                        T.C. Memo. 2003-66



                      UNITED STATES TAX COURT



         ESTATE OF NATALIE M. LEICHTER, DECEASED, STEVEN
       LEICHTER, CO-SPECIAL ADMINISTRATOR AND JEFFREY L.
        LEICHTER, CO-SPECIAL ADMINISTRATOR, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 2192-00.                Filed March 6, 2003.



     Walter Joseph Tribbey III, for petitioner.

     David R. Jojola, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     GERBER, Judge:   Respondent determined a $344,635 Federal

estate tax deficiency for the Estate of Natalie M. Leichter (the

estate).   This deficiency derives from respondent’s determination

that the fair market value of Harlee International, Inc., a

closely held corporation, was $2,718,358 instead of the
                                - 2 -

$2,091,750 reported as its fair market value on the estate’s tax

return.   The sole issue for our consideration is the fair market

value of Harlee International, Inc., on October 23, 1995, the

date of decedent’s death.

                           FINDINGS OF FACT1

     Decedent Natalie Leichter was a resident of Los Angeles,

California, at the time of her death on October 23, 1995.

Decedent’s spouse, Harvey A. Leichter, died approximately 3

months earlier during July 1995.     Decedent died testate and was

survived by two sons, Jeffrey L. Leichter and Steven F. Leichter.

Steven Leichter resided in Walnut, California, at the time the

estate’s petition was filed.    Among other things, the estate

included all of the outstanding common stock of Harlee

International, Inc. (Harlee).

     At the time of decedent’s death, Harlee was a California

corporation which had elected S corporation status for Federal

tax purposes.   Harlee had 20,000 shares outstanding and was a

wholesale distributor of futon frames.     Harlee was founded in

1981 by Harvey Leichter.    It began as a small importer and

distributor of industrial fasteners imported from Asia.

Initially, Harlee operated out of the Leichter residence.      In the

mid-1980s, Harlee entered into the business of the wholesale



     1
       The parties’ stipulations of facts are incorporated herein
by this reference.
                               - 3 -

distribution of waterbed frames and vinyl liners.    After a

decline in the waterbed market and approximately 1½ years before

his death, Harvey Leichter became involved in the re-emerging

futon market.

     Through his overseas contacts, Harvey Leichter sought out

Asian companies that could manufacture futon frames according to

photographs and samples provided by Harlee.    Harlee dealt

directly with representatives who, in turn, were responsible for

locating foreign companies and maintaining accounts with them.

Harlee did not have contractual relationships with the Asian

manufacturers.   Shortly before decedent’s death, Harlee’s

contractual relationship with two representatives ended:      One

manufacturer was taken over by Harlee’s competitor, and another

was closed as a result of embezzlement.

     As of decedent’s date of death, Harlee was still in a period

of transition from the waterbed to the futon market.    Harlee’s

product line consisted of approximately 60-percent futon-related

items and 40-percent waterbed-related items.    Of Harlee’s futon

products line, nearly 10 percent were metal fastener and liner

products manufactured in Taiwan.   The remaining 90 percent were

futon frames from three different manufacturers in Indonesia.
                                 - 4 -

     The use of Asian suppliers kept costs low but subjected

Harlee to concerns such as:    (1) A 3-to-4 month order, or lead

time; (2) additional delays during the Asian rainy season; (3)

the possibility of political unrest that stopped and/or

substantially decreased production; and (4) approximately 20

percent defective inventory.    For these reasons, Harlee

maintained at least 3 to 4 months of inventory at all times.

However, during two of Harlee’s biggest seasons, Christmas and

spring, which coincide with the Asian rainy season, inventory was

increased beyond the 3 to 4 months standard.    Harlee was

increasing its inventory at the time of decedent’s death.

     At the time of decedent’s death, Harlee conducted business

from leased premises in Corona, California.    Because the building

had become too small for Harlee’s needs and the lease was about

to expire, Harlee leased new premises beginning on January 1,

1996.

     Harlee was exposed to competition by similarly sized

companies on a national level.    Its customer base consisted of

approximately 100 customers, including retail stores,

distributors and manufacturers.    Although most of the customers

were retail stores, the distributors generated the largest amount

of revenue.    Once a distributor became sufficiently large enough

to import products directly, it would cut out the middleman, such

as Harlee.    Sometimes Harlee remained involved as an agent for
                                - 5 -

the distributors and received a 3- to 5-percent commission,

instead of the normal 30-percent profit.    Due to a large

turnover, Harlee continually needed to, and did, generate new

customers.

     Prior to his death in July 1995, Harvey Leichter was

Harlee’s president and primary salesman, generating 80 to 90

percent of all sales.    Decedent was Harlee’s bookkeeper.   Aside

from them, the management team consisted of James Woll, general

manager in charge of new product development; and James Seltzer,

assistant to the president.    Altogether, Harlee had a workforce

consisting of 8 to 10 employees.    Between Harvey Leichter’s death

in July 1995 and decedent’s death in October of that same year,

the workforce remained constant except that decedent became

president.

     For the 4 years preceding decedent’s death (1991 through

1994), Harlee had total sales of $2,426,721, $1,896,895,

$2,778,872, and $3,894,587, respectively.    In each of the 2 years

preceding death, Harlee’s sales increased more than 40 percent

from the prior year.    For that same period, Harlee’s cost of

goods sold averaged in the mid-to-high 70-percent range in

relation to total sales, and its operating expenses averaged

approximately 18 percent of total sales.    Harlee’s adjusted net

income for the 4 years preceding decedent’s death was generally

increasing, as follows:    $40,194, $83,640, $77,570, and $113,191.
                                - 6 -

Similarly, for Federal tax purposes, Harlee reported generally

increasing amounts of ordinary income culminating in $163,121 for

its 1994 taxable year.

     Steven Leichter worked for 13 years at Harlee until decedent

fired him in June 1994.    Consequently, he was not involved with

Harlee for the approximately 12 to 15 months preceding his

parents’ deaths.    Steven Leichter returned to Harlee shortly

after decedent’s death and assumed responsibility for the day-to-

day operations.    Jeffrey Leichter resided in Detroit Lakes,

Minnesota, at the time of decedent’s death.

     Jeffrey Leichter was nominated in decedent’s will to act as

her executor and, as such, was issued letters of special

administration on November 2, 1995.     On the same date, the estate

filed a petition seeking to probate the March 21, 1995, will and

the October 16, 1995, First Codicil.    In her First Codicil,

decedent disinherited her son, Steven Leichter.    Consequently, a

dispute arose between the two sons concerning the distribution of

the estate.   In particular the dispute concerned decedent’s

predeceased spouse’s estate and the First Restatement of the

January 12, 1991, Leichter Family Trust.

     On March 6, 1996, a Settlement Agreement and Mutual Release

(Settlement Agreement) was filed with the probate court

reflecting that a settlement had been reached between Jeffrey and
                                - 7 -

Steven Leichter.   Among other things, the Settlement Agreement

provided that

          1.5 * * * the Trust shall distribute to
          Steven * * *
                 a. One hundred percent (100%) of the
                 stock in Harlee * * * [20,000
                 shares];
                 b. the sum of $400,000.0 in
                 cash * * *

          1.5 [sic.] Steven shall assign his interest
          in * * * [decedent’s] Individual Retirement
          Account to Jeffrey * * *

          1.6 Steven shall also release any claims he
          may have for any portion of * * *
          [decedent’s] estate * * *.

     On March 20, 1996, the Superior Court appointed Joseph D.

Bua as probate referee to appraise and inventory the estate.     Mr.

Bua filed such appraisal and inventory of the estate with the

Superior Court on August 13, 1996.      The filed documents reflected

that the Harlee stock was inventoried and appraised at

$2,261,713.00.   Decedent’s Individual Retirement Account was

valued for Federal estate tax purposes at $2,240,966.

     On October 31 and December 16, 1996, the estate filed with

the Superior Court a Waiver of First and Final Account and a

First Supplement to the Waiver of First and Final Account,

respectively.    On December 17, 1996, the Superior Court ordered

that the outstanding stock in Harlee, appraised at $2,261,713,

was to be distributed to Steven Leichter.      On December 23, 1996,
                                - 8 -

Steven Leichter acknowledged receipt of the distribution of the

Harlee stock.

     On July 22, 1996, 1 day before the estate tax return was

due, the estate requested a 6-month extension until January 23,

1997.    The request was granted, and the estate’s tax return was

timely filed.    The return reflected that the unit value of the

20,000 shares of Harlee, which represented all of the issued and

outstanding stock, was $104.59, for a total value of $2,091,750.

Because the value of Harlee stock exceeded 35 percent of the

adjusted gross estate, the estate elected the section 6166(a)(1)2

benefit of paying $722,421 of estate tax in installments over 10

years.

     The $2,091,750 reported value stems from an appraisal

report, dated November 15, 1995.   It was prepared by Lawrence F.

Sherman of WIN Corporate Finance, Inc., who was hired by the

estate to value the business.   In his valuation of Harlee

(Sherman Appraisal), Mr. Sherman relied on Harlee’s October 31,

1995, interim financial statement.      This statement reflected that

a $1,253,021 note payable by Harlee to the Leichter Family Trust

had been converted to equity on or before decedent’s date of

death.   The note payable had shown an annual interest rate of 10


     2
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect as of the date of decedent’s
death, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
                               - 9 -

percent, which was payable monthly.     If the interest was not

paid, the amount of interest became part of the principal and was

compounded.   The note payable had been secured by a security

interest in substantially all of Harlee’s assets and had been

recorded by Harlee as a current liability.

     Approximately 4 years later and during the examination of

the estate’s tax return, the estate’s attorneys arranged a

meeting with Mr. Sherman and senior management at Harlee to

review and discuss the Sherman Appraisal.     One week later, Mr.

Sherman wrote a letter to one of the estate’s representatives

claiming that he had made an error on the Sherman Appraisal.       He

explained that “During * * * [the] meeting * * * last week, new

information was presented to me that was not considered in * * *

[the Sherman Appraisal] in 1995.”   Mr. Sherman stated that his

error resulted from a misunderstanding as to inventory policy and

existing liabilities.

     A statutory notice of deficiency was issued to the estate on

December 6, 1999.

                              OPINION

     We consider here the fair market value of a closely held

business and whether any discount is appropriate.     The estate

reported Harlee’s fair market value at $2,091,750 based on an

appraisal that was attached to its estate tax return.     Respondent

initially determined that the fair market value was $2,718,358 in
                               - 10 -

the statutory notice of deficiency.     Based on its expert’s

report, respondent, for purposes of trial, contends that the fair

market value was $2,150,000.   The estate, for purposes of trial,

contends that the appraisal relied upon for purposes of the

estate tax return was erroneous or flawed and that the fair

market value is, at most, $800,000.     At trial, both sides to this

controversy offered witnesses supporting their respective

positions.

     Property includable in a decedent’s gross estate is

generally included at its fair market value on the date of death.

Sec. 2031(a); sec. 20.2031-1(b), Estate Tax Regs.     Fair market

value is a factual determination, and the trier of fact must

weigh all relevant evidence of value and draw appropriate

references.   Commissioner v. Scottish Am. Inv. Co., 323 U.S. 119,

123-125 (1944); Helvering v. Natl. Grocery Co., 304 U.S. 282, 294

(1938); Symington v. Commissioner, 87 T.C. 892, 896 (1986).

     To determine the value of an unlisted stock, an actual

arm’s-length sale of a similar stock within a reasonable time

before or after decedent’s date of death is indicative of its

fair market value.   Ward v. Commissioner, 87 T.C. 78, 101 (1986).

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

represents the price that a hypothetical willing buyer would pay

a hypothetical willing seller, both persons having reasonable

knowledge of all relevant facts and neither person compelled to
                               - 11 -

buy or sell.   Estate of Hall v. Commissioner, 92 T.C. 312, 335

(1989).   It is implicit that the buyer and seller would aim to

maximize profit and/or minimize cost in the setting of a

hypothetical sale.    Estate of Watts v. Commissioner, 823 F.2d

483, 486 (11th Cir. 1987), affg. T.C. Memo. 1985-595; Estate of

Newhouse v. Commissioner, 94 T.C. 193, 218 (1990).    Therefore, we

consider the view of both the hypothetical seller and buyer.

Kolom v. Commissioner, 644 F.2d 1282, 1288 (9th Cir. 1981), affg.

71 T.C. 235 (1978).

     In this case, the estate reported Harlee’s value to be

$2,091,750 on its estate tax return.    For purposes of this

controversy, the estate contends that the value is, at most, less

than one-half of the amount it reported.    A valuation amount

reported on a taxpayer’s return is a deemed admission.     Estate of

Hall v. Commissioner, supra at 337-338.

     The estate argues that the Sherman Appraisal, upon which the

estate relied in filing its 1995 estate tax return, was

erroneous.   Specifically, the estate contends that the appraisal

by Mr. Sherman: (1) Inferred, mistakenly, that he had interviewed

the decedent; (2) stated, alternatively in different paragraphs

on the same page, that the estate to be valued was of Mrs. Lee

Leichter or of Mr. Harvey Leichter; (3) reported that decedent’s

date of death was October 18, 1995, when it was October 23, 1995;

(4) determined that the working capital was excessive without
                               - 12 -

considering the nature of the business; and (5) did not take into

account $90,000 of liabilities.

     We note that decedent and her husband died within a short

time of each other.   Furthermore, most of the errors complained

of by the estate are orthographic.      While they might reflect that

Mr. Sherman’s appraisal needed proofreading, they do not show

that the value is erroneous.

     As for the posited errors which appear to be more

substantive in nature, again, they do not show that the value,

itself, is erroneous.   The purported $90,000 in liabilities was

unknown and unforeseeable at the time of decedent’s death and

cannot be used for valuation purposes.     See, e.g., Estate of

Busch v. Commissioner, T.C. Memo. 2000-3.      Furthermore, despite

the estate’s claim, it does not appear that Mr. Sherman

overstated by $900,000 the amount of excess working capital.      In

fact, his valuation of excess working capital appears reasonable

and was approximately $100,000 lower than that of respondent’s

expert.

     Contrary to the estate’s contentions, the record is replete

with evidence that the value reported on the estate tax return

was correct.   For instance, in probate litigation between the

decedent’s two sons, Jeffrey and Steven Leichter settled the

dispute based upon a $2,261,713 value of Harlee, determined by a

probate referee, who was an independent party appointed by the
                                - 13 -

court.    Moreover, respondent’s expert arrived at a value that was

a mere $60,000 or 3 percent more than reported on the estate tax

return.

     In reaching our holding on the fair market value of Harlee,

we consider the expert witnesses’ reports.      It is within this

Court’s discretion to evaluate the cogency of their conclusions

and opinions.     Sammons v. Commissioner, 838 F.2d 330, 333 (9th

Cir. 1988), affg. on this point and revg. on another ground T.C.

Memo. 1986-318.    This Court evaluates opinions of experts in

light of each expert’s demonstrated qualifications and the

evidence in the record.     Estate of Davis v. Commissioner, 110

T.C. 530, 538 (1998) (and cases cited therein).      Accordingly,

this Court may accept or reject all or part of an expert’s

opinion.    Id.

     For purposes of supporting a substantially lower value than

reported, the estate offered two experts, one valuing Harlee at

$863,000 and the other at $400,000.      Respondent offered one

expert, who valued Harlee at $2,150,000.      While neither party

offered Mr. Sherman, who valued Harlee at $2,091,750 for purposes

of the estate tax return, the Sherman Appraisal itself is part of

the record.

     Mr. Burdette Garvin was hired by the estate for litigation

purposes and opined that the value of Harlee was $863,000 as of

October 23, 1995.    Although Mr. Garvin seemed to have working
                               - 14 -

knowledge of the market for this type of business, his appraisal

approach and methodology are weak in several respects.     As an

example, for adjusted book value, Mr. Garvin improperly included

the $1,254,408 Note Payable.   As of decedent’s date of death,

that Note Payable had already been converted to equity.3

Consequently, it was not a liability of Harlee, and Mr. Garvin’s

adjusted book value should have been substantially larger.

     In arriving at book value, Mr. Garvin increased other

noncurrent liabilities by approximately $1,400,000 from October

31 to December 31, 1995.   Mr. Garvin attributes this increase to

something he denominates as “negative goodwill”.   Negative

goodwill has been defined as a phenomenon which occurs when the

purchase price of a business is less than its book value.     See

Adventist Living Ctrs., Inc. v. Bowen, 686 F. Supp. 680 (N.D.

Ill. 1988), affd. 881 F.2d 1417 (7th Cir. 1989).   In that regard,

Mr. Garvin had already discounted Harlee’s assets substantially

for “soft” inventory and doubtful accounts.   Moreover, he

provided no viable reason for further reductions for “negative

goodwill”.

     Mr. Garvin employed established valuation methodologies:

Discounted earnings method, guideline company method, and

industry market ratios method.   However, he duplicated the


     3
       While this point was conceded by the estate on brief, the
estate did not address the change in book and adjusted book value
amounts.
                              - 15 -

discounts applied.   For instance, he discounted for the loss of

Harvey Leichter in all three methods and after weighing all

three, he discounted again for lack of marketability.   We found

this to be an attempt to discount for the same reasons he

discounted the values initially.    For that reason among others,

we question whether his report can be relied upon.

     Significantly, Mr. Garvin fails to explain his reasons for

not including a pure liquidation analysis as part of his report.

In effect, Mr. Garvin is opining that Harlee is worth

substantially less than its liquidation value.   He fails to

explain why the hypothetical seller would choose not to liquidate

when he concludes that the going concern value is less than the

value of its assets.4

     Mr. John McCallum was hired by the estate for litigation

purposes and opined that the value of Harlee was $400,000 as of

December 31, 1995.   In reviewing Mr. McCallum’s report, we find

that his conclusions and analysis are brief and cursory in

nature.   For instance, while acknowledging in the appraisal that

his date of valuation was 2 months after decedent’s date of

death, Mr. McCallum merely states that “this date is

appropriate.”   Mr. McCallum’s “Observations as to Conditions” of

Harlee is less than 10 sentences.   Mr. McCallum provides no


     4
       The estate points out that Steven Leichter wanted to
continue the family business and felt an obligation to the
employees. However, we can only consider the motivations of a
hypothetical seller or buyer, not those of Steven Leichter.
                               - 16 -

explanation of the Leichters’ role at Harlee in concluding that a

15-percent discount should be applied for the lack of continuity

of management.   We accord no weight to Mr. McCallum’s report

because of the lack of adequate explanations in support of his

conclusions.

     Mr. John Thomson was hired by respondent for litigation

purposes, and he opined that Harlee’s value was $2,150,000 as of

October 23, 1995–-an amount less than respondent’s original

determination of $2,718,358.   Primarily, Mr. Thomson used two

methods in arriving at his value.    Through the market approach,

he compared Harlee to five publicly traded firms, discounted the

value of Harlee to match more accurately the comparables to the

subject and added both a 15-percent control premium and an excess

working capital value of $900,000.      Through the income method,

Mr. Thomson forecasted Harlee’s sales for the subsequent 5 years

and used a net discounted cashflow method to value those sales at

present value.   In so doing, Mr. Thomson looked at Harlee’s

previous 5 years of operation and then discounted the future

cashflow by 17 percent.

     Mr. Thomson’s methodology was within reasonable range and

his conclusions were adequately supported by the facts in the

record.   Mr. Thomson’s $2,150,000 value was in harmony with the

$2,261,713 value arrived at by the probate referee and the

$2,091,750 value reported by the estate on its estate tax return.
                                - 17 -

However, we did find some weakness in his approach; i.e., the

fact that he chose guideline companies that, even in his own

opinion, were not similar to Harlee.

     In arguing for a lower value of Harlee, the estate

continually attempted to shift our focus to the rate of return

expected by a hypothetical buyer of Harlee.    However, we cannot,

overlook the fact that a hypothetical seller would not sell

Harlee valued as a going concern if a substantially larger amount

could be realized by means of Harlee’s liquidation.    Further,

Harlee had an established record of past earnings which belies

the estate’s position.

     We hold that the includable value of Harlee on October 23,

1995, was $2,091,750, the value reported on the Estate of Natalie

Leichter’s estate tax return.

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
