                        T.C. Memo. 2004-174



                      UNITED STATES TAX COURT



           ESTATE OF JOSEPHINE T. THOMPSON, DECEASED,
                CARL T. HOLST-KNUDSEN AND THE BANK
              OF NEW YORK, EXECUTORS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 4939-02.              Filed July 26, 2004.



     Kirk H. O’Ferrall, Robert H. Goldie, Jonathan G. Blattmachr,

Andrew E. Tomback, Edward A. Stelzer, and Jonathan W. Wolfe, for

petitioner.

     Robert A. Baxer and Joseph J. Boylan, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     SWIFT, Judge:   Respondent determined a deficiency of

$17,910,408 in the Federal estate tax of the estate of decedent
                              - 2 -

Josephine T. Thompson and a $7,164,163 accuracy-related penalty

under section 6662(a).

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect on May 2, 1998, the date of

decedent’s death, and all Rule references are to the Tax Court

Rules of Practice and Procedure.

     The issues for decision are:   (1) The fair market value of

487,440 shares of the voting common stock of Thomas Publishing

Co., Inc. (TPC), that were owned by decedent on her death; and

(2) whether the estate is liable for the accuracy-related

penalty.


                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

     On May 2, 1998, the date of her death, decedent resided in

New York.

     On May 14, 1998, Carl T. Holst-Knudsen (Holst-Knudsen),

decedent’s son, and The Bank of New York were appointed by the

Surrogate Court of the State of New York, County of Westchester,

as co-executors of decedent’s estate.   Holst-Knudsen resides in

New Jersey, and The Bank of New York is headquartered in New York

City.

     TPC is a private, closely held corporation that was formed

over 100 years ago, on January 28, 1898, as a New York
                               - 3 -

corporation.   At the time of trial, TPC’s principal place of

business was located in New York City.

     The 487,440 shares of TPC voting common stock that decedent

owned constituted 20.57 percent (hereinafter generally rounded to

20 percent) of TPC’s total outstanding common stock.   Decedent’s

shares constituted the largest block of TPC common stock owned by

any single stockholder.1

     On May 2, 1998, all but 300,000 shares of the remaining TPC

common stock were owned by approximately 20 other relatives of

Harvey Mark Thomas, the founder of TPC.

     Holst-Knudsen was designated as the sole testamentary

beneficiary of decedent’s 487,440 shares of TPC common stock.    As

of May 2, 1998, taking into account the 162,000 shares of TPC

common stock that he already owned and the 487,440 shares that he

inherited from decedent, it appears that Holst-Knudsen

individually and beneficially owned 649,440 shares of TPC stock

or approximately 27 percent of the total outstanding TPC common

stock.

     The last 300,000 shares of TPC common stock, representing

12.66 percent of the total outstanding TPC common stock, were

owned by an outside stockholder -- namely, Capital Cities/ABC,




     1
        Decedent also owned 237.6 shares of TPC nonvoting
preferred stock the value of which is not in dispute.
                               - 4 -

Inc., a New York Stock Exchange publicly traded company.2   As of

the date of decedent’s death, Capital Cities/ABC, Inc., or its

predecessor, apparently had owned these shares of TPC common

stock for at least 10 years.

     During 1998 and subsequent years through the time of trial

in 2003, Holst-Knudsen was president and Jose E. Andrade was

chairman of the TPC board of directors.   Both Holst-Knudsen and

Andrade are grandsons of Harvey Mark Thomas, TPC’s founder.

     None of the shares of TPC common stock has ever been

publicly traded, and, in the 10 years before decedent’s death and

in the years after decedent’s death through the time of trial, no

sales of TPC common stock occurred.    Also, as of May 2, 1998, no

buy/sell agreement or stockholder agreement affecting the value

of TPC common stock was in existence.

     Over the years, TPC’s primary business has been the

production and sale of industrial and manufacturing business

guides and directories.   TPC’s business directories provide




     2
        In 1996, the Walt Disney Co. (Disney) acquired Capital
Cities/ABC, Inc., for $19 billion. The TPC stockholder list in
evidence apparently does not take into account this 1996 Disney
acquisition and therefore provides the former name of this
outside TPC stockholder. Herein, we refer to this stockholder as
shown on TPC’s stockholder list.
                               - 5 -

detailed information on products and services, company profiles,

contact information, and catalog files.3

     As of May 2, 1998, TPC published and sold throughout the

United States and abroad approximately 24 business-to-business

industrial business directories, including the Thomas Register of

American Manufacturers (the Thomas Register), TPC’s 34-volume

directory which is recognized throughout North America as the

most comprehensive resource for finding manufacturing companies

and products.   TPC also published and sold a variety of news

magazines, software comparison guides, and a magazine relating to

factory automation, and it owned a product information exchange

service and a custom publishing group.

     By any measurement, as of May 2, 1998, TPC was regarded as a

very successful and profitable company and by some as holding an

effective monopoly in the United States on business-to-business

industrial and manufacturing print publications.




     3
        The first buying directory was published by Harvey Mark
Thomas in 1890, prior to incorporation of the business, and was
titled “Thomas’ Machinery, Iron, Steel, and Metal Trades
Reference Book”.
                             - 6 -

In its own publications, TPC describes itself as follows:


                          Thomas
                        Publishing
                         Company
         Your product information headquarters

      For more than 95 years, Thomas Publishing Company has
concentrated its full energies on filling one of industry’s
greatest needs...the need for up-to-date product information.   No
other publisher is as totally dedicated to this mission.

      Decision makers throughout industry need product information
to operate their companies successfully. Regardless of job
function, the hunger for up-to-date product information is
universal. It’s given priority attention because industry’s
appetite for products and services of every type is enormous. It
can be filled only when buying influences have comprehensive,
reliable, up-to-date vendor information. It influences
profitability profoundly because dozens of new products enter the
marketplace daily -- providing new functional and economic
benefits. To not keep up with these developments means operating
without the benefit of these improvements. And ultimately that
means relinquishing market position to one’s competitors.

      Thomas Publishing Company has become the acknowledged leader
in providing industry with the product information it needs.
Today, we publish twenty-four major buying guides, thirty-one
product news magazines, two product information exchange services,
a magazine on factory automation, and a publication to help buyers
select the most cost-efficient transportation modes for their
inbound freight. In addition, Thomas Business Lists offers
comprehensive list services for direct marketing. Also, the
Thomas Marketing Information Center helps industrial marketers
research and respond to industry’s need for new products. All of
these services are described in the pages that follow.

     *        *        *        *        *        *        *

      Published annually, Thomas Register of American
Manufacturers is by far the most complete and helpful specifying
and buying guide published today. It provides “instant” sourcing
information on nearly 52,000 industrial products and services,
along with comprehensive specifications and availability
information from thousands of manufacturers. In all, more than
1,500,000 individual product/service sources are included. Thomas
Register also contains a complete 2-volume Company Profiles
section and a comprehensive 8-volume Catalog File section.
Headquarters and branch addresses, phone numbers and asset ratings
are provided on more than 148,000 U.S. firms.
                                  - 7 -
           For everyone involved in specifying and buying industrial
     products and services, Thomas Register is invaluable. For
     everyone involved in selling industrial products and services,
     Thomas Register is invaluable. [22 Thomas Register of American
     Manufacturers 3573 (86th ed. 1996).]


     The primary sales force for TPC directories was made up of

independent salespersons located throughout the United States and

Canada.   The salespersons were paid on a commission basis with

the right to receive commission advances from TPC.

     In the early 1990s, the development and increased use of

electronic and digital media provided alternatives to the form

and manner in which information could be packaged and

distributed.   For example, the development of CD-ROM format

facilitated the transmission of large amounts of data quickly and

permitted the user to sort and to access data in different ways.

     Also, the development and expansion of the Internet and of

Internet search engines allowed traditional buyers of TPC’s

directories, to a certain extent, to locate and to purchase

products on their own without reference to TPC’s print

directories.

     Historically, TPC’s buying directories were published only

in print or paper format.      By the early 1990s, however, it was

recognized by TPC’s management that the Internet and other

technological advances would have an impact on TPC’s business,

presenting to TPC special challenges, risks, and new competition,

but also providing to TPC new growth opportunities.
                               - 8 -

     In 1993, in response to the significant advancements in

technology and to increased use by business entities of

electronic media, TPC began publishing and offering some of its

business-to-business buying directories on CD-ROM.

     In 1994, in an internal TPC management publication, the

Thomas Register was described as “the undisputed leader * * * in

electronic publishing” relating to business-to-business buying

directories.   Also, in that same internal publication, a TPC

management objective (relating to TPC’s continuing competitive

position with electronic publishing) was stated as follows:


     Finding ourselves now at such a juncture, we seek an
     approach to securing for * * * [TPC] a dominant
     position in the electronic interchange of information
     among industrial buyers and sellers comparable to that
     which it has enjoyed in the hard copy realm.


     In early 1995, although TPC’s management recognized that

TPC’s historical existence as a print publisher constituted a

certain liability in the new electronic environment, TPC’s

management also recognized that TPC brought “to the competitive

electronic information wars ahead” certain “great assets” which

were described as “the information that it traffics and the

methodologies, relationships and brand name recognition that

support that traffic”.

     In 1995, TPC began publishing and making its directories

available for free on the Internet.    The record does not indicate
                               - 9 -

exactly on which dates TPC’s various directories became available

on the Internet.

     At TPC’s 1996 annual stockholder meeting, Holst-Knudsen gave

a speech in which he acknowledged that the rapid advancements in

technology created uncertainty for the future of TPC, but in

which speech Holst-Knudsen also stated that the technological

advancements that were occurring constituted a “great”

opportunity for TPC.

     A colorful excerpt from a January 1998 TPC publication

comments on the positive manner by which TPC’s management, as of

early 1998, was addressing and dealing with the technological

challenges TPC faced:


     As the company’s flagship, Thomas Register absorbs the brunt
     of competitive initiative from the various evil empires
     aiming to unseat us in the new digital world. Asked to
     respond with a major Internet launch in 1996 and to add to
     that a major CD-ROM program in 1997 * * * [Thomas
     Register’s] production, editorial, circulation, sales and
     administrative people have handled a hailstorm of change and
     complexity with energy and skill that few would have been
     bold enough to anticipate only three years ago.


     By early 1998, ThomasRegister.com was recognized as one of

the 200 leading business-to-business Web sites in the United

States.   Among the 200 Web sites so recognized, TPC’s Web site

was ranked sixth.
                                  - 10 -

     For its fiscal years 1993-98, the number of purchasers or

subscribers to TPC’s print and CD-ROM directories, and the number

of subscribers to TPC’s Internet directories are set forth below:


     Fiscal            Print           CD-ROM           Internet
      Year          Subscribers      Subscribers       Subscribers
      1993            73,500            1,000              N/A
      1994            78,000            2,500              N/A
      1995            81,000            5,000             40,000
      1996            80,000           13,000            225,000
      1997            67,500           25,000            550,000
      1998            45,500           45,500               *

           *   Not in evidence


     Historically, TPC’s revenue was generated from the sale of

subscriptions to and advertising in its print directories.           For

the last 30-plus years, the largest percentage of TPC’s revenue

was generated from the sale of advertising.        For example, for its

fiscal year 1972, advertising revenue associated with TPC’s

directories accounted for 86 percent of TPC’s total revenue.          By

its 1993 fiscal year, advertising revenue associated with TPC’s

directories accounted for more than 90 percent of TPC’s total

revenue.

     Set forth below for each of TPC’s fiscal years 1993-2002 are

the numbers for TPC’s subscription and advertising revenue and

the percentage of TPC’s total sales revenue reflected by

subscription revenue and by advertising revenue:
                                    - 11 -


                    Subscription                      Advertising
                            Percentage                        Percentage
  Fiscal                      of Total                         of Total
   Year      Revenue       Sales Revenue       Revenue       Sales Revenue
   1993    $14,901,781          8.3          $165,386,826        91.7
   1994     15,310,520          7.9           177,924,154        92.1
   1995     16,978,851          7.9           197,451,678        92.1
   1996     17,173,690          7.4           215,653,261        92.6
   1997     17,240,197          6.7           239,828,771        93.3
   1998     14,068,891          5.2           257,901,815        94.8
   1999      8,834,385          3.0           284,004,912        97.0
   2000      6,580,888          2.2           291,617,859        97.8
   2001         *                *                 *               *
   2002        957,646          0.4           249,187,069        99.6

           *   Not in evidence.


     For 1993-2002, decreases in TPC’s subscription revenue

generally coincided with TPC making its directories available on

CD-ROM and on the Internet.        For 1993-2000, however, increases in

TPC’s advertising revenue relating to CD-ROM and Internet

versions of its directories, more than offset decreases in TPC’s

subscription revenue.

     For its fiscal years 1998-2002, TPC’s combined subscription

and advertising revenue relating to its respective print, CD-ROM,

and Internet directories is set forth below:

                   Combined Subscription and Advertising Sales Revenue
  Fiscal          Print          CD-ROM         Internet
   Year        Directories     Directories     Directories      Multimedia*
   1998        $60,974,928     $21,545,793     $ 3,801,224     $190,135,238
   1999         55,183,301      30,148,498      11,701,065      196,831,426
   2000         49,567,582      32,233,952      20,295,520      196,595,142
   2001         40,320,705      29,578,071      27,962,016      187,279,835
   2002         29,054,729      24,285,826      29,485,156      167,486,238

           *   Multimedia sales revenue reflects the sale of
               bundled advertising in TPC’s print, CD-ROM, and
               Internet directories. Revenue numbers in this
               table do not match up entirely with the revenue
               numbers in the table above.
                              - 12 -

     In addition to developing and implementing technology to

make its directories available on CD-ROM and on the Internet, TPC

engaged in other technology projects.   A list and a brief

description of other technology-related projects undertaken by

TPC during its 1995-2002 fiscal years are set forth below:


     (1)   Development of the nationally recognized TPC Web site;

     (2)   Development of TPN Register, a joint venture
           between TPC and General Electric Co., through
           which product information similar to information
           contained in TPC’s directories was to be provided
           to companies via each company’s respective
           internal intranet. In 2001, TPC apparently
           terminated this TPN Register project;

     (3)   Development of Thomas.Net, a software product that
           enabled users to use keywords to make online
           digital searches of TPC’s electronic directories
           for industrial product information;

     (4)   Development of Product News Network (PNN), an
           electronic magazine containing information
           regarding new industrial products;

     (5)   Development in 1995 of Thomas Global Register
           (TGR), an Internet directory for TPC’s customers
           located outside the United States; and

     (6)   Purchase in 1997 of Plant Spec, a Web-based software
           system that permitted the electronic transfer of
           computer assisted design (CAD) drawings.


     During its 1995-97 fiscal years, TPC spent approximately $36

million on the above technology-related projects.   As of May of

1998, TPC’s management anticipated that during 1998-2002 TPC

would undertake additional projects, incur additional
                                                              - 13 -

expenditures, and realize additional income relating to

technology-related projects.

         During its 1998-2002 fiscal years, TPC’s actual expenditures

associated with development and marketing of technology-related

projects totaled approximately $234 million.4

         Set forth below are TPC’s technology-related expenditures

for its 1995-2002 fiscal years:


Fiscal         TPC          TPN
 Year        Web Site     Register     Thomas.Net           PNN        Plant Spec           TGR           Misc            Total

1995     $     --        $ 2,901,153   $     --        $     --        $     --        $     --        $ 1,310,520   $   4,211,673

1996            3,450     7,283,842         462,942          N/A             --            1,131,845    2,336,691        11,218,770

1997         3,692,116    8,133,557        1,670,582       1,639,314         20,818        3,740,603    2,146,855        21,043,845

1998         6,220,263    6,583,382        3,681,100       3,567,351       7,867,906       4,092,326    2,420,544        34,432,872

1999         3,348,521    5,800,000        5,908,513       3,619,148       7,445,476       5,832,464    6,120,977        38,075,099

2000         6,534,901   16,359,397        6,376,417       2,278,640   10,459,145          9,383,771   16,772,912        68,165,183

2001         8,519,175    3,700,000        5,797,868       2,278,640       9,955,829       9,383,771   16,352,359        55,987,642

2002         7,869,933       --            4,173,741        930,655        4,547,589       9,423,411    8,101,439        35,046,768

TOTAL    $36,188,359     $50,761,331   $28,071,163     $14,313,748     $40,296,763     $42,988,191     $55,562,297   $268,181,852




         For its 1993-2000 fiscal years, TPC’s reported financial

statements reflect steady, consistent, and increasing revenue and

show that TPC was profitable through the end of its 1999 fiscal

year.          As reported, for each of 1993-2000, TPC realized record

         4
        Apparently, for Federal income tax purposes and in the
valuations made by the estate’s experts herein, TPC treated all
of its technology-related expenditures as current ordinary and
necessary business expenses, rather than as capital expenditures.
Respondent herein complains mildly about such current expense
treatment but stops short of asserting that the technology-
related expenditures should have been capitalized and stops short
of asking that TPC’s financial statements and financial
projections be redone to treat such expenditures as capital in
nature.
                                  - 14 -

total revenue and, as of the end of TPC’s 1997 fiscal year, TPC’s

financial data reflected shareholder equity of $148,605,729.

     As of May of 1998, TPC had reported positive net income for

every year for the prior 24 years, and the then-current in-house

management financial forecast for TPC estimated net profits for

1998.

     In late 1997, TPC’s senior management, while acknowledging

significant challenges, predicted that 1998 would be better than

1997 and “our best [year] ever.”

     For each of its 1993-98 fiscal years, TPC’s net sales

revenue, expenditures (including TPC’s technology-related

developmental expenditures), operating income, and total net

income, as reported on TPC’s financial statements, are reflected

in the table below:


Fiscal         Net Sales                    Operating       Total
 Year           Revenue     Expenditures      Income      Net Income
 1993        $168,059,000   $142,602,855   $25,456,145   $14,333,288
 1994         179,287,018    148,510,315    30,776,703    12,804,431
 1995         200,487,153    170,208,645    30,278,508    11,107,716
 1996         216,924,156    199,871,672    17,052,484    13,171,595
 1997         240,116,975    217,559,833    22,557,142    15,927,549
 1998         256,806,493    231,436,437    25,370,056    18,024,858


        Also at the end of each of its 1993-98 fiscal years, TPC

owned substantial liquid short-term investments and marketable

securities as set forth below:
                                   - 15 -
         Fiscal      Short-Term        Marketable       Total Liquid
          Year       Investments       Securities       Investments
          1993       $38,052,200       $10,264,800       $48,317,000
          1994        45,640,865        12,050,249        57,691,114
          1995        52,919,162        18,292,503        71,211,665
          1996        50,915,037        21,986,280        72,901,317
          1997        68,993,367        28,261,773        97,255,140
          1998        68,687,060        29,988,533        98,675,593


     For each of its 4 fiscal years (1999-2002), subsequent to

the year in which decedent died, TPC’s net sales revenue,

expenditures (including TPC’s technology-related developmental

expenditures), operating income or loss, and total net income or

loss, as reported on TPC’s financial statements, are reflected in

the table below:

                                                                Total
Fiscal        Net Sales                       Operating       Net Income
 Year          Revenue     Expenditures     Income (Loss)       (Loss)
 1999       $273,386,403   $253,677,683      $19,708,720     $14,988,447
 2000        278,741,064    282,500,513       (3,759,449)     (5,477,876)
 2001        267,003,996    278,332,392      (11,328,396)    (13,807,358)
 2002        234,832,485    234,323,041          509,444       1,738,420


     At the end of each of its 1999-2002 fiscal years, TPC

continued to own substantial liquid short-term investments and

marketable securities as set forth below:

         Fiscal      Short-Term        Marketable       Total Liquid
          Year       Investments       Securities       Investments
          1999       $77,529,513       $36,787,208      $114,316,721
          2000        32,501,250        45,582,058        78,083,308
          2001        20,279,591        37,594,522        57,874,113
          2002        27,752,994        34,207,692        61,960,686


     TPC had a long history of paying annual cash dividends to

its stockholders.     In each of its 1993-2002 fiscal years,

including in its 2 loss years of 2000 and 2001, TPC paid cash
                                    - 16 -

dividends on its outstanding common stock ranging from a low of

$.85 per share in its 1993 fiscal year to a high of $3.21 per

share in its 1998 fiscal year.         The total and the per-share cash

dividends paid by TPC in its 1993-2002 fiscal years to its common

and to its nonvoting preferred stockholders is set forth below:

                                                  Cash Dividends
            Fiscal           Total                  Per Share
             Year        Cash Dividends        Common    Preferred*
             1993          $2,022,900          $0.85         $6
             1994           2,259,900           0.95          6
             1995           2,259,900           0.95          6
             1996           2,259,900           0.95          6
             1997           2,615,400           1.10          6
             1998           7,616,100           3.21          6
             1999           2,615,400           1.10          6
             2000           2,615,400           1.10          6
             2001           2,828,700           1.10          6
             2002           2,899,800           1.22          6

            *   TPC only had 1,400 shares of nonvoting preferred
                stock and approximately 99 percent of TPC’s cash
                dividends paid each year were paid to TPC’s common
                stockholders.


As of May of 1998, TPC’s management planned to continue paying

annual cash dividends to its stockholders.

       As of the date of decedent’s death in May of 1998, the

management of TPC had no intent to liquidate or to sell TPC.

       In the early fall of 1998, in anticipation of the filing of

a Federal estate tax return on behalf of the estate, even though

he lived in Alaska, the executors of the estate hired George E.

Goerig (Goerig), an Alaskan lawyer to appraise and to prepare a

valuation report for the estate’s 20-percent stock interest in

TPC.
                                - 17 -

     Also, on November 16, 1998, the executors of the estate

filed a petition with the Surrogate Court of the State of New

York, County of Westchester, requesting that limited estate

administrative powers be granted to Goerig for the purposes of

representing decedent’s estate in connection with the anticipated

audit by respondent of the estate’s Federal estate tax return and

of handling the anticipated negotiations with respondent over the

fair market value of decedent’s 487,440 shares of TPC stock.    On

December 18, 1998, the court granted to Goerig such limited

estate administrative powers.

     The acknowledged reason the estate hired Goerig (to value

the TPC stock owned by decedent and to represent the estate as

administrator) was to have respondent’s audit of decedent’s

Federal estate tax return conducted not by respondent’s New York

City office but by respondent’s Alaska office, where Goerig

believed and apparently represented to the estate’s

representative that he would be able to obtain for the estate a

more favorable valuation of the estate’s TPC stock.

     Executors for the estate had learned about Goerig from an

attorney for decedent’s family who had met Goerig on a fishing

trip.

     TPC’s financial books and records were maintained on the

basis of a fiscal year ending September 30.
                             - 18 -

     On approximately February 2, 1999, the executors of the

estate timely filed on behalf of the estate a Federal estate tax

return, whereon the estate, based on a valuation report of Goerig

and Paul M. Wichorek (Wichorek), an Alaskan accountant whom

Goerig had hired to assist him in the valuation, reported a total

value of $1,750,000 for the estate’s 20-percent stock interest in

TPC, or $3.59 per share ($1,750,000 ÷ 487,440 shares = $3.59 per

share).

     On audit, based on a valuation report dated November 9,

2000, prepared by Brian C. Becker, a valuation expert hired by

respondent, respondent determined a total value of $35,273,000

for the estate’s 20-percent stock interest in TPC, or $72.36 per

share ($35,273,000 ÷ 487,440 = $72.36), and respondent determined

an estate tax deficiency of $17,910,408.   Respondent also

determined that the entire $17,910,408 estate tax deficiency

determined was attributable to a substantial understatement and

therefore that under section 6662 the estate was subject to a

$7,164,163 gross valuation understatement penalty.

     Shortly before trial, respondent’s expert prepared a revised

valuation report in which respondent’s expert adjusted downward

his valuation of the estate’s 20-percent TPC stock interest from
                             - 19 -

$35,273,000 to $32,387,730, or from $72.36 per share to $66.45

per share ($32,387,730 ÷ 487,440 = $66.45).5

     Respondent’s expert’s revised valuation of the estate’s TPC

stock interest was necessitated by errors in his original report.

In his original valuation, respondent’s expert had added back to

his calculation of TPC’s 1997 cashflow (which was the basis for

his TPC cashflow estimates for 1998-2002) deferred income taxes

of $13,294,000, although the correct amount of deferred taxes

that should have been added back to TPC’s 1997 cashflow was only

$1,609,793.

     Also shortly before trial, the estate’s experts prepared an

“updated” or revised valuation report to make the estate’s

original report “more readable”, in which revised report the

estate’s experts again opined that the May 2, 1998, date-of-death

value of the estate’s TPC common stock was $1,750,000, or $3.59

per share.

                             OPINION

     Generally, under section 2031(a) the value of a decedent’s

gross estate is based on the fair market value of property owned

by the decedent on the date of death.   For Federal estate tax

purposes, the term “fair market value” is defined as the price at

which property would change hands between a willing buyer and a

     5
        Based on this adjustment, respondent reduced the estate’s
tax deficiency to $16,326,408 and the accuracy-related penalty to
$6,530,563.
                              - 20 -

willing seller, neither being under any compulsion to buy or sell

and both having reasonable knowledge of relevant facts.   United

States v. Cartwright, 411 U.S. 546, 551 (1973); sec. 20.2031-

1(b), Estate Tax Regs.

     With regard particularly to unlisted, closely held stock in

corporations such as TPC (with regard to which no bid and asked

prices or other arm’s-length sales information is available), the

statutory language of section 2031 provides that the value of

stock in comparable public corporations shall be taken into

account.   Section 2031(b) provides --


          In the case of stock and securities of a
     corporation the value of which * * * cannot be
     determined with reference to bid and asked prices or
     with reference to sales prices, the value thereof shall
     be determined by taking into consideration, in addition
     to all other factors, the value of stock or securities
     of corporations engaged in the same or a similar line
     of business which are listed on an exchange.


     In utilizing, however, public companies to estimate the

value of private, closely held companies, care must be taken to

ensure that the public companies used are sufficiently comparable

to the private companies being valued.   In this regard, Rev. Rul.

59-60, 1959-1 C.B. 237, 242, cautions as follows:


     Although the only restrictive requirement as to
     comparable corporations specified in the statute [sec.
     2031(b)] is that their lines of business be the same or
     similar, yet it is obvious that consideration must be
     given to other relevant factors in order that the most
     valid comparison possible will be obtained. * * *
                                 - 21 -


     Courts recognize that a comparable company valuation may be

rejected where the companies relied on are not sufficiently

similar to the company being valued.          In Estate of Jung v.

Commissioner, 101 T.C. 412, 433 (1993), significant differences

between the companies used as comparables and the company being

valued caused the Court to reject the comparable public company

method.   In Estate of Klauss v. Commissioner, T.C. Memo. 2000-

191, an expert’s comparability analysis was found to be

inadequate because the expert failed to take into account

differences in size, product mix, customer concentration, and

other factors between the companies used as comparables and the

company being valued.

     With regard to “the other factors” referred to in section

2031(b) to be taken into account in the valuation of private,

closely held companies, section 20.2031-2(f), Estate Tax Regs.,

explains, in part, as follows:


          (f) Where selling prices or bid and asked prices
     are unavailable. If the provisions of paragraphs (b),
     (c), and (d) of this section are inapplicable because
     actual sale prices and bona fide bid and asked prices
     are lacking, then the fair market value is to be
     determined by taking the following factors into
     consideration:

                     *   *   *     *      *     *   *
                              - 22 -

               (2) In the case of shares of stock, the
     company’s net worth, prospective earning power and
     dividend-paying capacity, and other relevant factors.

     Some of the “other relevant factors” * * * are: the
     good will of the business; the economic outlook in the
     particular industry; the company’s position in the
     industry and its management; the degree of control of
     the business represented by the block of stock to be
     valued; and the values of securities of corporations
     engaged in the same or similar lines of business which
     are listed on a stock exchange. However, the weight to
     be accorded such comparisons or any other evidentiary
     factors considered in the determination of a value
     depends upon the facts of each case. * * *


     Rev. Rul. 59-60, 1959-1 C.B. 237, 238-239, lists eight

factors that are particularly relevant to the fair market value

of stock of closely held companies as follows:


     (1)   The nature of the business and the history of the
           enterprise;

     (2)   The general economic outlook and the particular
           outlook for the specific industry;

     (3)   The financial condition of the business and its
           book value;

     (4)   The earning capacity of the company;

     (5)   The dividend-paying capacity of the company;

     (6)   The value of any intangible assets and goodwill;

     (7)   Previous sales of the stock and the size of the
           interest to be valued; and

     (8)   The market price of stocks of corporations engaged in
           the same or a similar line of business having their
                              - 23 -

          stocks actively traded in a free and open market,
          either on an exchange or over-the-counter.


     Rev. Rul. 59-60, supra, acknowledges that a valuation of

closely held stock is not an exact science, but rather involves a

question of fact.   In this regard, Rev. Rul. 59-60, states --


     A sound valuation will be based upon all the relevant
     facts, but the elements of common sense, informed
     judgment and reasonableness must enter into the process
     of weighing those facts and determining their aggregate
     significance. [1959-1 C.B. 237, 238.]


     As noted, although in valuing the fair market value of

corporate stock the future prospects of a company are relevant,

generally an appraisal of fair market value is made without

regard to actual subsequent-year events (i.e., to actual events

occurring after the relevant valuation date).   Krapf v. United

States, 977 F.2d 1454, 1458 (Fed. Cir. 1992).

     The authorities allow, however, that in a number of

situations subsequent-year events may be considered.   For

example, actual subsequent-year events may be considered where

such “evidence would make more or less probable the proposition

that the property had a certain fair market value on a given

date”.   First Natl. Bank of Kenosha v. United States, 763 F.2d

891, 894 (7th Cir. 1985).   Subsequent-year events may be

considered where they are “reasonably foreseeable”, Saltzman v.

Commissioner, 131 F.3d 87, 93 (2d Cir. 1997), revg. T.C. Memo.
                                - 24 -

1994-641, or “corroborate an appraisal that is based on facts

known as of the valuation date”, Jacobson v. Commissioner, T.C.

Memo. 1989-606.    Further, subsequent-year events may be

admissible where relevant as to whether asserted expectations or

prospects (as of the valuation date) were “reasonable and

intelligent.”     Estate of Gilford v. Commissioner, 88 T.C. 38, 54

(1987); Estate of Jephson v. Commissioner, 81 T.C. 999, 1002

(1983); Regents Park Partners v. Commissioner, T.C. Memo. 1992-

336.

       As explained, in the case herein, for Federal estate tax

purposes, both parties relied on valuation reports to estimate

the date-of-death value of the estate’s 20-percent interest in

TPC.    The estate’s experts valued decedent’s interest in TPC at

approximately $1.750 million.    Respondent’s expert valued

decedent’s interest at approximately $32.4 million.    The large

disparity between the parties’ valuations is startling.

       Where conflicting valuations are submitted, a court may give

different weight to the valuations and factors relied on by the

parties.    Casey v. Commissioner, 38 T.C. 357, 381 (1962).   The

Court is not bound to adopt either party’s valuation carte

blanche and is to reach a decision based on its analysis and its

consideration of the evidence.     Helvering v. Natl. Grocery Co.,

304 U.S. 282, 295 (1938); McCord v. Commissioner, 120 T.C. 358,
                                - 25 -

374 (2003); Estate of Newhouse v. Commissioner, 94 T.C. 193, 217

(1990).6

     In this case, the estate’s experts impress us as too

inexperienced, accommodating, and biased in favor of the estate.

     Respondent’s expert appears to have selected his comparable

companies in a casual manner, based only on broad industry

classification factors.   He made significant errors in his

calculations and analysis, and he made questionable and

inadequately explained adjustments in his discounted cashflow

valuation method.


The Estate’s Valuation

     As stated, in their original and revised valuation reports

the estate’s experts from Alaska calculated a total date-of-death

value of $1,749,709 ($3.59 per share) for the estate’s 20-percent

common stock interest in TPC.    In arriving at this number, the

estate’s experts concluded that no companies existed that were


     6
        Under sec. 7491, where a taxpayer produces credible
evidence and otherwise satisfies the requirements of sec.
7491(a)(2), the burden of proof with respect to a factual issue
relevant to ascertaining the taxpayer’s tax liability (such as
the fair market value of property) may shift from the taxpayer to
respondent. Herein, in preparation for trial, the parties
stipulated that the estate satisfied the requirements set forth
in sec. 7491(a)(2). At trial, we determined that for purposes of
sec. 7491(a)(1), the evidence produced by the estate as to the
valuation of the TPC stock was to be treated as credible
evidence. Therefore, respondent has the burden of proof with
regard to the valuation of the estate’s 20-percent stock interest
in TPC.
                               - 26 -

comparable to TPC, and they valued TPC as an entity using the

capitalization of income method.

     In capitalizing the income of TPC, however, the estate’s

experts significantly downplayed TPC’s long history of

substantial income.   They misstated certain financial data,7 and

they opined that TPC’s business would be heavily and adversely

impacted by the Internet and by other advances in technology,

even though the estate’s experts demonstrated no experience with

the Internet- and technology-related companies.

     Under the capitalization of income valuation method, a

business is valued based on a projected stream of “normalized” or

sustainable income, capitalized by a risk-adjusted rate of

return.    The basic steps involved in the capitalization of income

method are as follows:


     (1)   A capitalization rate for the business is selected;

     (2)   The business’s sustainable income is projected;

     (3)   The capitalization rate is applied to the projected
           sustainable income for the business to calculate an
           operating value for the business; and

     (4)   The amount or value of nonoperating assets owned by the
           business is added to the operating value of the
           business.



     7
        For example, in their original report, the estate’s
experts stated that TPC’s growth in revenue for years subsequent
to 1994 was flat, contrary to the fact that TPC’s revenue reached
record levels in each of the years 1994-99.
                              - 27 -


     Obviously, the particular capitalization rate that is

selected has a significant impact on the ultimate valuation and

is intended to reflect risks or volatility associated with a

company’s income stream and seeks to reflect what a stockholder

would require for a rate of return on an investment in the

company being valued.   The more risky and volatile the income

stream is perceived to be, the higher the capitalization rate.

Conversely, the more stable the income stream is perceived to be,

the lower the capitalization rate.

     In this case, the estate’s experts calculated a

capitalization rate of 30.5 percent for TPC.   This capitalization

rate was calculated by the estate’s experts by adding together

the following risk factors and percentages:


     (1)   6 percent to reflect a risk-free rate of return (equal
           to the May 1, 1998, yield on 20-year U.S. Treasury
           securities);

     (2)   7.8 percent to reflect an equity-risk premium (to
           compensate an investor for the risk of investing in
           stocks as compared to long-term U.S. government
           securities, reflecting the percentage by which the
           average annual return on large corporate stocks exceeds
           the average annual return on U.S. government
           securities, as provided in the Ibbotson Associates’
           Stocks, Bonds, Bills & Inflation Yearbook for the years
           1926-97);

     (3)   4.7 percent to reflect a small stock risk (to
           compensate an investor for the risk of investing in
           stock of a small corporation as compared to a large
           corporation, reflecting the percentage by which the
           average annual return earned on small corporate stock
           exceeds the average annual return on large corporate
           stock, as provided in the Ibbotson Associates’ Stocks,
                                - 28 -

           Bonds, Bills & Inflation Yearbook for the years 1926-
           97); and

     (4)   12 percent primarily to reflect risks to TPC relating
           to the Internet and to technology and to the loss of
           advertising revenue that might be related thereto,
           including perceived risks in TPC’s management
           structure.


The 30.5-percent capitalization rate used by the estate’s experts

in the valuation of TPC stock is summarized below:


                        Risk Factors           Percentage
                  Risk-Free Rate of Return         6.0
                  Corporate Equity Risk            7.8
                  Small Stock Risk                 4.7
                  Internet & Management Risk      12.0
                     Capitalization Rate          30.5


     In estimating TPC’s sustainable annual net income against

which to apply the above capitalization rate, the experts for the

estate adjusted TPC’s historical income statements for 1993-97 as

follows:


     (1)   Based on projections of TPC management, $10 million per
           year was subtracted from TPC’s pretax income to reflect
           projected additional expenditures to maintain and to
           further TPC’s presence on the Internet, and to develop
           additional technology-related projects; and

     (2)   Because TPC purportedly depreciated its fixed assets at
           a slower rate than the assets’ actual rate of economic
           depreciation, the experts for the estate subtracted an
           amount to reflect the cost of additional economic
           depreciation to fixed assets not booked each year by
           TPC.
                                                    - 29 -

The adjustments made by the estate’s experts to TPC’s historic

pretax income for 1993-97 are summarized below:8

                                         1993           1994          1995          1996          1997
  Reported Pretax Income              $24,902,000    $22,152,000   $18,737,000   $23,057,000   $26,921,000
     Less Technology Expenditures      10,000,000     10,000,000    10,000,000    10,000,000    10,000,000
     Less Additional Depreciation       1,340,000        756,000       920,000     1,183,000     1,078,000
        Adjusted Pretax Income        $13,562,000    $11,396,000   $ 7,817,000   $11,874,000   $15,843,000




      In order to then calculate an after-tax average sustainable

annual net income for TPC, using the above adjusted pretax income

figures for 1993-97, the estate’s experts made the following

calculations:


                                                                          Adjusted
                                    Year                               Pretax Income
                                    1993                                 $13,562,000
                                    1994                                  11,396,000
                                    1995                                   7,817,000
                                    1996                                  11,874,000
                                    1997                                  15,843,000

               Total Adj. Pretax Income for 5 Years                       $60,492,000
                  Divided by Number of Years                                        5

               TPC Average Annual Sustainable Net
                     Income                                                 12,098,000
                  Less 35% Taxes                                             4,234,000

               TPC After-Tax Average
                  Sustainable Annual Net Income                           $ 7,864,000


      The experts for the estate then applied their 30-percent

capitalization rate for TPC to their $7,864,000 after-tax average

sustainable annual net income for TPC and thereby calculated a

value for TPC of $25,784,000 ($7,864,000 ÷ .305 = $25,784,000).




      8
        In this and the following tables, generally, the numbers
are rounded to the nearest thousand.
                                   - 30 -

     After calculating the above $25,784,000 entity value for

TPC, the estate’s experts calculated a prediscounted value for

the estate’s 20-percent interest in TPC as follows:


     Value of TPC                                          $25,784,000
     Multiplied by Estate’s 20.57% Interest                      .2057
     Prediscounted Value of Estate’s Interest              $ 5,304,000


     The estate’s experts then discounted the above $5,304,000 by

applying a 40-percent minority interest discount and an

additional 45-percent lack of marketability discount to arrive at

a date-of-death value of $1,750,000 for the 487,440 shares of TPC

common stock includable in decedent’s estate, as summarized

below:


         Prediscounted Value of Estate’s 20.57% Interest          $5,304,000
            Less 40% Minority Interest Discount                    2,122,000

         Subtotal                                                 $3,182,000
            Less 45% Lack of Marketability Discount                1,432,000

         Value of Estate’s 20.57% TPC Stock Interest              $1,750,000


     The estate’s experts’ 40-percent minority interest discount

was based primarily on their reading of general valuation texts.9

     The estate’s experts’ 45-percent lack of marketability

discount was based largely on the following factors:             (1) The

stated intent of TPC’s management that it had no interest in



     9
        Coolidge, “Survey Shows Trend Toward Larger Minority
Discounts”, Estate Planning 282 (Sept. 1983); Coolidge, “Fixing
Value of Minority Interest in a Business; Actual Sales Suggest
Discount as High as 70%”, Estate Planning 141 (Spring 1975).
                               - 31 -

going public; (2) the absence of sales of TPC stock for the

10 years prior to May 2, 1998; (3) the inability of any

stockholder of TPC to obtain control of TPC by purchasing merely

the estate’s 20-percent interest; and (4) the inability of the

holder of the estate’s block of TPC stock to force a liquidation

of TPC.

     The estate’s experts, however, provided no credible

explanation for why they used 40-percent and 45-percent minority

interest and lack of marketability discounts, as distinguished

from some other numbers –– e.g., 20 percent or 30 percent.


Respondent’s Valuation

     Respondent’s expert estimated a date-of-death fair market

value for TPC of $225 million and a date-of-death fair market

value for the estate’s 20-percent TPC stock interest of $32.4

million.   Respondent’s expert utilized two valuation methods to

value TPC -- the comparable public company method and the

discounted cashflow method.   In his revised report, in the

process of making certain corrections to errors made in his

original report, respondent’s expert made significant

questionable adjustments in his discounted cashflow method that

are inconsistent with the methodology utilized in his original

report.    In his original and revised reports respondent’s expert

did not utilize the capitalization of income method.
                                    - 32 -

      Using the comparable public company method, respondent’s

expert identified 11 publicly traded companies and treated them

as comparable to TPC on the basis of only two broad criteria as

follows:


      (1)   Classification under the same general U.S. Department
            of Labor Standard Industrial Codes as TPC (namely, Code
            #2731 –– Books: Publishing, or Publishing and
            Printing, and Code #2741 –- Miscellaneous Publishing);
            and

      (2)   Reported positive cashflows for 1995-97.


      Set forth below in schedule format is a listing of TPC and

the 11 companies selected by respondent’s expert as comparable to

TPC, a brief description of the primary type of content material

which each company, as of July 31, 2000, published, and the

amount of each company’s 1997 reported revenue:

       Company                    Publication Material           1997 Revenue
TPC                      Industrial buying directories          $ 240,110,000

American Educational     Educational textbooks, journals, and       8,392,000
  Products               games

Harcourt General, Inc.   Scholarly books and journals,          3,691,639,000
                         educational material, popular books.
                         Owns the Neiman Marcus Group, Inc.

Houghton Mifflin Co.     Textbooks and educational reference      797,320,000
                         materials

Intervisual Books, Inc. Popup and dimensional novelty books        18,733,000

McGraw-Hill Co.          Educational books and magazines.       3,534,095,000
                         Owns Standard & Poor’s and four
                         television stations

Millbrook Press, Inc.    Children’s nonfiction books               12,573,000

Nelson (Thomas), Inc.    Religious and family value books         243,436,000
                                     - 33 -
        Company                   Publication Material               1997 Revenue
Readers Digest           Magazines, and educational,                $2,839,000,000
  Association            condensed, and popular books,
                         recorded music collections, and home
                         videos

Scholastic Corp.         Children’s books and classroom and           966,300,000
                         professional magazines

Touchstone Applied       Reading and English testing materials          4,588,000
  Science Associates

Wiley (John) & Sons      Professional and reference works,            431,947,000
                         consumer books, and textbooks


     From publicly reported financial information relating to the

above public companies, respondent’s expert calculated four

financial measurement ratios applicable to each company --

namely, stock price to net income, stock price to cashflow, stock

market value to book value of tangible and intangible assets, and

stock price to revenue.

     Applying the ratios so calculated to the 11 companies,

respondent’s expert calculated the median ratio for each

measurement, and he applied that respective median ratio as a

multiple to TPC’s 5-year (1993-97) average annual net income,

cashflow, book value, and revenue as follows:

                       Net Income     Cashflow       Book Value         Revenue

TPC 5-Year
   Average            $ 13,259,000   $ 15,187,000    $148,606,000    $235,995,000
Multiple Based on
   Median Ratio
   for 11 Public
   Companies                 25.9             14.3            2.5            1.04

Total for TPC         $343,659,000   $216,780,000    $364,787,000    $245,681,000


     Using the $216,780,000 (rounded to $217 million) calculated

above for the cashflow ratio (apparently because the cashflow
                              - 34 -

ratio was the most consistent measurement ratio as between the 11

companies), respondent’s expert adjusted upward this $217 million

to take into account the higher valuation amounts reflected by

the other measurement ratios, and he calculated a total value for

TPC under his comparable public company method of $260 million.

     As stated, in both his original report and in his revised

report, respondent’s expert also valued TPC using the discounted

cashflow method.   Thereunder, using TPC’s 1997 reported income,

respondent’s expert calculated a 2.7-percent annual income growth

rate (in his original report) and a 2.4-percent annual income

growth rate (in his revised report), which growth rates he

applied to TPC’s actual net cashflow for 1997 to estimate TPC’s

net cashflow for the subsequent 5 years (1998-2002).

     As explained supra, however, in his original report, for

TPC’s 1997 net cashflow number, respondent’s expert used

$13,069,000.   This number was incorrect and was significantly

overstated because respondent’s expert added back to TPC’s 1997

cashflow deferred taxes of $13,294,000, instead of the correct

deferred tax add-back of only $1,609,793.10

     To his estimated TPC net cashflow numbers for 1998-2002

(based on his calculation of TPC’s $13,069,000 net 1997



     10
        In his revised report, in calculating TPC’s 1997 net
cashflow, respondent’s expert used the corrected deferred tax
add-back of $1,609,793. This correction resulted in a revised or
new number for TPC’s 1997 net cashflow of only $1,384,000.
                                   - 35 -

cashflow), respondent’s expert applied a discount rate to

calculate a present value, as of May 2, 1998, of the estimated

1998-2002 net cashflow.

     Respondent’s expert’s discount rate for each year was based

on his estimate of TPC’s cost of equity, calculated under the

capital asset pricing model, and involved the following elements:


     (1)   A risk-free rate of return of 5.933 percent, equal to
           the U.S. government long-term bond rate as of May 2,
           1998;

     (2)   A market-risk premium that varied to reflect the risk
           of investing in a private company and the perceived
           risks of investing in stocks rather than in long-term
           government bonds; and

     (3)   An estimate   of unlevered beta for TPC of 0.60 to
           reflect the   volatility or level of risk associated with
           TPC’s stock   as compared to the volatility of the stock
           market as a   whole (where the market has an overall beta
           of 1).11


     In his original report, respondent’s expert also calculated

and added to his present value calculations of TPC’s estimated

net cashflow for 1998-2002 a $153,174,000 estimate of TPC’s

residual value, based on a discounted “terminal value” for TPC.

In the words of respondent’s expert, this terminal value

     11
        The discount rate which respondent’s expert applied to
TPC’s estimated net cashflow for each year is set forth below:

                            Year        Percentage
                            1998          10.482
                            1999           9.855
                            2000           9.497
                            2001           9.246
                            2002           9.145
                                - 36 -

“incorporates all [estimated cash] flows [for TPC] after Fiscal

2002” discounted back to the end of 2002.       With his discounted

terminal value for TPC added to his present value calculation of

TPC’s estimated net cashflow for 1998-2002, respondent’s expert

concluded in his original report that TPC had a May 2, 1998, fair

market value of $212.6 million as follows:

                                                Present Value
          Fiscal                                of Estimated
           Year                                   Cashflows
           1998                                  $ 13,141,000
           1999                                    12,637,000
           2000                                    11,884,000
           2001                                    11,217,000
           2002                                    10,579,000
                   Subtotal                      $ 59,458,000
               Plus Discounted Terminal Value     153,174,000

          Valuation of TPC                       $212,632,000


     In his revised report, however, after adjusting his add-back

to TPC’s 1997 net cashflow for the corrected $1,609,793 deferred

taxes (discussed supra) (which as indicated resulted in a greatly

reduced calculation of TPC’s estimated net cashflow number for

1998-2002), respondent’s expert switched his residual value

calculation for TPC after 2002 by estimating what he refers to as

a $152,567,000 “liquidation” value for TPC.       Respondent’s

expert’s revised discounted cashflow calculation using the much

reduced cashflow numbers but a liquidation (rather than a

terminal) value for TPC is summarized below:
                                - 37 -
                                           Present Value
          Fiscal                           of Estimated
           Year                              Cashflows
           1998                             $ 1,390,000
           1999                                1,333,000
           2000                                1,251,000
           2001                                1,178,000
           2002                                1,108,000
                   Subtotal                 $ 6,260,000
               Plus Liquidation Value        152,567,000

          Valuation of TPC                  $158,827,000


     In calculating the residual value for TPC to be added to his

net cashflow projections for 1998-2002, respondent’s expert’s

switch in his revised report from a terminal value to a

liquidation value calculation appears to us to be an effort on

the part of respondent’s expert to keep the valuation for TPC

relatively high.12



     12
         Generally, terminal value is used to compute an entity’s
residual value beyond the period for which an entity’s net
cashflows are projected, whereas liquidation value generally is
used only when the entity being valued has plans to liquidate at
the end of the projection period. Copeland, et al., Valuation
284 (3d ed. 2000) (providing that liquidation value should not be
used “unless liquidation is likely at the end of the forecast
period”). Here, TPC’s management, as of May of 1998, had no
plans to liquidate TPC. Using the correct $1.609 million in
deferred tax add-back, the calculation under respondent’s
expert’s discounted cashflow method using a terminal value
calculation for TPC’s 2002 residual value would have reflected a
May 2, 1998, fair market value for TPC of only $21.7 million as
follows:
                                           Present Value
          Fiscal                           of Estimated
           Year                              Cashflows
           1998                             $ 1,390,000
           1999                               1,333,000
           2000                               1,251,000
           2001                               1,178,000
           2002                               1,108,000
                   Subtotal                 $ 6,260,000
               Plus 2002 Terminal Value      15,415,372

          Valuation of TPC                  $21,675,372
                             - 38 -

     In his revised report, respondent’s expert, apparently still

not satisfied with his revised $158.8 million valuation for TPC

(using the corrected deferred tax add-back and a liquidation

value for TPC), goes on to recalculate much higher projected net

cashflow numbers for TPC for 1998-2002, and he calculates

three higher valuations for TPC.

     The major aspect or component of respondent’s expert’s

recalculation of TPC’s projected net cashflows for 1998-2002 is

his use of TPC’s 1997 yearend total working capital, instead of

TPC’s 1997 change in net working capital.   The effect of using

yearend total working capital (against which his growth rate for

TPC was applied) was to significantly increase TPC’s estimated

cashflow for 1998-2002 by approximately $12 million a year.

     Based on the various calculations under his various methods,

respondent’s expert ultimately concluded that the total fair

market value for TPC as an entity, as of May 2, 1998, was

$225 million.

     To the estate’s $46,282,500 20-percent share of this

$225 million ($225,000,000 x .2057 = $46,282,500), respondent’s

expert applied a 30-percent lack of marketability discount and

arrives at a date-of-death value of $32,393,000 for the estate’s

20-percent stock interest in TPC.

     Respondent’s expert bases his 30-percent (as opposed to a

higher) lack of marketability discount on the following:    (1) TPC
                                  - 39 -

was not publicly traded; (2) historically, TPC was profitable;

(3) investment risks associated with TPC were moderate; (4) TPC

had consistently paid cash dividends; (5) as of May 2, 1998, TPC

held more than $137 million in net liquid assets; and (6) the

estate owned the single largest block of TPC stock.           Respondent’s

expert’s calculation of the $32,393,000 valuation for the

estate’s 20.57-percent stock interest in TPC may be summarized as

follows:


     Value of TPC                                    $225,000,000
        Multiplied by Estate’s Interest in TPC             20.57%

     Prediscounted Value of Estate’s Interest        $ 46,282,500
        Less 30% Marketability Discount                13,884,750

     Value of Estate’s 20.57% Interest in TPC        $ 32,393,000*

           * $32,393,000 represents the calculation as reflected
             in respondent’s expert’s revised report. The
             corrected math calculates to $32,397,750.


     As indicated, respondent’s expert does not apply a minority

interest discount to the estate’s 20-percent TPC stock interest.

Rather, respondent’s expert states that his discounted cashflow

method of valuation inherently reflects a minority interest in

TPC and therefore that no separate or additional minority

interest discount is appropriate.
                              - 40 -


Our Analysis

     As mentioned, we find both the estate’s and respondent’s

valuations to be deficient and unpersuasive in calculating the

fair market value of TPC as an entity and in calculating the fair

market value of the estate’s 20-percent interest therein.

     In this case, the estate, the executors of the estate, and

the underlying company, the stock of which is being valued, were

all headquartered and based in the New York City metropolitan

area, but the estate hired a lawyer and an accountant from

Alaska, both with relatively little valuation experience, to

value the estate’s 20-percent interest in TPC.   The estate’s

experts valued TPC and the estate’s interest in TPC in an

aggressive manner largely by over calculating as of the May 2,

1998, valuation date, the risks associated with the Internet and

technology and by applying excessive minority and lack of

marketability discounts.

     Goerig is a lawyer with an audit and tax dispute resolution

practice, and a tax return preparer, and he undertakes occasional

valuations for small businesses and private individuals.    From

his resume, he appears to have attended limited appraisal

courses, other than a few courses while working for respondent

many years ago.   Goerig also was appointed to act as

administrator for the estate to handle the anticipated audit by

respondent of the estate’s Federal estate tax return, a role
                                - 41 -

which we regard as somewhat in tension with his role as a

purported independent valuation expert for the estate.

     Wichorek provides accounting and tax preparation services,

does business consulting, and undertakes occasional valuations

for small businesses, generally in the context of divorce and

property settlement disputes.    He belongs to no professional

organizations or associations relating to his appraisal or

valuation work.

     Although we admitted into evidence the estate’s valuation

reports and treated them as credible, we regard those reports and

the testimony of the estate’s experts to be only marginally

credible.   Goerig and Wichorek were barely qualified to value a

highly successful and well-established New York City-based

company with annual income in the millions of dollars.13

     In our opinion, in computing the sustainable net income of

TPC, the estate’s experts incorrectly applied a 12-percent risk

factor relating to the Internet and technology.    We acknowledge

that while the Internet posed certain risks to TPC, the Internet

also provided significant new business and financial

opportunities to TPC to increase revenue and profitability.      As



     13
        At trial, the estate called additional expert witnesses
in an attempt to provide corroboration for aspects of the
valuation of TPC and of the estate’s interest in TPC by Goerig
and Wichorek. Such witnesses, however, have not cured the
concerns we have with Goerig’s and Wichorek’s valuation of TPC
and of the estate’s interest therein.
                              - 42 -

of May 2, 1998, TPC appeared to be well situated on the Internet,

and TPC’s future as to its Internet operations appeared good, if

not, in the words of TPC’s president, “great”.   As stated in the

estate’s experts’ report, as of May of 1998, TPC “appears to be

in a strong overall financial position when compared to the

industry.   [TPC] has more liquidity, no leverage, and operates

more profitably than the median industry.   Based on the financial

analyses of [TPC], the business has less financial risk than does

the median company in the same industry.”

     The use by the estate’s experts of a 12-percent technology-

related risk factor, particularly in light of their failure to

project any additional income to be produced from technology-

related expenditures, seems to us inappropriate and unjustified.

     Supporting our conclusion that TPC’s risks relating to the

Internet and technology do not support a 12-percent risk factor,

we note that, during its 1998 fiscal year, TPC paid out cash

dividends to its stockholders in excess of $7 million, a

significant increase over total cash dividends paid out to

stockholders in prior years and inconsistent with any management

perception that, as of May of 1998, or in the near future, TPC

faced extraordinarily risky additional Internet- and technology-

related expenditures.

     TPC’s 1998 cash dividends, particularly in light of the

lower level of stockholder dividends that had been paid in prior
                               - 43 -

years, are indicative of an optimistic management outlook for TPC

as of May of 1998.

     As explained by TPC’s president, although its profitability

margins and net income were declining due to increased spending

on technology-related projects, in 1997 and 1998 TPC experienced

record revenue.    Not until 2001 was TPC’s total revenue adversely

affected in a significant way by the Internet and by new

technology.    Mr. Holst-Knudsen explained at trial as follows:


     Q. [By petitioner’s counsel] When, if at all, did [TPC]
     take what you’ve termed a “hit”?

     A. We were taking a hit in the sense of, as I said before,
     the investments we were making. That hit became more
     serious as we went on. I would say that the years 2001,
     2002, and the fiscal year that will close this year is when
     we really began to take the hit on our top line, on
     revenues. We have shed approximately 30 percent of our
     revenue, and about 35 to 40 percent of our account basis
     disappeared over that period of time.


     The additional $10 million a year in technology-related

expenditures that the estate’s experts factored into their

projections of subsequent-year income, and that we also allow, we

believe to be an adequate indication or quantification of the

level of Internet- and technology-related risks TPC faced, as of

May 2, 1998.

     Also, we regard TPC as an extremely well managed company,

with top quality managers throughout the company.    We allow no
                             - 44 -

separate risk factor for what the estate’s experts refer to as

management risk.

     Respondent asserts that the estate’s $25 million valuation

for TPC as an entity (and $1.7 million for the estate’s 20-

percent interest therein) is absurd in light of TPC’s 1997 fiscal

yearend book value in the range of $148 million.   Respondent also

asserts that if we utilize the capitalization of income method to

value TPC (as did the estate’s experts and as we do), we should

take the cash and short-term liquid assets from TPC’s balance

sheet, treat them as nonoperating assets, and add them to any

calculation of the capitalized income of TPC that we make.

     From the end of its 1993 fiscal year through the end of its

1997 fiscal year, TPC’s cash and outside short-term (more than 3-

month) investments reported on its yearend balance sheets

increased from $42.3 million to $73.6 million.   Throughout the

1990s, TPC increased its short-term liquid investments and still

paid significant cash dividends to its stockholders.   Not until

its 2000 fiscal year does TPC’s yearend balance sheet reflect any

significant reduction in outside short-term investments.

     On each of TPC’s 1997 and 1998 fiscal yearend balance

sheets, approximately $68 million is shown as outside short-term

investments with an investment term of more than 3 months.    We

treat these $68 million in short-term liquid investments as

nonoperating assets to be added to the valuation of TPC under a
                              - 45 -

capitalization of income valuation method.     We are not persuaded

that these liquid investments should be treated as operating

assets due to TPC’s commitment to advance sales commissions.14

     TPC’s yearend cash on hand, however, is not to be treated as

anything other than an operating asset and is not to be treated

as an add-on in the calculation of TPC’s value under the

capitalization of income method.

     As to the valuation of the particular 20-percent block of

TPC stock includable in the estate, we disagree with the large

minority (45-percent) and lack of marketability (40-percent)

discounts utilized by the estate’s experts in calculating the

fair market value of the estate’s 20-percent TPC stock interest.

     As noted, the estate’s experts based their minority and lack

of marketability discounts on general studies and not on the

facts of this case.   The experts for the estate selected discount

rates that were extreme and highly favorable for the estate,

without any credible substantive discussion of how the facts of

this case support such particular discounts.

     Also, as we have noted, as of May of 1998, at least one

outside, public investor owned and had owned for at least 10

years a substantial TPC stock interest.   The evidence before us

does not suggest any problem, discontent, dissatisfaction, or


     14
        In our calculation of prior year TPC income, we also
add-back additional depreciation that the estate’s experts add-
back and that respondent apparently does not dispute.
                                - 46 -

other concern with the presence of this outside stockholder.     The

longstanding stock interest of this actual outside investor in

TPC suggests that a hypothetical outside investor would be

interested in an investment in TPC in the nature of the minority

20-percent stock interest held by the estate.

     We reject the minority and lack of marketability discounts

used by the estate’s experts.

     Turning to respondent’s expert’s valuation, respondent’s

expert appeared to be concerned with numbers only and did not

appear to make an effort to base his valuation of TPC on a real

company.    His sterile approach is reflected both in his

comparable public company analysis and in his discounted cashflow

analysis.

     In his comparable public company analysis, respondent’s

expert used information on 11 companies which, only in a broad

sense, relate to TPC.   Valuation of a company under a comparable

public company method may be simple and quick, but such an

approach also may be easily misapplied.    With regard to this

concern, valuation textbooks caution:


          The allure of multiples is that they are simple
     and easy to relate to. * * *
          By the same token, they are also easy to misuse and
     manipulate, especially when comparable firms are used.
     Given that no two firms are exactly similar in terms of risk
     and growth, the definition of comparable firm is a
     subjective one. Consequently a biased analyst can choose a
     group of comparable firms to confirm his or her biases about
                              - 47 -

     a firm’s value * * *.   [Damodaran, Damodaran on Valuation 16
     (1994).]


and further:


     Since the selection of comparable firms has such a
     paramount role in valuation with multiples, special
     attention must be paid to selecting a true comparable
     sample of firms -- firms that are in the same industry,
     employ the same technology, apply to similar
     clienteles, are of similar size, and so on. * * *
     [Benninga & Sarig, Corporate Finance A Valuation
     Approach 330 (1997).]


     We reject respondent’s expert’s 11 companies as comparable

to TPC.   See Estate of Clarke v. Commissioner, T.C. Memo. 1976-

328, where we rejected public companies as comparable,

explaining as follows:


     the fact that two companies are both part of the same
     general industry does not, as respondent’s expert
     implies, make them comparable per se. Such a standard
     clearly ignores the interplay of the myriad of complex
     factors and features that must be accounted for in any
     meaningful comparison. Rather we think it imperative
     that the characteristics of the subject company and the
     purportedly comparable company relevant to the question
     of value be isolated and examined so that a significant
     comparison can be made. Those factors include the
     respective products, market, management, earnings,
     dividend paying capacity, book value, and position in
     the industry of each company. See Cent. Trust Co. v.
     United States, 305 F.2d 393 (Ct. Cl. 1962). [Emphasis
     added.]


     Also, we reject respondent’s expert’s discounted cashflow

analysis.   As explained, significant errors were made therein,
                              - 48 -

and respondent’s expert’s numerous recalculations were suspect,

not sufficiently explained, and not persuasive.

     Also, we disagree with respondent’s expert that no discount

should be applied to the estate’s 20-percent interest to reflect

its minority status.   In cases cited just in the parties’ briefs,

the following minority discounts are observed:    25 percent--N.

Trust Co. v. Commissioner, 87 T.C. 349, 389 (1986); 10 percent--

Estate of Heck v. Commissioner, T.C. Memo. 2002-34; 15 percent

and 20 percent--Gow v. Commissioner, T.C. Memo. 2000-93, affd. 19

Fed. Appx. 90 (4th Cir. 2001).

     In cases cited in the parties’ briefs, the following lack of

marketability discounts are observed:   20 percent--N. Trust Co.

v. Commissioner, supra at 389; 30 percent--Estate of Desmond v.

Commissioner, T.C. Memo. 1999-76; 40 percent and 45 percent--

Barnes v. Commissioner, T.C. Memo. 1998-413; 30 percent--

Mandelbaum v. Commissioner, T.C. Memo. 1995-255, affd. without

published opinion 91 F.3d 124 (3d Cir. 1996); 30 percent--Estate

of Gallo v. Commissioner, T.C. Memo. 1985-363.

     On the evidence before us in this case, we conclude that the

appropriate valuation of the estate’s 20-percent stock interest

in TPC, as of May 2, 1998, should be based on a capitalization of

TPC’s estimated sustainable net income for 1998-2002 calculated

as an average of TPC’s 1993-97 income with an additional $10

million per year in expenditures relating to projected Internet-
                                  - 49 -

and technology-related expenditures.         The 30.5-percent

capitalization rate used by the estate’s experts should be

reduced by 12 percent, from 30.5 percent to 18.5 percent, to

better reflect our belief that the Internet, as of May 2, 1998,

constituted a factor for TPC almost as positive as it was

negative.   Also, $68 million of nonoperating assets should be

added.

     Our calculation of the appropriate 18.5-percent

capitalization rate is as follows:

                       Risk Factors                Percentage
                Risk-Free Rate of Return               6.0
                Corporate Equity Risk                  7.8
                Small Stock Risk                       4.7*
                Internet & Management Risk             0.0
                   Capitalization Rate                18.5

                *   We note that, in spite of the size of TPC,
                    respondent did not discretely challenge
                    this small stock discount.


     In discounting to reflect the estate’s minority 20-percent

interest in TPC, we allow a 15-percent minority interest discount

and a 30-percent lack of marketability discount.          We scale back

the minority and lack of marketability discounts from those used

by the estate’s experts because, as noted above, we find the

estate’s experts’ numbers to be arbitrary and without support.

     We believe a minority interest discount of 15 percent is a

better reflection of the estate’s 20-percent common stock

interest in TPC.    Although a minority interest, the holder of

such interest would own the single largest block of stock in TPC,
                              - 50 -

a major, well-established, well-run company with relatively few

stockholders, in which a longstanding outside investor is already

present and apparently content.

     With regard to the lack of marketability discount, we

believe a 30-percent lack of marketability discount adequately

reflects difficulties the estate and a hypothetical investor

might have in marketing the estate’s 20-percent TPC stock

interest.   Indeed, but for the fact that respondent’s expert

allowed a 30-percent discount for lack of marketability, we might

have been inclined to reduce this discount.   A discount any

higher would not appear to be justified, particularly in light of

the presence among TPC’s stockholders of a significant outsider

stockholder who already owns a relatively large, minority block

of TPC stock.   We also note the dividend-paying history of TPC,

and TPC’s plans, as of May of 1998, to continue its practice of

paying substantial cash dividends, which subsequent-year

dividends would allow a holder of a 20-percent interest in TPC to

recover annually, based on prior-year dividends paid, in excess

of one quarter of a million dollars.

     We conclude that the date-of-death value of TPC as an

entity, as of May 2, 1998, is $110,508,000 and that the date-of-

death value of the estate’s 20.57-percent interest in TPC is

$13,525,240, or $27.75 per share.
                                   - 51 -

     Our calculation of the fair market value of TPC as an entity

and of the estate’s 20.57-percent interest in TPC is set forth

below:


          Capitalization Rate                              18.5%
          Minority Discount                                15%
          Marketability Discount                           30%


                         TPC’s Sustainable Net Income
                                                       Pretax
          Year                                         Income
          1993                                      $ 13,562,000
          1994                                        11,396,000
          1995                                         7,817,000
          1996                                        11,874,000
          1997                                        15,843,000

          Total Pretax Income                       $ 60,492,000
             Divided by Number of Years                        5

          Average Pretax Income                     $ 12,098,000
             Less Estimated 35% Taxes              (   4,234,000)

          Sustainable Net Income                    $   7,864,000
             Divided by Capitalization Rate                 18.5%

          Subtotal                                  $ 42,508,000
             Plus Nonoperating Assets                 68,000,000

          Value of TPC                              $110,508,000


                 Value of Estate’s 20-Percent Stock Interest

          Value of TPC                                    $110,508,000
             Multiplied by Estate’s Percent Interest            20.57%

          Subtotal                                        $ 22,731,496
             Less 15% Minority Discount                      3,409,724

          Subtotal                                        $ 19,321,771
             Less 30% Marketability Discount                 5,796,531

          Value of Estate’s 20% TPC Interest              $ 13,525,240

                             Per-Share Value                    $27.75


     Taking into account all of the evidence before us and the

arguments of the parties, we believe that our above valuation
                               - 52 -

constitutes a fair and appropriate valuation of TPC and of the

estate’s interest in TPC.


Accuracy-Related Penalty

     Generally, a 20-percent penalty is imposed on “any portion

of an underpayment of tax required to be shown on a return” where

the underpayment constitutes a substantial estate tax valuation

understatement.   Sec. 6662(a) and (b)(5).

     For purposes of section 6662, an estate tax valuation

understatement is treated as substantial where property required

to be reported on an estate tax return is reported at a value

50 percent or less than the value eventually determined by the

court.   Sec. 6662(g)(1).   Where property is reported at a value

less than 25 percent of the value eventually determined by the

court, the penalty imposed under section 6662 is increased from

20 percent to 40 percent.   Sec. 6662(h).

     We have determined the value of the estate’s 20-percent

interest in TPC to be $13,525,240.      Because the value reported by

the estate for its 20-percent interest in TPC ($1.8 million) is

less than 25 percent of the value determined herein ($13,525,240

x .25 = $3,381,310), unless an exception to the application of

the section 6662 penalty applies, the estate would be liable for

a 40-percent penalty on its understated valuation.

     Under section 6664, an exception is provided to the

imposition of a section 6662 accuracy-related penalty where a
                              - 53 -

taxpayer establishes that there was reasonable cause for the

understatement and that the taxpayer acted in good faith.    Sec.

6664(c).

     The regulations provide that whether an understatement of

tax is made in good faith and due to reasonable cause will depend

upon the facts and circumstances of each case.   Sec. 1.6664-4(b),

Income Tax Regs.   In determining whether a taxpayer acted

reasonably and in good faith with regard to the valuation of

property, factors to be considered include:   (1) Whether the

value reported on the tax return was based on an appraisal;

(2) the methodology and assumptions underlying the appraisal;

(3) the appraised value; (4) the circumstances under which the

appraisal was obtained; and (5) the appraiser’s relationship to

the taxpayer.   Sec. 1.6664-4(b)(1), Income Tax Regs.

     The estate contends that it acted reasonably and in good

faith in the valuation of the estate’s 20-percent TPC stock

interest, in filing its Federal estate tax return, and in

reporting thereon the value of the TPC stock.

     The valuation herein of the estate’s 20-percent stock

interest in TPC was particularly difficult and unique.   Companies

comparable to TPC were not found.   Valuation of the estate’s 20-

percent TPC stock interest under the capitalization of income and

under the discounted cashflow methods involved a number of

difficult judgment calls.   We believe it noteworthy and relevant
                             - 54 -

to the appropriateness of the section 6662 penalty that even

respondent’s expert made significant errors in his various

calculations.

     Complicating the valuation presented to the parties and to

the Court herein was the difficult question as to how the

Internet and the risks and opportunities associated therewith

should be regarded as affecting TPC.   The evaluation in this case

of such intangible risks and opportunities was difficult and

imprecise.

     Certainly, the experts for the estate were aggressive in

their relatively low valuation of TPC.   Respondent’s expert was

aggressive in his relatively high valuation of TPC.   We note that

our valuation of TPC and of the estate’s 20-percent interest in

TPC is closer to the estate’s valuation than to respondent’s

valuation.

     On the record before us, we believe it inappropriate to

impose the accuracy-related penalty.   The estate is not liable

for the accuracy-related penalty.

     Accordingly,


                                    Decision will be entered

                              under Rule 155.
