five

years plus a residual period after the valuation date which ranged from


      46
       By contrast, respondent’s valuation in the notice of deficiency was greater
than $92 million.
                                       - 36 -

[*36] approximately $18.5 million to $26 million during the projection period.

Mr. Burns noted that the sales projections assumed that The Word would continue

its practice of paying STN.Com according to its revenues rather than STN.Com’s

actual costs. He also adjusted officers compensation to market rates, explaining

that a hypothetical investor would maximize STN.Com’s cashflow by paying

compensation at market rates. Mr. Burns did not, however, address whether his

adjustment to officers compensation would reduce STN.Com’s program fee

pursuant to the terms of the services agreement.

      Mr. Burns also addressed the importance of Kevin’s relationship with The

Word to STN.Com’s continued business operations. Instead of applying an

economic charge for Kevin’s personal goodwill similar to the one found in Mr.

Risius’ first valuation report, Mr. Burns concluded that a hypothetical investor

would anticipate retaining Kevin as an officer of STN.Com and would need to

compensate Kevin at an acceptable rate of 8.1% of sales. Mr. Burns noted that his

assumed compensation level for Kevin of nearly $1.3 million in 2006 was

significantly higher than Mr. Risius’ estimate of $528,000 in his first valuation

report.

      On the basis of STN.Com’s existing level of interest-bearing debt and

estimates of its equity value, Mr. Burns assumed a capital structure of 5% debt and
                                        - 37 -

[*37] 95% equity and calculated a weighted average cost of capital (or discount

rate) of 25.5%. Mr. Burns’ discount rate was higher than the 20% used by Mr.

Risius and, according to Mr. Burns, led to a lower valuation of the STN.Com

stock. However, Mr. Burns applied the 25.5% discount rate to a stream of annual

net cashflow that was substantially higher than the net cashflow calculated by Mr.

Risius in his first report. Mr. Risius’ calculation of distributable cash was

substantially lower than that calculated by Mr. Burns primarily because Mr. Risius

reduced STN.Com’s projected sales, which were the same numbers used by Mr.

Burns, by the economic charge for Kevin’s personal goodwill. The result was a

net present value of total invested capital of $30,689,559, which was much higher

than Mr. Risius’ enterprise value of approximately $7,700,000.

      After making adjustments to the value of total invested capital to account

for STN.Com’s cash and cash equivalents, interest-bearing debt, and nonoperating

assets, Mr. Burns applied a 20% discount for lack of marketability and concluded

that the fair market value of the STN.Com stock on Mr. Adell’s date of death was

$26,341,030.

                                     OPINION

      The Court is asked to determine the fair market value of Mr. Adell’s 100%

interest in STN.Com on his date of death and whether the estate is liable for the
                                        - 38 -

[*38] substantial estate tax valuation understatement penalty with respect to the

STN.Com stock. The parties have both substantially changed their positions

reflected in the notice of deficiency, the original petition, and the answer to the

Court. The estate now argues that the fair market value of the STN.Com stock it

held on the valuation date was $4.3 million. Respondent now asserts that the fair

market value of the stock was $26,341,030.

I. Burden of Proof

      During the trial the estate filed a motion to shift the burden of proof to

respondent under section 7491(a). In an order entered on December 6, 2012, the

Court found that the estate’s substantially inconsistent positions regarding the

valuation of the STN.Com stock demonstrated a failure to meet the requirements

of section 7491(a)(2) and therefore the burden of proof remained with the estate.47

The Court noted that notwithstanding its declining to shift the burden of proof to

respondent the case will ultimately be decided on the preponderance of the

evidence. In its posttrial brief the estate again argues that the burden of proof

should shift to respondent with respect to the valuation of the STN.Com stock.

      47
        The estate asserted the STN.Com stock was worth $9.3 million on its
original estate tax return and on its second amended estate tax return. On the
original petition filed with the Court the estate asserted the STN.Com stock had
zero value. The estate’s position at trial was that STN.Com stock should be
valued at $4.3 million.
                                        - 39 -

[*39] After review of the estate’s posttrial brief, the Court sustains the order

denying the motion to shift the burden of proof.48

      In general, the Commissioner’s determinations in the notice of deficiency

are presumed correct, and the taxpayer has the burden of proving that the

Commissioner’s determinations are incorrect. See Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933). Section 7491(a) allows a taxpayer to shift

the burden of proof to the Commissioner with respect to a factual issue if the

taxpayer introduces credible evidence regarding that issue relevant to ascertaining

the taxpayer’s liability for a tax (under subtitle A or B). “‘Credible evidence is

* * * evidence which, after critical analysis, the court would find sufficient * * *

to base a decision on the issue’” in the taxpayer’s favor, absent any contrary

evidence. Higbee v. Commissioner, 116 T.C. 438, 442 (2001) (quoting H. R.

Conf. Rept. No. 105-599, at 240-241, 1998-3 C.B. 747, 994-995).

      The estate did not present evidence which, after critical analysis, the Court

would find sufficient to base a decision on the issue on because the evidence was

inconsistent. See id. Inconsistent evidence is not credible and is not persuasive to

shift the burden under section 7491. See Gutierrez v. Commissioner, T.C. Memo.

      48
        The parties briefed a number of evidentiary objections that the Court had
reserved ruling on at trial. Those objections not dealt with in this opinion have
been dealt with by order dated August 4, 2014.
                                        - 40 -

[*40] 2003-321. The estate presented conflicting expert reports and three different

values of the STN.Com stock. The three different positions taken highlight the

lack of credible evidence necessary to shift the burden. Instead of one position on

which the Court could base a decision according to the standard in Higbee, the

estate presented three different views that may each have some merit.

Accordingly, the inconsistent evidence presented is not credible under section

7491 and the burden remains with the estate.

      Further, the parties have stipulated the operative facts and documents, and

specifically the terms of the services agreement between STN.Com and its only

customer, The Word. The parties dispute, however, the impact of the services

agreement on the valuation of the STN.Com stock as of the date of Mr. Adell’s

death. In these circumstances, there is no need to analyze or decide which party

has the burden of proof or whether the estate met the “credible evidence”

requirement. As the finder of fact, the Court considers the underlying facts agreed

upon by the parties and presented at trial and looks to the experts’ reports for

guidance on deciding the valuation issue.

II. Valuation of the STN.Com Stock

      After concessions by the parties, the remaining issues for decision are the

value of the STN.Com stock included in the gross estate and the related penalty.
                                        - 41 -

[*41] The value of property is a question of fact. Estate of Newhouse v.

Commissioner, 94 T.C. 193, 217 (1990). During the trial, the estate asserted that

the value of the STN.Com stock was $4.3 million, and respondent asserted that the

value was $26,341,030.

      A. Fair Market Value

      The transfer of the taxable estate on Mr. Adell’s death is subject to estate

tax. Sec. 2001; Estate of Deputy v. Commissioner, T.C. Memo. 2003-176. The

taxable estate is the gross estate less allowable deductions. Sec. 2051. The gross

estate includes the value of all property that Mr. Adell owned on the date of death.

Sec. 2031. Generally, the value of the gross estate is the fair market value of the

included property as of the date of death. Sec. 20.2031-1(b), Estate Tax Regs.

      Fair market value is the price at which property would change hands

between a willing buyer and a willing seller, neither under any compulsion to buy

or sell and both having knowledge of relevant facts. Id. The willing buyer and

seller are hypothetical, and valuation does not take into account the personal

characteristics of the actual buyer or the actual seller. Estate of Curry v. United

States, 706 F.2d 1424, 1428-1429, 1431 (7th Cir. 1983); Estate of Noble v.

Commissioner, T.C. Memo. 2005-2. The hypothetical willing buyer and seller are

presumed to be dedicated to achieving the maximum economic advantage, namely
                                        - 42 -

[*42] the maximum profit from the hypothetical sale. Estate of Noble v.

Commissioner, T.C. Memo. 2005-2. The determination of fair market value is a

question of fact, and the trier of fact must weigh all relevant evidence of value and

draw appropriate inferences. Commissioner v. Scottish Am. Inv. Co., 323 U.S.

119, 123-125 (1944); see also Estate of Newhouse v. Commissioner, 94 T.C. at

217.

       While listed prices of publicly traded stock are usually representative of the

fair market value of that stock for Federal tax purposes, special rules apply when

valuing stock of a closely held corporation. Estate of Noble v. Commissioner,

T.C. Memo. 2005-2. 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 within a reasonable time before or after the valuation date. Id. If the

value of the stock cannot be determined by using arm’s-length sales, fair market

value is generally determined by considering all relevant factors that would affect

fair market value. Id. These factors include the corporation’s net worth,

prospective earning power, dividend-paying capacity, and other factors. Sec.

20.2031-2(f), Estate Tax Regs.; Rev. Rul. 59-60, sec. 4.01, 1959-1 C.B. at 238.

These factors cannot be applied with mathematical precision, and must be

considered in the light of the particular facts of each case. Estate of Andrews v.
                                        - 43 -

[*43] Commissioner, 79 T.C. 938, 940-941 (1982); Kohler v. Commissioner, T.C.

Memo. 2006-152.

      In the absence of arm’s-length sales, the fair market value of nonpublicly

traded stock is generally determined by using three approaches--market, income,

and asset based. Estate of Noble v. Commissioner, T.C. Memo. 2005-2. The

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. Id. The income approach values a company’s nonpublicly

traded stock by converting anticipated economic benefits into a single present

amount. Id. The asset-based approach values a company’s nonpublicly traded

stock by looking to the company’s assets net of its liabilities. Id.

      B. Expert Opinions

      Both parties submitted expert reports providing valuations of the estate’s

STN.Com stock as of Mr. Adell’s date of death. The expert reports used different

valuation methods resulting in two proposed valuations, $4.3 million as proposed

by the estate and $26,341,030 as proposed by respondent.

      When considering expert testimony, the Court is not required to follow the

opinion of any expert if it is contrary to the Court’s judgment. Estate of Deputy v.

Commissioner, T.C. Memo. 2003-176 (citing Helvering v. Nat’l Grocery Co., 304
                                       - 44 -

[*44] U.S. 282, 295 (1938), and Silverman v. Commissioner, 538 F.2d 927, 933

(2d Cir. 1976), aff’g T.C. Memo. 1974-285). The Court may adopt or reject expert

testimony in whole or in part. Estate of Davis v. Commissioner, 110 T.C. 530,

538 (1998).

      The Court is not obligated to pay any regard to an expert opinion that lacks

credibility. Estate of Hall v. Commissioner, 92 T.C. 312, 338 (1989). The Court

may find evidence of valuation provided by one of the parties to be more credible

than that of the other party, rather than a compromise between the two. See

Buffalo Tool & Die Mfg. Co. v. Commissioner, 74 T.C. 441, 452 (1980).

      C. The Estate’s Expert Witnesses: Jeffrey Risius and Alex Howard

      Before the estate submitted Mr. Risius’ and Mr. Howard’s expert testimony

at trial, it filed its original Form 706 on November 13, 2007, with a valuation

report of the estate’s STN.Com stock that was prepared primarily by Mr. Risius on

June 15, 2007, 10 months after Mr. Adell’s death and before the probate litigation.

In the valuation report Mr. Risius used the discounted cashflow analysis of the

income approach to determine that the fair market value of STN.Com’s stock was

$9.3 million. On the basis of Mr. Risius’ valuation the estate reported that the

date-of-death value of the STN.Com stock was $9.3 million.
                                       - 45 -

[*45] The estate now asserts that the fair market value was less than $9.3 million,

relying on Mr. Risius’ second valuation report and on Mr. Howard’s valuation

report, both of which are dated October 29, 2012. The expert reports prepared by

Mr. Risius and Mr. Howard came to the same conclusion: the appropriate

valuation method of the STN.Com stock on Mr. Adell’s date of death was the

asset approach and under that approach the fair market value of the STN.Com

stock was $4.3 million. The reported value on the estate’s original return,

however, was an admission by the estate, and the lower value of $4.3 million

cannot be substituted without cogent proof that the reported value was erroneous.

See Estate of Hall v. Commissioner, 92 T.C. at 337-338.

      As proof that the reported value on the estate’s original return was

erroneous, the estate relies on the terms of the services agreement. Specifically,

the estate cites the provision in the services agreement that limits STN.Com’s

programming fee to the lesser of its actual cost or 95% of The Word’s revenue.

The estate argues that this provision prevents STN.Com from being profitable and

therefore any valuation of STN.Com must be based on the liquidation of its assets,

its highest and best use.49

      49
        In his first and second valuation reports, Mr. Risius explained that the
highest and best use of a company is on either a going concern or a liquidation
                                                                       (continued...)
                                       - 46 -

[*46] In his first valuation report, Mr. Risius did not mention the limitation on

STN.Com’s programming fee. Rather, he described STN.Com’s sales as 95% of

The Word’s broadcasting revenue relying on the description reflected on

STN.Com’s Financial Statements for the years reviewed. In his second valuation

report, however, Mr. Risius relied on the limitation to STN.Com’s programming

fee under the terms of the services agreement to conclude that STN.Com could not

legally make a profit if the agreement with The Word was strictly construed.

Therefore, notwithstanding STN.Com’s profitability during the five years

preceding Mr. Adell’s date of death,50 Mr. Risius found that STN.Com’s highest

value was not as a going concern but as the liquidation of its assets. Mr. Risius’

second valuation report determined that the asset approach to valuation was

therefore appropriate.




      49
        (...continued)
basis depending on which generates the higher value.
      50
        Mr. Adell’s date of death was August 13, 2006. STN.Com’s tax year
ended in June and the financial statements reflected $3.8 million in shareholder
equity. STN.Com accordingly paid the Adell Trust $1,157,976, for a total
compensation paid to Mr. Adell of $7,354,594 that was reported on the return for
the TYE in June 2007. The same return shows that Kevin received $1,292,758 in
compensation. In TYE June 2007 and 2008 STN.Com paid Kiven compensation
of $9,734,643 and $8,204,066, respectively. See supra p. 14.
                                       - 47 -

[*47] To the extent that Mr. Risius’ determination that STN.Com could not

legally make a profit relied on Mr. Kolmin’s excluded expert report regarding the

same, his determination and the conclusion drawn thereon, i.e., that STN.Com’s

highest value was the liquidation of its assets, is mistaken. Even if Mr. Risius did

not rely on Mr. Kolmin’s excluded expert report, which is plausible since he

testified that he realized his mistake at a probate hearing before Mr. Kolmin

prepared his expert report, he incorrectly assumed that STN.Com was not a

profitable company.

      Despite the limitation of STN.Com’s programming fee, STN.Com was a

profitable company on the date of Mr. Adell’s death and it was reasonable to

conclude that it would continue to be profitable thereafter. The profitability of

STN.Com was supported by five years of STN.Com’s financial statements,51

which were prepared by Mr. Lameti’s accounting firm, and by discussions with

STN.Com’s management during the year after Mr. Adell’s date of death.

Although The Word could have enforced the limitation on STN.Com’s

programming fee, it did not do so for the five years preceding Mr. Adell’s date of

death, or the four years thereafter. Moreover, management made no indication


      51
       The same financial statements reported the contractual arrangement as
being 95% of the revenue generated by The Word. See supra p. 24 and note 34.
                                        - 48 -

[*48] that The Word would enforce the limitation and in fact predicted that its

sales would increase, resulting in expected capital expenditures that would

enhance the value of STN.Com such as the purchase of an $800,000 tour bus and

substantial expenditures for additional broadcasting equipment. Management’s

discussions during the first year after Mr. Adell’s death were particularly

important because management, mainly Kevin, controlled The Word and could

therefore give Mr. Risius an accurate picture of STN.Com’s historical and

projected profitability as of the date of Mr. Adell’s death.52

      Furthermore, even if The Word decided to enforce the limitation on

STN.Com’s programming, the limitation did not necessarily mean that STN.Com

could not be profitable. The company would continue to collect sales revenue

from its contract with The Word and, with its broadcasting equipment and

expertise, could potentially expand its operations to provide uplinking services for

other customers.53 In addition, if a hypothetical investor participated in

management as Mr. Adell and Kevin had, STN.Com would not only be profitable


      52
        The parties do not address, and the Court will not discuss, whether The
Word’s sec. 501(c)(3) exemption was at risk of revocation because of the
unenforced contractual limitation, or the potential issue of private inurement; both
topics are outside the scope of the estate’s notice of deficiency.
      53
        In fact, STN Satellite, STN.Com’s predecessor, provided uplinking
services to other companies.
                                       - 49 -

[*49] but would also be valuable, as evidenced by the compensation paid to

management and the provision of other benefits such as luxury cars. The biggest

risk to profitability and STN.Com’s value was The Word’s ability to choose a

different uplink provider for any reason, thereby terminating STN.Com’s contract

with its only customer. This risk, however, did not make STN.Com unprofitable

and could be accounted for by applying a company risk adjustment.54

      The Court therefore finds that a hypothetical willing seller and a

hypothetical willing buyer could not ignore the historical performance of

STN.Com’s profits on Mr. Adell’s date of death, and notwithstanding the

programming fee limitation, STN.Com was indeed a profitable company. Thus, an

income approach is the most appropriate method to determine the value of the

STN.Com stock because the business’ best value is as a going concern. See Smith

v. Commissioner, T.C. Memo. 1999-368; Rev. Rul. 59-60, supra. In his first

valuation report, Mr. Risius correctly assumed STN.Com was profitable and

therefore correctly applied the discounted cashflow method of the income

      54
         Mr. Risius, for example, applied a company risk adjustment of 3% in his
first valuation report. In addition, Kevin testified that many ministers who
currently purchase programming had inquired as to purchasing The Word. It is
not a great leap of faith to conclude they could merely purchase STN.Com (and its
uplinking license) and broadcast themselves and skip the middleman’s
programming fees, especially since the urban religious program broadcasters were
typically nonprofit churches already.
                                        - 50 -

[*50] approach to value STN.Com. Accordingly, the Court finds that Mr. Risius’

second valuation report and Mr. Howard’s valuation report, both of which use the

asset approach to value the STN.Com stock are not creditable to determine the

total value of STN.Com.

      D. Respondent’s Expert Witness: Francis Burns

      Respondent’s expert witness, Mr. Burns, used the same discounted cashflow

analysis of the income approach that Mr. Risius used to value the STN.Com stock

in his first valuation. In addition, Mr. Burns substantially relied on Mr. Risius’

determinations in his first valuation report, including his projected sales for

STN.Com, which were based on the company’s historical performance and on

conversations with management during the first year after Mr. Adell’s date of

death. Mr. Burns, however, determined that the date-of-death value of the

STN.Com stock was $26,341,030, whereas Mr. Risius determined that its date-of-

death value was $9.3 million.

      The most significant difference between Mr. Risius’ first valuation report

and Mr. Burns’ valuation report is their treatment of the intangible value that

Kevin provided STN.Com. While both Mr. Risius and Mr. Burns recognized that

the success of STN.Com depended on Kevin’s relationships with The Word and its

customers, they accounted for that value differently. In his first report Mr. Risius
                                       - 51 -

[*51] applied an economic charge for Kevin’s personal goodwill that ranged from

$8 million to $12 million over the projection period, thereby increasing

STN.Com’s projected operating expenses and decreasing its net cashflow. Mr.

Burns, however, determined that a hypothetical willing investor would be able to

retain Kevin for an acceptable salary, which he determined to be 8.1% of sales, or

approximately $1.3 million in 2006. Mr. Burns’ approach resulted in a higher

estimate of STN.Com’s projected net cashflow, and thus a higher valuation of the

STN.Com stock.

      Goodwill is often defined as the expectation of continued patronage by

existing customers. Network Morning Ledger Co. v. United States, 507 U.S. 546,

572-573 (1993). A key employee may personally create and own goodwill

independent of the corporate employer by developing client relationships. Martin

Ice Cream Co. v. Commissioner, 110 T.C. 189, 207-208 (1998). The corporation

may benefit from using the personally developed goodwill while the key employee

works for the entity, but the corporation does not own the goodwill and therefore it

is not considered a corporate asset. Id. at 208. The employee may, however,

transfer any personal goodwill to the employer through a covenant not to compete

or other agreement that transfers the relationships to the employer. See id. at 207;

H&M, Inc. v. Commissioner, T.C. Memo. 2012-290. Absent such an agreement,
                                       - 52 -

[*52] the employer cannot freely use the asset and the value of the goodwill

should not be attributed to the corporation.

      Kevin’s goodwill was personally owned independent of STN.Com.

STN.Com’s success was heavily dependent on The Word because of their

symbiotic relationship. To launch The Word, it was Kevin who contacted

religious leaders in the Detroit area and Rev. Jackson in Chicago. Along with his

notable contacts and his father, he went to Los Angeles to meet with DirecTV

representatives about broadcasting The Word. His meeting was successful and it

eventually led to the national broadcasting of The Word on cable television.

Kevin was the face of the operation because he was the individual soliciting

content and pursuing broadcast opportunities.

      Kevin’s personal goodwill was further displayed when ministers chose to

contribute to The Word after learning that The Word was a nonprofit organization.

When contributing ministers asked about ownership opportunities, Kevin

responded that The Word was a nonprofit organization and could not be sold. It

appeared to the contributing ministers that there was not a corporation employing

Kevin. The ministers conducted business with Kevin because they trusted him

personally, not because he was a representative or employee of STN.Com. In

other words, STN.Com could not own Kevin’s goodwill because the customers did
                                        - 53 -

[*53] not readily realize that Kevin actually worked for STN.Com. Thus, he

cultivated personal goodwill with these professionals and he independently owned

the asset of personal goodwill, not STN.Com.

      Although Mr. Adell was a board member and officer of both STN.Com and

The Word, Kevin operated both companies. Kevin had the education and

background to perform uplinking broadcast services. After graduating with a

communications degree, he built Mr. Adell’s first television station, WADL, and

on account of his experience with WADL became interested in the uplinking

business. Using STN.Com’s predecessor, STN Satellite, Kevin learned about the

uplinking business by providing uplink services to various customers, including

Hughes Electronics Corp., a major customer brought on by Kevin. Kevin, who

continued to explore business opportunities that would capitalize on his

background, decided to combine his success with religious programming on

WADL with his uplinking services from STN Satellite by creating The Word and

its uplink service provider, STN.Com.

       Further, Kevin did not transfer his goodwill to STN.Com through a

covenant not to compete or other agreement. Kevin was free to leave STN.Com

and use his relationships to directly compete against his previous employer. If

Kevin quit, STN.Com could not exclusively use the relationships that Kevin
                                        - 54 -

[*54] cultivated; thus, the value of those relationships should not be attributed to

STN.Com.

      Accordingly, Mr. Risius properly adjusted STN.Com’s operating expenses

to include an economic charge of $8 million to $12 million for Kevin’s personal

goodwill at an amount high enough to account for the significant value of Kevin’s

relationships. See Derby v. Commissioner, T.C. Memo. 2008-45. Mr. Burns, on

the other hand, not only failed to apply an economic charge for Kevin’s personal

goodwill but also gave too low an estimate of acceptable compensation for Kevin,

i.e., $1.3 million in 2006. This was especially so because Kevin had stepped into

the position of Mr. Adell, who had previously made between over $2 million and

$7 million of compensation in each of the five years before his death.

III. Valuation of the Estate’s STN.Com Stock

      As stated above, the Court gives no weight to the expert valuations that the

estate submitted at trial, except for the consistent treatment of the underlying value

of STN.Com’s assets. The Court also finds that respondent’s expert valuation is

not persuasive because it did not reasonably account for Kevin’s personal

goodwill.

      The Court therefore finds that the estate failed to introduce any evidence or

present any arguments to persuade the Court that the value reported on its original
                                        - 55 -

[*55] tax return was incorrect. Thus, the Court concludes that Mr. Risius’ first

valuation report on the STN.Com stock included with the original estate tax return

was the most creditable because it properly accounted for Kevin’s personal

goodwill and appropriately used the discounted cashflow analysis of the income

approach to value the STN.Com stock.

      Accordingly, on the basis of the Court’s review of all of the valuation

evidence, giving due regard to our observation at trial of the witnesses for both

parties and considering their testimony and the expert reports, the Court concludes

that the fair market value of the STN.Com stock owned by the estate on August

13, 2006, was $9.3 million.

IV. Substantial Estate Tax Valuation Understatement Penalty

      The Court has found that the value of the STN.Com stock held by the estate

is the value the estate reported on its original Form 706. Therefore, the Court need

not address whether the estate is liable for the substantial estate tax valuation

understatement penalty under section 6662(g) or (h) for the STN.Com stock. An

accuracy-related penalty under section 6662 may still be applicable to other items

found in the stipulation of settled issues and from parties’ concessions. Further,

section 6662(c) is inapplicable because there was not an underpayment of tax

shown on the original Form 706 from the STN.Com stock. The accuracy-related
                                        - 56 -

[*56] penalty under section 6662 for substantial estate tax valuation

understatements of the balance of the notice of deficiency will be calculated

separately on all items found in the stipulation of settled issues and from the

parties concessions.

      The Court has considered the parties’ arguments and, to the extent not

addressed herein, concludes that they are moot, irrelevant, or without merit.

      To reflect the foregoing and the concessions of the parties,


                                                           Decision will be entered

                                                    under Rule 155.
