                          T.C. Memo. 2004-116



                     UNITED STATES TAX COURT



ESTATE OF GEORGE C. BLOUNT, DECEASED, FRED B. AFTERGUT, EXECUTOR,
                           Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 540-02.                 Filed May 12, 2004.

          D and J each owned 50 percent of the outstanding
     shares of B corporation. In 1981, D, J, and B entered
     into a buy-sell agreement restricting transfers of B’s
     stock both during the shareholders’ lifetimes and at
     death. Lifetime transfers required the consent of the
     other shareholders. At death, a shareholder’s estate
     was required to sell, and B was required to buy, the
     shareholder’s shares at a price set in the agreement.
     The agreement further provided that it could be
     modified only by the written consent of the parties to
     the agreement, which consisted of D, J, and B. D and J
     subsequently transferred shares to an employee stock
     ownership plan (ESOP) that B established. J died, and
     B redeemed his shares pursuant to the agreement,
     leaving D and the ESOP as the only remaining
     shareholders, with D owning a controlling interest in
     B. D and B were the only remaining parties to the
     agreement.

          In 1996, without obtaining the ESOP’s consent, D
     and B modified the agreement, changing the price and
                               - 2 -

     terms under which B would redeem D’s shares on D’s
     death, but leaving unchanged the provision requiring
     the consent of other shareholders for lifetime
     transfers. The modified price was substantially below
     the price that would have been payable pursuant to the
     unmodified agreement. D died, and B redeemed his
     shares as set forth in the modified agreement. D’s
     estate reported the value of the shares D held at death
     as equal to the price set forth in the modified
     agreement.

          Held: The modified agreement is disregarded for
     purposes of determining the value of D’s shares for
     Federal estate tax purposes because D had the
     unilateral ability to modify the agreement, rendering
     the agreement not binding during D’s lifetime, as
     required by sec. 20.2031-2(h), Estate Tax Regs.

          Held, further: Sec. 2703, I.R.C., applies to the
     modified agreement because the 1996 modification, which
     occurred after the effective date of sec. 2703, I.R.C.,
     was a substantial modification.

          Held, further: The modified agreement is also
     disregarded under sec. 2703(a), I.R.C., because it
     fails to satisfy sec. 2703(b)(3), I.R.C., which
     requires that the terms of the agreement be comparable
     to similar arrangements entered into by persons in an
     arm’s-length transaction.

          Held, further:   Fair market value of D’s shares
     determined.


     R. Douglas Wright, Larry S. Pike, Alfred B. Adams, III,

and Sara L. Doyle, for petitioner.

     Travis Vance, III, for respondent.
                                 - 3 -


MEMORANDUM FINDINGS OF FACT AND OPINION . . . . . . . . . . . . 4

FINDINGS OF FACT     . . . . . . . . . . . . . . . . . . . . . . . 4

I.     Decedent and BCC . . . . . . . . . . . . . . . . . . . . . 5

II.    1981 Agreement . . . . . . . . . . . . . . . . . . . . . . 6

III. ESOP . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

IV.    Life Insurance and the Death of Mr. Jennings . . . . . .                     10

V.     1996 Agreement and Redemption of Decedent’s BCC Shares .                     11

VI.    Estate’s Return   . . . . . . . . . . . . . . . . . . . .                    15

VII. Expert Testimony . . . . . . . . . . .     .   .   .   .   .   .   .   .   .   16
     A.   Estate’s Expert Mr. Grizzle . . .     .   .   .   .   .   .   .   .   .   17
     B.   Estate’s Expert Mr. Fodor . . . .     .   .   .   .   .   .   .   .   .   19
     C.   Respondent’s Expert, Mr. Hitchner     .   .   .   .   .   .   .   .   .   21

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . .                       25

I.    Effectiveness of the Buy-Sell Agreement   .   .   .   .   .   .   .   .   .   25
       A.   Terms of the Buy-Sell Agreement .   .   .   .   .   .   .   .   .   .   28
       B.   Binding-During-Life Requirement .   .   .   .   .   .   .   .   .   .   33
       C.   Section 2703 . . . . . . . . . .    .   .   .   .   .   .   .   .   .   39
            1. Applicability of Section 2703    .   .   .   .   .   .   .   .   .   40
            2. Section 2703(b)(3) . . . . .     .   .   .   .   .   .   .   .   .   46

II.    Valuation of Decedent’s BCC Shares . . . . . . . . . . .                     55
       A.   Fair Market Value . . . . . . . . . . . . . . . . .                     55
       B.   Expert Testimony . . . . . . . . . . . . . . . . .                      56
       C.   BCC’s Value Exclusive of Insurance Proceeds . . . .                     58
            1. Experts’ Concluded Value Exclusive of Insurance
                   Proceeds . . . . . . . . . . . . . . . . . .                     58
            2. Mr. Fodor’s Adjustment for ESOP Repurchase
                   Obligation . . . . . . . . . . . . . . . . .                     60
            3. Mr. Hitchner’s Estimate of Excess Cash . . . .                       64
            4. Conclusion . . . . . . . . . . . . . . . . . .                       65
       D.   Effect of Redemption Obligation on Insurance
                   Proceeds . . . . . . . . . . . . . . . . . .                     66
       E.   Accounting for Insurance Proceeds . . . . . . . . .                     75

III.    Conclusion   . . . . . . . . . . . . . . . . . . . . . .                    81
                                - 4 -

             MEMORANDUM FINDINGS OF FACT AND OPINION


     GALE, Judge:   Respondent determined a Federal estate tax

deficiency of $2,354,521 with respect to the Estate of George C.

Blount (the estate).   After concessions, the issue remaining for

decision is the value for Federal estate tax purposes of

43,079.9657 shares of Blount Construction Co. (BCC) owned by

George C. Blount (decedent) on September 21, 1997, his date of

death and the valuation date.   Subsumed within that issue is the

question of whether a buy-sell agreement covering the BCC shares

fixes their value, or whether the agreement should be disregarded

in determining that value.

     Unless otherwise noted, all section references are to the

Internal Revenue Code in effect for the date of decedent’s death,

and all Rule references are to the Tax Court Rules of Practice

and Procedure.

                         FINDINGS OF FACT

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

incorporate by this reference the stipulation of facts and the

accompanying exhibits.
                                - 5 -

I.   Decedent and BCC

     Decedent was a U.S. citizen domiciled in Georgia when he

died testate on September 21, 1997.     Decedent’s will was probated

in Fulton County, Georgia, with Fred B. Aftergut appointed as

executor.

     At his death, decedent owned 43,079.9657 (hereinafter

rounded to 43,080) shares of BCC, constituting 83.2 percent of

its outstanding stock.   BCC was located in Atlanta, Georgia, and

had been in existence in one form or another since 1946, when

decedent’s father founded Blount Asphalt Co.    Decedent became

involved in the business shortly thereafter, and when his father

died, decedent and his brother-in-law, James M. Jennings, became

equal owners.

     BCC was in the general business of the construction and

repair of roads, streets, driveways, parking lots, and similar

projects.   At decedent’s death, BCC also operated an asphalt

plant.   In addition, BCC had certain nonoperating assets,

including an idle asphalt plant and notes receivable.    BCC

required approximately $1.5 million in cash and cash equivalents

to operate.    Among other things, this allowed it to meet bonding

requirements without the need for personal guaranties.     When

decedent died, BCC had at least $2.5 million in cash and cash

equivalents.
                               - 6 -

      BCC performed work for private entities, commercial

enterprises, municipalities, and the State of Georgia.   It

obtained work through a competitive bid and negotiation process

and did not rely on any one client or customer for a large

percentage of its revenues.   BCC operated on a fiscal year ending

January 31.   Each year, it prepared “value in use” analyses in

which it estimated the value of its assets, relying on published

information regarding used equipment values, including auction

prices and information published by the equipment manufacturers.

      Other than his brother-in-law, Mr. Jennings, decedent had no

family member who owned stock in or worked at BCC.   BCC had a

core group of long-term employees, some employed at BCC for more

than 30 years when decedent died.   Decedent did not have a

personal relationship with these or any other BCC employees

outside of work.   Decedent served as BCC’s president and was

actively involved in its management, making most major decisions,

including the selection of projects on which to bid and the bid

amounts, until the months preceding his death.

II.   1981 Agreement

      In 1981, decedent, Mr. Jennings, and BCC entered into an

agreement restricting the transfer of BCC’s stock entitled
                               - 7 -

“Shareholders Agreement” (the 1981 Agreement).1    At the time,

decedent and Mr. Jennings each owned one-half of BCC’s

outstanding stock.   The 1981 Agreement contained restrictions on

transfers of BCC stock both during the shareholders’ lifetimes

and at death.   The preamble provided that subsequent shareholders

would “benefit from and be bound by” the agreement.    With respect

to lifetime transfers, a section entitled “Restrictions on

Transfer of Capital Stock During Life” provided:    “No Shareholder

shall transfer or encumber any of his Capital Stock in the

Company to any person, firm, or corporation without the written

consent of the other Shareholders.”    “Shareholders” were defined

in the 1981 Agreement’s first paragraph as decedent and Mr.

Jennings, a definition that excluded subsequent shareholders.

However, section 3(a) of the 1981 Agreement, entitled “Other

Shareholders to be Bound”, also denoted as “shareholders” persons

other than Mr. Jennings or decedent who received shares directly

from BCC or as transferees from other shareholders.    The section

further provided that the shares of such other shareholders would




     1
       Decedent, Mr. Jennings, and BCC had previously entered
into a restrictive agreement in 1958 covering their BCC stock.
The 1981 Agreement expressly provided that it superseded any
earlier agreements.
                                 - 8 -

be subject to the same terms and conditions as the shares owned

by decedent and Mr. Jennings.2

     With respect to transfers at death, the 1981 Agreement in a

section entitled “Purchase Upon Death” required that a

shareholder’s estate sell and BCC buy the shareholder’s stock at

an established price.   The purchase price initially set in the

1981 Agreement was $3,300 per share, described as book value.

The 1981 Agreement provided that BCC and the shareholders were to

redetermine the per-share purchase price annually on August 1,

but no such redetermination was ever done.   In the absence of any

redetermination, the 1981 Agreement provided that the per-share

purchase price would be equal to BCC’s book value at the fiscal

yearend immediately preceding the deceased shareholder’s death.

     The 1981 Agreement provided that it would be governed by

Georgia law, and it expressly set forth the manner in which it

could be modified:   “Modification–-No change or modification of


     2
       Elsewhere, the 1981 Agreement set forth an endorsement,
required to be placed on BCC’s stock certificates, that cross-
referenced the 1981 Agreement and its restrictions on
transferability. The endorsement further stated that the
restrictions “provide, among other things, that such shares must
first be offered for sale to the Company and the other
Shareholders before they may be offered or sold to any other
person.” The only two stock certificates in the record, issued
in 1996, do not contain the foregoing endorsement, however.
     There were apparently other restrictions on the transfer of
the BCC stock that are not in the record. The aforementioned
stock certificates issued in 1996 refer to a letter agreement
dated Jan. 16, 1996, that is not in the record.
                                 - 9 -

this Agreement shall be valid unless it is in writing and signed

by all of the parties hereto.”    The 1981 Agreement did not define

“parties” or contain any mechanism for adding parties.

III. ESOP

     In 1992, BCC adopted the Blount Construction Co. Employee

Stock Ownership Plan (ESOP).3    BCC made annual cash contributions

to the ESOP, and the ESOP obtained shares of BCC stock either

from decedent and Mr. Jennings or from the company, making it a

third, minority shareholder.    According to the ESOP’s Summary

Plan Description, when plan participants retired or were

otherwise entitled to obtain distributions, the ESOP was to

distribute shares of BCC stock to them, and they had the right to

require BCC to purchase their shares at designated times.

     The ESOP participants were BCC employees, excluding decedent

and Mr. Jennings.   Decedent, Mr. Jennings, and Richard E. Lord (a

longtime employee) were the original trustees of the ESOP.    John

Truono, who served as BCC’s controller and corporate secretary,

replaced Mr. Jennings as a trustee as of February 1, 1996.

     Business Valuation Services, Inc. (BVS), performed an

independent appraisal of BCC each year to establish the per-share

value of BCC stock to be used for ESOP transactions.    These per-


     3
       In 1995, BCC established the Blount Construction Co., Inc.
Employee Stock Ownership Plan/MMP. In 1996, this plan was merged
into the ESOP.
                              - 10 -

share values were used when the ESOP purchased BCC shares and

when the BCC stock of ESOP participants was redeemed.   BVS

concluded that the value of 100 percent of BCC stock was

$8,041,126 ($86.73/share) as of January 31, 1996, and $8,491,321

($164.01/share) as of January 31, 1997.4

IV.   Life Insurance and the Death of Mr. Jennings

      As part of succession planning, BCC obtained life insurance

of approximately $3 million each on the lives of decedent and Mr.

Jennings.   Decedent also had BCC’s controller, Mr. Truono,

prepare “pro forma” financial analyses showing the impact on BCC

of the redemption of his and Mr. Jennings’s shares at different

prices and under various assumptions.   Mr. Jennings died on

January 13, 1996, and BCC received $3,046,823 in life insurance

proceeds.   BCC redeemed Mr. Jennings’s shares in September 1996

for $2,990,791, the price being based on BCC’s book value of

approximately $6.4 million at the preceding fiscal yearend, as

required in the 1981 Agreement.5   BCC used $1,990,791 in cash and



      4
       Mr. Jennings died on Jan. 13, 1996, and his 43,080 shares
were redeemed pursuant to the 1981 Agreement, see infra Pt. IV,
on Sept. 4, 1996. The substantial difference in per-share value
between the 1996 and 1997 BVS valuations reflects the redemption
of Mr. Jennings’s shares that occurred between the two
valuations.
      5
       Mr. Truono calculated BCC’s book value as of the preceding
fiscal yearend (Jan. 31, 1995) and the resulting price for Mr.
Jennings’s shares.
                               - 11 -

issued a note to Mr. Jennings’s estate for $1 million to fund the

redemption.

V.   1996 Agreement and Redemption of Decedent’s BCC Shares

     As a result of Mr. Jennings’s death and the subsequent

redemption of his shares in September 1996, decedent’s 43,080 BCC

shares became a controlling interest in the company, constituting

83.2 percent of the outstanding shares.    The ESOP held the

remaining 8,692 outstanding shares.     After Mr. Jennings’s death,

decedent was the sole member of BCC’s board of directors, and

decedent and BCC were the only remaining signatories to the 1981

Agreement.

     In October 1996, decedent discovered he had cancer.    After

consulting several doctors, decedent came to understand he was

gravely ill, and the available treatment options would only

extend his life a short time, if at all.    One treatment option

involved a life-threatening surgical procedure.    Decedent began

to put his affairs in order.   Decedent had Mr. Truono prepare

additional “pro forma” analyses showing the impact on BCC of the

redemption of his shares at different prices.

     One such analysis, pro forma 15, prepared in early November

1996 (Pro Forma 15), analyzed the impact on BCC of a purchase of

decedent’s shares for $4 million.   Pro Forma 15 indicated that,

taking into account BCC’s receipt of approximately $3 million in
                              - 12 -

life insurance proceeds on decedent’s death, the redemption of

decedent’s shares for $4 million would leave BCC with

approximately $1.5 million in cash and cash equivalents.    In Mr.

Truono’s judgment, this was the minimum amount that BCC required

to operate without the need for personal guaranties for BCC’s

performance bonds and to ensure that BCC would be able to meet

any obligations to its ESOP participants.6

     Pro Forma 15, reviewed by decedent in early November 1996,

assumed BCC had a fair market value of $155.32 per share, which

Mr. Truono determined by dividing the $8,041,126 fair market

value for BCC estimated in the then most recent BVS appraisal

(for the fiscal year ended January 31, 1996) by BCC’s 51,772

shares outstanding after the redemption of Mr. Jennings’s

shares.7   Pro Forma 15 also showed a per-share book value of

$173.77, which, assuming 51,772 outstanding shares, results in a

total book value for BCC of $8,996,420.8


     6
       Mr. Truono testified that, as of 1996, BCC had never spent
more than $100,000 in a given year to redeem BCC shares.
     7
       The 1996 BVS appraisal itself estimated a per-share fair
market value of $86.73, which is the per-share value derived when
the $8,041,126 fair market value it estimated for BCC is divided
by the number of BCC shares outstanding before the redemption of
Mr. Jennings’s shares; i.e., 92,718.
     8
       The per-share book value for BCC reflected in Pro Forma 15
does not appear to be derived from the book value as of the
fiscal year ended Jan. 31, 1996 ($9,135,506, as reflected in the
                                                   (continued...)
                              - 13 -

     On November 11, 1996, decedent and BCC executed an agreement

entitled “Shareholders Agreement” (the 1996 Agreement), with

decedent signing in his individual capacity and on behalf of BCC

as its president.   Mr. Truono attested decedent’s signature.   The

1996 Agreement required BCC to buy, and decedent’s estate to

sell, decedent’s BCC shares for $4 million; i.e., the maximum

price Mr. Truono believed BCC could pay in cash, taking into

account BCC’s receipt of approximately $3 million in life

insurance proceeds from the policy on decedent’s life.   The next

day decedent executed a codicil to his will.   Decedent did not

consult an attorney regarding the 1996 Agreement.

     Given his review of Mr. Truono’s Pro Forma 15, decedent was

aware when he signed the 1996 Agreement setting the price for his

shares as $4 million ($92.85/share) that the most recent BVS

appraisal had valued BCC at approximately $8 million

($155.32/share), suggesting that decedent’s shares had a fair

market value of approximately $6.7 million.    Decedent was further

aware that Mr. Truono had computed BCC’s book value to be

approximately $9 million, suggesting that decedent’s BCC shares

had a book value of approximately $7.5 million.   The unmodified


     8
      (...continued)
1996 BVS appraisal), since 51,772 outstanding shares at a total
book value of $9,135,506 would yield a per-share value of
$176.46. Instead, the figure used in Pro Forma 15 appears to be
a mid-year estimate of BCC’s per-share book value.
                                - 14 -

1981 Agreement provided that the purchase price of decedent’s

shares would have been equal to their book value as of January

31, 1996 (as opposed to the figure contained in Pro Forma 15), or

approximately $7.6 million, were he to die before February 1,

1997.9

     In contrast to the 1981 Agreement, the 1996 Agreement was

one page in length and addressed only the purchase and sale of

decedent’s BCC shares at his death.      The operative section was

entitled “Purchase Upon Death”, similar to the section covering

redemptions in the 1981 Agreement, and the language and

organization of that section tracked the corresponding section

found in the 1981 Agreement.     The section covered the obligation

to buy and sell, the purchase price, and the payment terms.

         Unlike the 1981 Agreement, which contained a formula for

adjusting the purchase price over time and allowed for payment of

the purchase price in installments, the 1996 Agreement set a

fixed purchase price of $4 million, without any provision for

future adjustment, to be paid in one lump sum.



     9
       This figure is calculated by dividing BCC’s book value of
$9,135,506, as of Jan. 31, 1996, by the 51,772 shares outstanding
as of November 1996 to derive a per-share value of $176.46, and
then multiplying that figure by decedent’s 43,080 shares. Had
the 1981 Agreement not been modified when decedent died in
September 1997 (i.e., after Jan. 31, 1997, but before Feb. 1,
1998), BCC’s book value as of Jan. 31, 1997, would have been used
to determine the purchase price of his shares.
                              - 15 -

      Despite the similarities in structure and language, the 1996

Agreement made no reference to the 1981 Agreement.    The 1996

Agreement did not contain a provision restricting lifetime

transfers or contain any other provision similar to those in the

1981 Agreement, such as required endorsements on stock

certificates, the choice of law, or a provision indicating that

the current agreement superseded all earlier agreements.     It

contained no requirement regarding the source of funds BCC was to

use to purchase decedent’s shares.     The only signatories to the

1996 Agreement were decedent and BCC.    The ESOP did not sign or

otherwise consent to the 1996 Agreement.

      Decedent died on September 21, 1997.   Shortly after

decedent’s death, BCC redeemed his shares for $4 million as

required in the 1996 Agreement, using the entire proceeds of

$3,146,134 from his life insurance policy along with additional

cash on hand.   After the redemption of decedent’s shares, the

ESOP owned 100 percent of the stock of BCC.

VI.   Estate’s Return

      The estate timely filed its Form 706, United States Estate

(and Generation-Skipping Transfer) Tax Return, reporting the

value of decedent’s 43,080 shares of BCC stock as of the

valuation date at $4 million, the purchase price set forth in the

1996 Agreement.   In a notice of deficiency, respondent determined
                              - 16 -

that decedent’s BCC stock had a fair market value of $7,921,975.

The estate timely petitioned this Court for redetermination.

VII. Expert Testimony

     The estate submitted the expert report and testimony of John

T. Grizzle in support of its contention that the terms of the

buy-sell agreement at issue were comparable to similar agreements

entered into by persons in arm’s-length transactions within the

meaning of section 2703(b)(3).

     In light of the possibility that the value stipulated in the

buy-sell agreement at issue would be disregarded in this

proceeding, both the estate and respondent submitted expert

reports and testimony regarding the fair market value of

decedent’s BCC stock as of the valuation date.   The estate

offered Mr. Grizzle and Gerald M. Fodor as experts in valuation

of closely held companies.   Respondent offered James R.

Hitchner.10




     10
       Before trial, respondent also indicated that he would
seek to have the appraisals of BCC performed by BVS for purposes
of the ESOP received into evidence as party admissions.
Respondent has not maintained this contention on brief, and we
deem it abandoned. See Bradley v. Commissioner, 100 T.C. 367,
370 (1993); Sundstrand Corp. v. Commissioner, 96 T.C. 226, 344
(1991); Rybak v. Commissioner, 91 T.C. 524, 566 n.19 (1988).
Moreover, neither party made any attempt to comply with the
requirements of Rule 143(f) for submitting the BVS appraisals as
expert testimony.
                               - 17 -

     We accepted all three as experts and received their written

reports into evidence as direct testimony.

     A.     Estate’s Expert Mr. Grizzle

     Mr. Grizzle is a certified public accountant who has

represented clients in mergers and acquisitions.

     Mr. Grizzle concluded that the terms of the buy-sell

agreement at issue were comparable to similar arrangements

negotiated at arm’s length.    In reaching this conclusion, Mr.

Grizzle focused solely on the price term.    He asserted that

“Professionals familiar with the industry most often value a

construction company by applying a multiple of four (4) to the

entities’ [sic] cash-flow adjusted for non-operating and non-

recurring items.”    He then adjusted BCC’s cashflow and compared

the purchase price for decedent’s BCC stock in the 1996 Agreement

to the adjusted cashflow.    He concluded that the price for

decedent’s BCC shares represented a 4.25 multiple of its adjusted

cashflow.    Because this multiple was consistent with the multiple

he claimed professionals familiar with the construction industry

most often use, he concluded that the price set forth in the 1996

Agreement was a fair market price and that the terms of the

Modified 1981 Agreement were therefore comparable to similar

arrangements entered into at arm’s length.
                               - 18 -

       Mr. Grizzle also looked at the sales to third parties of 100

percent of the stock of three companies allegedly comparable to

BCC.    One of the companies was sold twice, so Mr. Grizzle

examined four transactions in all.      The companies Mr. Grizzle

considered included a company that constructed cellular telephone

towers, a company that installed natural gas compressors and

pipelines, and a management company that hired subcontractors to

build chemical and natural gas liquefaction plants.      In each

case, he determined the company had sold for approximately four

times adjusted cashflow.

       Mr. Grizzle did not contend that the sale prices of the

companies he examined were determined by using a multiple of

adjusted cashflow.    Rather, he backed into the multiples after

the fact by comparing the sale prices to the adjusted cashflows.

He compared those multiples to the multiple of cashflow implicit

in the purchase price designated in the 1996 Agreement to

conclude that the price term was comparable to what unrelated

parties have negotiated at arm’s length.

       On the basis of this analysis, Mr. Grizzle calculated BCC’s

fair market value, and the value of decedent’s shares, by

multiplying the weighted average of BCC’s adjusted cashflows over

the 5 fiscal years ended January 31, 1997, by four, weighting the

most recent year more heavily than the earliest one.      Mr. Grizzle
                                - 19 -

concluded that the fair market value for BCC was $4,541,678, and

decedent’s 43,080 BCC shares had a fair market value of

$3,778,676 as of the valuation date.

     In valuing BCC, and comparing the multiple implicit in BCC’s

price to the multiples implicit in the sale prices of companies

he reviewed, Mr. Grizzle did not consider the value of BCC’s

nonoperating assets.    He testified that in actual sales such

assets are not normally part of the transaction, as the seller

usually retains those assets.

     B.   Estate’s Expert Mr. Fodor

     Mr. Fodor is a certified business appraiser.      He is a member

of the Institute of Business Appraisers and the Appraisal

Foundation, organizations which he has served in a number of

capacities.   Mr. Fodor has published articles and given lectures

regarding appraising.    He has performed numerous appraisals for

business and litigation support purposes.

     Mr. Fodor relied on a blend of income- and asset-based

valuation approaches to value BCC.       For his income approach, Mr.

Fodor used a capitalization of earnings model.      He began by

projecting BCC’s “net free cash flow capacity” for the year

immediately following the valuation date, relying on BCC’s

historical earnings data to do so.       Mr. Fodor adjusted revenues

and expenses as he deemed appropriate to reflect earning
                               - 20 -

capacity, including an allowance for taxes and a downward

adjustment to earning capacity of $200,000 to account for annual

contributions to the ESOP.    He also adjusted for depreciation,

capital investment, and retained working capital.    He concluded

that BCC would have $234,060 in net free cashflow capacity.

     Mr. Fodor then determined a capitalization rate; i.e., the

rate an investor would require to invest in BCC taking into

account the riskiness of the investment, and an expected growth

rate.   Mr. Fodor calculated a capitalization rate of 32.94

percent.    He chose 4 percent as his expected growth rate.   Mr.

Fodor subtracted the expected growth rate from the capitalization

rate to yield a net capitalization rate, which he then divided

into the net free cashflow capacity to calculate BCC’s

capitalized earnings.   He determined capitalized earnings of

$809,896.

     Mr. Fodor added approximately $5.6 million to capitalized

earnings, consisting of BCC’s net working capital (current assets

less current liabilities) as of the valuation date ($3,187,372)

as well as an amount equal to the difference between BCC’s

assets’ book value and fair market value (as reflected in BCC’s

internal “value in use” analyses) ($2,555,895).    He then

subtracted $750,000, which he claimed reflected the obligation to

repurchase BCC shares held by ESOP participants upon retirement
                               - 21 -

or separation.   This yielded a total company income-based value

of $5,803,163.

     Mr. Fodor used the capitalized excess earnings method to

determine that BCC’s asset-based value equaled $8,678,805 as of

the valuation date.   Mr. Fodor then subtracted from the net asset

value the $750,000 estimate of the obligation to repurchase BCC

shares from ESOP participants to reach a final asset-based value

of $7,928,805.

     Mr. Fodor weighted the income-based value of $5.8 million at

75 percent and the asset-based value of $7.9 million at 25

percent, to yield a final blended value of $6 million (rounded)

for 100 percent of the shares of BCC.   Multiplying this value by

decedent’s 83.2-percent interest in BCC resulted in a

corresponding $4,992,537 fair market value for decedent’s 43,080

shares, as of the valuation date.   Mr. Fodor did not include the

life insurance proceeds BCC received on decedent’s life in either

his income- or asset-based approach on the grounds that those

proceeds were offset by BCC’s obligation to redeem decedent’s BCC

stock.    Nor did he apply any discounts or premiums in valuing the

block of shares at issue.

     C.    Respondent’s Expert, Mr. Hitchner

     Mr. Hitchner is accredited in business valuation with the

American Institute of Certified Public Accountants and is an
                                - 22 -

accredited senior appraiser with the American Society of

Appraisers.    He has 22 years of valuation experience and has

taught courses and written several articles on business

valuation.

     Mr. Hitchner also relied on a blend of income- and asset-

based approaches to value BCC.    Like Mr. Fodor, Mr. Hitchner used

a capitalization of earnings model to derive his income-based

value.    Mr. Hitchner projected BCC’s net free cashflow capacity

for the year immediately following the valuation date based on

BCC’s historical earnings over four different periods,11

adjusted for taxes, depreciation, capital investment, and

retained working capital.    He increased the historical net after-

tax earnings by an estimated 5-percent growth rate.12

     Mr. Hitchner then calculated a capitalization rate of 20

percent, from which he subtracted his estimated 5-percent growth

rate, to yield a net capitalization rate of 15 percent.    By



     11
       Mr. Hitchner removed from earnings certain interest
income generated by the company’s “excess cash”; i.e., cash that
he considered in excess of operating, or working capital, needs.
He considered this “excess cash” to be a nonoperating asset to be
accounted for separately in his income-based approach. Insofar
as nonoperating assets were to be taken into account separately
under his approach, he removed the income from those assets,
including the interest generated by “excess cash”, from BCC’s
earnings.
     12
          Mr. Fodor did not adjust for any projected earnings
growth.
                              - 23 -

dividing the net capitalization rate into the net free cashflow

capacity he derived for each of the four different periods, Mr.

Hitchner determined capitalized earnings of $2.5 to $4.1 million.

     Mr. Hitchner calculated that BCC had approximately $2.3

million of nonoperating assets by identifying actual nonoperating

assets (valued at $433,572) and determining the “excess cash” on

hand, which he estimated at $1,869,941.   He derived this figure

by comparing BCC’s ratio of cash to assets as of the valuation

date with industry standards for the Standard Industrial Code

(SIC) category that he believed most closely matched BCC.    He

then added this $2.3 million of nonoperating assets to his range

of capitalized earnings to yield an income-based value in a range

from $4.8 to $6.4 million.   Unlike Mr. Fodor, Mr. Hitchner did

not decrease his income-based value by any amount associated with

the obligation to repurchase shares held by the ESOP

participants.

     Mr. Hitchner used two different approaches to determine

BCC’s asset-based value:   The adjusted book value approach, where

he determined BCC’s book value and then adjusted it to reflect

the fair market value of BCC’s machinery and equipment, as

reported in BCC’s internal “value in use” analyses, and the

modified adjusted book value approach, where he made the

adjustments described above and then decreased the value of BCC’s
                               - 24 -

machinery and equipment by 40 percent to reflect the opinion of

BCC management that BCC’s machinery and equipment could be sold

for only about 60 percent of the value reflected in the “value in

use” analyses.   Rather than attempting to compute asset values as

of the valuation date, Mr. Hitchner provided value estimates as

of the fiscal yearends immediately before and after the valuation

date.   The values estimated under the adjusted book value

approach were $8,891,024 and $8,478,254 for the fiscal years

ended January 31, 1997 and 1998, respectively.    The values

estimated under the modified adjusted book value approach were

$7,596,838 and $7,052,766 for the fiscal years ended January 31,

1997 and 1998, respectively.   As with the income approach, Mr.

Hitchner did not reduce the asset-based value to reflect any ESOP

repurchase obligation.   He also did not indicate a final value

under either approach.

     To determine a final value for BCC, Mr. Hitchner indicated

that he gave the greater weight to the modified adjusted book

value approach and equal but lesser weight to the income approach

and the adjusted book value approach.    He did not disclose the

precise weighting for each approach.    Rather, he presented a

“concluded” value of $7 million.
                              - 25 -

      To this amount, Mr. Hitchner added $3,046,823 of insurance

proceeds on decedent’s life13 to yield a value of approximately

$10 million for 100 percent of BCC’s shares.    Multiplying this

amount by decedent’s 83.2-percent interest in BCC resulted in a

corresponding value of $8,360,000 (rounded) for decedent’s 43,080

BCC shares, as of the valuation date.    Like Mr. Fodor, Mr.

Hitchner did not apply any discounts or premiums in valuing

decedent’s block of shares.

                              OPINION

I.   Effectiveness of the Buy-Sell Agreement

      Federal estate tax is imposed on the transfer of a U.S.

citizen’s taxable estate.   Sec. 2001(a); U.S. Trust Co. v.

Helvering, 307 U.S. 57, 60 (1939).     The taxable estate is defined

as the gross estate less prescribed deductions.    See sec. 2051.

The gross estate includes all property interests owned by the

decedent at death; the value of the gross estate is generally the

fair market value of the included property as of the valuation

date, which is generally the date of death.    See secs. 2031(a),

2033; sec. 20.2031-1(b), Estate Tax Regs.




      13
       Although described as the life insurance proceeds on
decedent’s life, the figure Mr. Hitchner actually used was that
for the proceeds from the policy on Mr. Jennings’s life. The
insurance proceeds received on decedent’s life were $3,146,134.
                              - 26 -

     An exception to the general valuation rule exists where the

property in question is subject to an enforceable buy-sell

agreement.   See, e.g., St. Louis County Bank v. United States,

674 F.2d 1207, 1210 (8th Cir. 1982); Bommer Revocable Trust v.

Commissioner, T.C. Memo. 1997-380.     However, for a buy-sell

agreement to control value for Federal estate tax purposes, it

must meet certain requirements set forth in section 20.2031-2(h),

Estate Tax Regs., Rev. Rul. 59-60, 1959-1 C.B. 237, and the

caselaw.   We summarized those requirements in Estate of Lauder v.

Commissioner, T.C. Memo. 1992-736, as follows:

     It is axiomatic that the offering price must be fixed
     and determinable under the agreement. In addition, the
     agreement must be binding on the parties both during
     life and after death. Finally, the restrictive
     agreement must have been entered into for a bona fide
     business reason and must not be a substitute for a
     testamentary disposition. [Citations omitted.]

Buy-sell agreements that fail to meet these requirements are

disregarded in determining value.    Estate of Weil v.

Commissioner, 22 T.C. 1267, 1274 (1954); Estate of Lauder v.

Commissioner, supra; sec. 20.2031-2(h), Estate Tax Regs.14


     14
       While sec. 20.2031-2(h), Estate Tax Regs., provides that
agreements not binding during life will be accorded “little
weight”, whereas binding-during-life agreements found to be
testamentary devices will be “disregarded”, this difference in
nomenclature carries no practical import. See, e.g., Hoffman v.
Commissioner, 2 T.C. 1160, 1178-1180 (1943) (agreement not
binding during life disregarded), affd. sub nom. Giannini v.
Commissioner, 148 F.2d 285 (9th Cir. 1945); Estate of Caplan v.
                                                   (continued...)
                                - 27 -

     In 1990, section 2703 was enacted.   Omnibus Budget

Reconciliation Act of 1990 (OBRA), Pub. L. 101-508, sec.

11602(a), 104 Stat. 1388-491.    It provides that any agreement to

acquire property at less than its fair market value will be

disregarded in valuing such property for Federal estate tax

purposes unless the agreement satisfies certain requirements

enumerated in the statute.   Those requirements include the

requirements of preexisting law that the agreement be a bona fide

business arrangement and not a testamentary device as well as a

new requirement that the terms of the agreement be comparable to

those of similar arrangements negotiated at arm’s length.     Sec.

2703(b).   Section 2703 applies to agreements created or

substantially modified after October 8, 1990.   OBRA sec.

11602(e), 104 Stat. 1388-500; sec. 25.2703-2, Gift Tax Regs.

     As the legislative history makes clear, section 2703 was

intended to supplement, not supplant, the existing legal

requirements:   “The bill does not otherwise alter the

requirements for giving weight to a buy-sell agreement.     For

example, it leaves intact present law rules requiring that an

agreement have lifetime restrictions in order to be binding on



     14
      (...continued)
Commissioner, T.C. Memo. 1974-39 (to same effect).
                                - 28 -

death.”     136 Cong. Rec. S15683 (daily ed. Oct. 18, 1990).15

Thus, regardless of whether section 2703 applies to a buy-sell

agreement, the agreement must meet the requirements of the pre-

section-2703 law to control value for Federal estate tax

purposes.

     The parties raise numerous issues regarding the efficacy of

the buy-sell agreement at issue here.     First, they dispute the

terms of the agreement, arguing over the validity and interplay

of the 1981 and 1996 Agreements.     Second, the parties dispute

whether the buy-sell agreement satisfies the requirements of pre-

section-2703 law, including the requirement that it be binding

during life.     Third, the parties dispute whether section 2703

applies to the agreement and, if so, whether the agreement

satisfies the requirements of section 2703(b), thus saving the

agreement from being disregarded under section 2703(a).     We

address each issue below.

     A.      Terms of the Buy-Sell Agreement

     As a threshold matter, we must first determine the terms of

the buy-sell agreement at issue.     Respondent argues that either


     15
       Sec. 2703 originated in the Senate version of the Omnibus
Budget Reconciliation Act of 1990 (OBRA). H. Conf. Rept. 101-
964, at 1133 (1990), 1991-2 C.B. 560, 604. The committee report
with respect to the Senate legislation was printed in the
Congressional Record, without separate publication, because of
time constraints. 136 Cong. Rec. S15629-04 (daily ed. Oct. 18,
1990).
                             - 29 -

the 1996 Agreement is invalid, in which case it cannot control

value because it is not enforceable, see Estate of Carpenter v.

Commissioner, T.C. Memo. 1992-653, or the 1996 Agreement is a

novation of the 1981 Agreement, in which case the 1996 Agreement

stands alone as the operative agreement and is entitled to no

weight because it lacks restrictions on lifetime transfers, see

sec. 20.2031-2(h), Estate Tax Regs.   The estate contends that the

1996 Agreement modifies the 1981 Agreement and that the two

agreements must be read together, with the 1981 Agreement’s

restrictions on lifetime transfers surviving the modification.

As all the relevant events occurred in Georgia, and the 1981

Agreement specifies that it will be subject to and governed by

the laws of the State of Georgia, we analyze these claims under

Georgia law.

     Respondent contends the 1996 Agreement is invalid because

decedent, a trustee of the ESOP, breached a fiduciary duty to the

ESOP participants in entering into the agreement.   Respondent

argues that, were the ESOP to adopt the $92.85 price per share

implicit in the 1996 Agreement, a price almost 50 percent lower

than the $164.01 per-share value determined by BVS in its January

31, 1997, appraisal, one-half of BCC’s value would disappear, to

the detriment of the ESOP participants.
                               - 30 -

     Transactions in BCC stock between the ESOP and other

parties, including shareholders and plan participants, must be

effected at values established by an independent appraiser.      See

sec. 401(a)(28)(C).    Respondent does not explain the basis on

which the ESOP trustees could adopt the per-share value contained

in the 1996 Agreement.    Nor are we aware of one.16

      More fundamentally, decedent’s agreement to have his BCC

shares redeemed at a price that respondent himself urges was

below fair market value actually inured to the benefit of the

ESOP participants.    Before the redemption, the ESOP’s 8,692

shares represented approximately 17 percent of the outstanding

equity interests in BCC.    After the redemption, the ESOP’s shares

represented 100-percent ownership of BCC.    The redemption of

decedent’s shares at a bargain price left relatively more

corporate assets for the ESOP owners than would have been the

case at a higher redemption price, thus increasing rather than

decreasing the value of the BCC shares held by the ESOP and its

participants.   Accordingly, respondent’s contention that



     16
       While a subsequent appraisal of BCC’s outstanding shares
might consider the price at which decedent’s BCC shares had been
redeemed, such a non-arm’s-length sale between a corporation and
its controlling shareholder would presumably be disregarded as an
indicator of fair market value. Indeed, BVS did not consider
either the obligation to redeem decedent’s BCC shares or the
actual redemption of those shares for $4 million in its 1997 or
1998 appraisal.
                              - 31 -

decedent’s bargain sale of his shares breached a fiduciary duty

to the ESOP or its participants is unavailing, and we decline to

find the 1996 Agreement invalid on this basis.

     Nor do we find the 1996 Agreement to be a novation of the

1981 Agreement.   To qualify as a novation, a contract must meet

four requirements.   There must be:    (i) A previous valid

contract; (ii) the parties’ agreement to a new contract; (iii)

the extinguishment of the old contract; and (iv) a valid new

contract.   Savannah Bank & Trust Co. v. Wolff, 11 S.E.2d 766, 772

(Ga. 1940).   Here, the key question is whether the 1996 Agreement

extinguished the 1981 Agreement.    To satisfy this element, either

a mutual intent to create a novation must be shown, Mayer v.

Turner, 234 S.E.2d 853 (Ga. Ct. App. 1977), or the later

inconsistent agreement must be one that “completely cover[s] the

subject matter” of the prior agreement, Powell v. Norman Elec.

Galaxy, Inc., 493 S.E.2d 205, 207 (Ga. Ct. App. 1997).        We

consider each of these possibilities in turn.

     Respondent argues that the 1996 Agreement’s lack of any

express intent to modify the 1981 Agreement requires an inference

that decedent intended to extinguish the 1981 Agreement by

entering into the 1996 Agreement.     We disagree.   First, we are

unaware of any rule requiring that a modification to a contract

explicitly indicate it is intended as such.     Second, that some
                              - 32 -

essential terms of the 1981 Agreement were supplanted, while

others were ignored, supports the inference that only those terms

addressed were meant to be changed.    Third, the 1981 Agreement

expressly stated that it superseded earlier agreements.    As it is

apparent from the title, structure, and language of the two

agreements that decedent drew upon the 1981 Agreement in drafting

the 1996 Agreement, the absence of such an express revocation in

the latter agreement suggests that decedent did not intend to

supplant the 1981 Agreement in its entirety.    Finally, decedent

was not an attorney and did not consult one when he drafted the

1996 Agreement.   In these circumstances, we are persuaded that a

layman in decedent’s circumstances would more likely assume that

entering into an agreement inconsistent with one section of an

earlier agreement would result in a modification, and not a

termination, of the earlier agreement.

     Respondent further argues that because the 1996 Agreement

“eclipsed the terms” of the 1981 Agreement, it necessarily

extinguished the 1981 Agreement, regardless of decedent’s intent.

We disagree.   Under Georgia law, a prior agreement will be

extinguished where a later inconsistent agreement completely

covers the subject matter of the prior agreement.    Id.   The 1996

Agreement did not cover several matters covered in the 1981

Agreement, most notably the restrictions on the lifetime transfer
                              - 33 -

of BCC shares.   Accordingly, we find that the 1996 Agreement did

not completely cover the subject matter of the 1981 Agreement, so

as to extinguish it.

      For the foregoing reasons, we conclude that under Georgia

law, the 1996 Agreement did not effect a novation of the 1981

Agreement, but rather a modification thereof.17   Thus, the two

agreements must be read together and constitute the Modified 1981

Agreement.

     B.   Binding-During-Life Requirement

     Before turning to the questions of whether section 2703

applies to the Modified 1981 Agreement and whether the agreement

is disregarded thereunder, we first consider whether the Modified

1981 Agreement satisfies the requirements of pre-section-2703 law

that a buy-sell agreement, to be respected for purposes of

Federal estate tax value, must be binding not just at death, but

also during the decedent’s lifetime.   See, e.g., Estate of

Matthews v. Commissioner, 3 T.C. 525 (1944); Hoffman v.

Commissioner, 2 T.C. 1160, 1179 (1943), affd. sub nom. Giannini




     17
       If the 1996 Agreement were construed to be a novation of
the 1981 Agreement, the 1996 Agreement would not meet the
binding-during-life requirement of sec. 20.2031-2(h), Estate Tax
Regs., because the 1996 Agreement contained no provisions
restricting lifetime transfers of BCC stock. Accordingly, it
would be disregarded in determining the value of decedent’s BCC
stock for Federal estate tax purposes.
                               - 34 -

v. Commissioner, 148 F.2d 285 (9th Cir. 1945); sec. 20.2031-2(h),

Estate Tax Regs.

     The 1981 Agreement provided that no “Shareholder” could

transfer his BCC shares without the written consent of the other

“Shareholders.”18   Because the 1996 Agreement was not a novation

but merely a modification of the 1981 Agreement, the latter’s

provision requiring “Shareholders” to consent to any lifetime

transfer of BCC shares survived.   The estate argues that the

Modified 1981 Agreement was binding during decedent’s life

because any lifetime transfer of decedent’s BCC shares required

the consent of other shareholders; namely, the ESOP.   Respondent

argues that the requirement of shareholder consent was not

sufficient to satisfy the binding-during-life requirement, and,

in any event, the ESOP’s consent was not a meaningful restriction




     18
       The 1981 Agreement also set forth an endorsement that was
required to be placed on BCC’s stock certificates. The
endorsement cross-referenced the 1981 Agreement’s requirement of
shareholder consent to transfers of stock, and, in addition,
provided that shares must first be offered for sale to BCC and
other shareholders before being offered or sold to third parties.
     There is no evidence in the record that this endorsement was
actually placed on any BCC stock certificate; the only
certificates in the record do not contain it, and the parties
have not addressed it. In any event, since the mandated
endorsement cross-referenced the requirement of shareholder
consent to transfers, we conclude that the endorsement’s
additional reference to a right of first refusal in no way
derogates the requirement of shareholder consent.
                              - 35 -

on decedent’s ability to transfer shares during his lifetime

because decedent could have caused the ESOP to consent.

     We note that the term “Shareholders” is initially defined in

the 1981 Agreement as decedent and Mr. Jennings, and thus would

exclude the ESOP.   If the term “Shareholders” were construed to

exclude the ESOP, then decedent would not have been required to

obtain the ESOP’s consent before making a lifetime transfer of

his BCC shares, and the Modified 1981 Agreement would fail to

satisfy the binding-during-life requirement.    However, the term

“Shareholders” was used later in section 3(a) of the 1981

Agreement to denote persons other than decedent or Mr. Jennings,

who received shares directly from BCC or as transferees from

other shareholders, thus creating an ambiguity.   In construing

the 1981 Agreement, we must consider the agreement as a whole.

See Ga. Code Ann. sec. 13-2-2(4) (2001); Sachs v. Jones, 63

S.E.2d 685 (Ga. Ct. App. 1951).   The agreement’s preamble

contemplated additional shareholders and provided that one of the

purposes of the agreement was to ensure that such shareholders

“benefit from and be bound by” the agreement.   Construing the

1981 Agreement to allow lifetime transfers without the consent of

subsequent shareholders would thwart the agreement’s express

purpose of bestowing its benefits on all shareholders equally.

Consequently, we are persuaded that the term “Shareholders” was
                             - 36 -

intended to encompass subsequent shareholders and conclude that

the 1981 Agreement required the consent of subsequent

shareholders (i.e., the ESOP) to any lifetime transfer of

shares.19

     While we agree with the estate that a requirement of

shareholder consent to lifetime transfers may be a sufficient

restriction to render a buy-sell agreement binding during life,20

see Estate of Weil v. Commissioner, 22 T.C. at 1275, we

nevertheless do not agree that the Modified 1981 Agreement was

binding during decedent’s lifetime because decedent had the

unilateral ability to amend it.

     Where a decedent had the unilateral ability to change a buy-

sell agreement while alive, the agreement will not be considered

binding during his lifetime and, therefore, cannot control value

for Federal estate tax purposes.     Bommer Revocable Trust v.

Commissioner, T.C. Memo. 1997-380; see also Estate of True v.

Commissioner, T.C. Memo. 2001-167.    In Bommer, the buy-sell


     19
       We note that this interpretation is consistent with
respondent’s assumption implicit in his alternate argument that
the consent requirement was not meaningful because decedent could
require the ESOP to give consent.
     20
       Respondent’s argument regarding decedent’s ability to
cause the ESOP to consent may overlook possible fiduciary
obligations of the ESOP’s trustees. Regardless, we need not
consider it further in light of our conclusion, on other grounds,
infra, that the Modified 1981 Agreement was not binding during
decedent’s lifetime.
                               - 37 -

agreement contained a valid restriction on lifetime transfers.21

However, it also expressly gave any shareholder owning 75 percent

of the shares the right to amend the agreement.   The decedent

owned over 75 percent when the agreement was drafted and at all

times thereafter.22   Because the decedent had the unilateral

ability to amend the agreement, we concluded that the agreement

was not binding during his lifetime and disregarded it for

purposes of determining the stock’s value for Federal estate tax

purposes.   We expressly rejected a claim that the decedent’s

ability to modify the agreement was limited by a fiduciary duty

he owed as a majority shareholder to the minority shareholders.

     In Estate of True, the decedent was a party to a buy-sell

agreement, along with other shareholders and the corporation in

which they held stock.   The decedent had a controlling interest

in the corporation.   The Commissioner argued that the agreement

was not binding during the decedent’s lifetime because he had the

unilateral ability to amend the agreement by virtue of his


     21
       The agreement required any shareholder wishing to sell
his shares to offer those shares first to the corporation at the
same price payable upon his death.
     22
       The agreement was later amended to increase the
percentage of outstanding shares required to confer unilateral
amendment rights to an amount just exceeding the amount directly
owned by the decedent. However, additional shares deemed owned
by the decedent through attribution caused him to satisfy the
amended higher percentage requirement. Bommer Revocable Trust v.
Commissioner, T.C. Memo. 1997-380.
                               - 38 -

control of the corporation.    We rejected that argument because

there were other shareholders whose consent was required to amend

the agreement.    Thus, control of the corporation did not, under

those facts, give the decedent the unilateral ability to amend

the agreement.

     In the instant case, the 1981 Agreement provided that it

could be modified only by the written consent of the “parties

thereto”.   The agreement contained no mechanism for adding

parties.    Thus, after Mr. Jennings died and his shares were

redeemed, decedent and BCC were the only remaining parties.23

Moreover, decedent owned shares constituting a controlling 83.2-

percent interest in BCC.   Consequently, after Mr. Jennings’s



     23
       Because persons who became BCC shareholders after the
1981 Agreement was executed were fully subject to the
restrictions on the transfer of BCC’s shares established in that
agreement, an argument could be made that such subsequent
shareholders--in particular, the ESOP--were “parties” to the 1981
Agreement. In contending that the 1996 Agreement validly
modified the 1981 Agreement and set the purchase price of
decedent’s BCC shares at $4 million, the estate has necessarily
taken the position (and respondent does not dispute) that the
ESOP was not a “party” to the 1981 Agreement and that its consent
was not required to make modifications thereto.
     If, alternatively, “party” for purposes of the modification
provision of the 1981 Agreement were interpreted to include
subsequent shareholders like the ESOP, then the 1996 Agreement on
which the estate relies in this case as establishing the value of
decedent’s BCC shares would be an invalid modification (because
it would lack the consent of all “parties”). As a consequence,
the 1981 Agreement in its unmodified form would presumably
survive. However, the estate has not argued in the alternative
that the (unmodified) 1981 Agreement established the value of
decedent’s shares, and we deem that argument waived.
                              - 39 -

death, decedent, by virtue of his control of BCC, could (and did)

unilaterally modify the 1981 Agreement.

     Decedent did not obtain the consent of the remaining BCC

shareholder, i.e., the ESOP, in connection with the modification

of the 1981 Agreement, demonstrating that decedent, BCC, and the

estate in its arguments herein took the position that the consent

of only decedent and BCC was required.    Because no other

shareholder had to consent to a modification of the 1981

Agreement (original or modified), unlike the circumstances in

Estate of True v. Commissioner, supra, control over the

corporation here gave decedent the unilateral ability to modify

the 1981 Agreement.   Thus, consistent with Bommer Revocable Trust

v. Commissioner, supra, the restrictions in the Modified 1981

Agreement were not binding on decedent during his life.

Accordingly, the Modified 1981 Agreement is disregarded for

purposes of determining the value of the BCC shares held by

decedent at death.

     C.   Section 2703

     Even if the Modified 1981 Agreement satisfied the binding-

during-life requirement, the agreement would nonetheless be

disregarded under section 2703.
                                - 40 -

            1.   Applicability of Section 2703

     Section 2703 applies to agreements entered into or

substantially modified” after October 8, 1990.    OBRA sec.

11602(e); sec. 25.2703-2, Gift Tax Regs.    A “substantial

modification” for this purpose is further defined in section

25.2703-1(c)(1), Gift Tax Regs., which provides that

     Any discretionary modification of a right or
     restriction, whether or not authorized by the terms of
     the agreement, that results in other than a de minimis
     change to the quality, value, or timing of the rights
     of any party with respect to property that is subject
     to the right or restriction is a substantial
     modification. * * *

     The 1981 Agreement required BCC to purchase, and a deceased

shareholder’s estate to sell, the deceased shareholder’s BCC

shares at a price initially set at the book value of the shares

being redeemed.    This price automatically adjusted each year to

reflect increases in book value.    The 1981 Agreement allowed the

shareholders by agreement to set a different price annually on

August 1.    Thus, any shareholder could preserve the book value

redemption price by refusing to agree to reset the price.

Assuming the parties did agree to change the purchase price on

August 1, absent further adjustment by agreement of the

shareholders, the new price would automatically adjust annually

on the basis of increases in BCC’s book value.    BCC had the right

to pay for the redeemed stock in installments.
                               - 41 -

     Because BCC’s shareholders had not exercised their right to

reset the purchase price, when decedent modified the 1981

Agreement in November 1996, the price dictated under that

agreement was set by reference to book value.     Thus, had decedent

died during the fiscal year in which he modified the 1981

Agreement, he would have received approximately $7.6 million for

his BCC shares under the 1981 Agreement in unmodified form.

     The 1996 Agreement modified the “Purchase Upon Death”

section of the 1981 Agreement by (1) eliminating book value as

the redemption price for decedent’s shares and replacing it

instead with a fixed price of $4 million, (2) removing the

automatic mechanism for adjusting the price annually on the basis

of book value, (3) eliminating the shareholders’ right to set the

price annually on August 1, and (4) precluding the right of BCC

to pay in installments.

     The estate raises several arguments as to why these changes

are not substantial modifications.      Focusing first on the change

in price, the estate argues that the setting of a new price in

the 1996 Agreement was not a change in shareholder rights because

the 1981 Agreement gave the shareholders the ability to change

the price, and thus the price change was “in compliance with the

agreement.”   We disagree.   As set forth in the regulations, the

validity of which has not been challenged, even if a change is
                              - 42 -

authorized by the agreement at issue, if it results in a non-de

minimis change in the value, quality, or timing of the right at

issue, it will be deemed a substantial modification.    Sec.

25.2703-1(c)(1), Gift Tax Regs.   Assuming, arguendo, that a price

change made on a date other than August 1, and without the

consent of all shareholders, was in compliance with the 1981

Agreement, decedent’s change in the price is a substantial

modification under the regulations if it produced more than a de

minimis change in value.   Before the modification, decedent had

the right to have his shares redeemed on the basis of BCC’s book

value from the most recent fiscal yearend, which in November 1996

would have yielded a purchase price for his shares of $7.6

million (based on the January 31, 1996, fiscal yearend book value

of $9,135,506).   After the modification, he had the right to have

his shares redeemed at $4 million.     Conversely, BCC’s redemption

obligation changed from $7.6 to $4 million.    We conclude that

this is a non-de minimis change in the value of decedent’s and

BCC’s rights with respect to decedent’s BCC shares.

     The estate further argues that the quality of the right was

not changed by virtue of decedent’s designation of a $4 million

purchase price because it falls under an exception listed in

section 25.2703-1(c)(2), Gift Tax Regs.    Section 25.2703-

1(c)(2)(iv), Gift Tax Regs., provides that “A modification that
                               - 43 -

results in an option price that more closely approximates fair

market value” is de minimis.   The estate asserts that the book

value price under the 1981 Agreement for decedent’s shares at the

time of the 1996 modification was $4.2 million.   It further

asserts that the fair market value of decedent’s shares at the

time of the modification was $3,736,242, as demonstrated by the

1996 BVS appraisal.   The estate claims that the change in price

of decedent’s shares from $4.2 to $4 million thus qualifies as de

minimis under section 25.2703-1(c)(2)(iv), Gift Tax Regs.,

because it results in a price that more closely reflected the

fair market value of decedent’s BCC shares.

     Assuming, arguendo, that the purchase price in the 1981

Agreement is an “option price”, this argument fails because the

estate’s calculation of BCC’s book value and fair market value at

the time of the modification is flawed.   In calculating the book

value price for decedent’s BCC shares under the 1981 Agreement,

the estate’s argument assumes that BCC had 92,718 shares

outstanding.   At the time decedent modified the 1981 Agreement,

however, BCC had redeemed Mr. Jennings’s shares, and there were

only 51,772 shares outstanding.   Dividing BCC’s book value as of

January 31, 1996 ($9,135,506),24 by the actual number of shares


     24
       While the Jan. 31, 1996, book value would not reflect
BCC’s transfer of $1,990,791 in cash and a $1 million note to Mr.
                                                   (continued...)
                              - 44 -

outstanding produces a per-share value of $176.46, which yields a

book value for decedent’s 43,080 shares of approximately $7.6

million, not the $4.2 million contended by the estate.25

     Similarly, when the estate contends that the 1996 BVS

appraisal suggested that the fair market value of decedent’s BCC

shares was $3,736,242, its calculation is likewise based on the

erroneous assumption that BCC had 92,718 shares outstanding as of

November 1996.   Thus, the estate’s argument overlooks the

redemption of Mr. Jennings’s shares and incorrectly assumes a

per-share fair market value of $86.73.   Taking the redemption of

Mr. Jennings’s shares into account yields a per-share fair market

value of $155.32, the same figure BCC’s controller, Mr. Truono,

used in his November 1996 analysis of BCC’s financial condition

(i.e., Pro Forma 15).   Using this corrected figure to calculate


     24
      (...continued)
Jennings’s estate for the redemption of his shares in September
1996, BCC had received approximately $3 million in life insurance
proceeds upon Mr. Jennings’s death, which essentially offset the
foregoing transfers for purposes of book value.
     25
       Even if the 1981 Agreement were interpreted to require
the calculation of BCC’s per-share book value as of Jan. 31,
1996, using the number of shares outstanding at that date, i.e.,
92,718, resulting in a purchase price of approximately $4.2
million (as the estate contends), the 1996 modification would
still have produced a non-de minimis change in the value of
decedent’s rights because the per-share price for decedent’s
shares under the 1981 Agreement would have automatically adjusted
at the close of the fiscal year ended Jan. 31, 1997, to reflect
the reduction in outstanding shares to 51,772 after the
redemption of Mr. Jennings’s shares.
                               - 45 -

the value of decedent’s 43,080 BCC shares suggests that those

shares were worth approximately $6.7 million in November 1996.

Thus, the 1996 Agreement’s change in the price for decedent’s BCC

shares did not result in a change in price that more closely

approximated fair market value.

     In addition to the changes in the value and quality of the

rights wrought by the change in price, the 1996 modification

worked other substantial changes to the 1981 Agreement.   Under

the 1981 Agreement, the redemption price was based on book value.

Moreover, the ESOP had the right to insist on book value as the

basis for any redemption by refusing to agree to reset the price.

It further was entitled to have the price automatically adjusted

to reflect changes in book value.   Decedent eliminated the ESOP’s

rights in this regard when he modified the 1981 Agreement.   He

also extinguished BCC’s right to pay the redemption price in

installments, as provided in the 1981 Agreement.

     We find that the foregoing changes are more than de minimis

and that they substantially altered decedent’s, BCC’s, and the

ESOP’s rights with respect to the stock covered by the agreement,

including the value, quality, and timing of those rights.

Accordingly, we conclude that the 1996 Agreement substantially

modified the 1981 Agreement.   Insofar as this substantial

modification occurred after October 8, 1990, the Modified 1981
                              - 46 -

Agreement is subject to section 2703.   See OBRA sec. 11602(e);

sec. 25.2703-2, Gift Tax Regs.

          2.   Section 2703(b)(3)

     Section 2703(a) provides that in general any agreement or

right to acquire property at a price less than its fair market

value will be disregarded in valuing the property for Federal

estate tax purposes.   Section 2703(b) creates an exception to the

operation of section 2703(a), as follows:

     SEC. 2703. CERTAIN RIGHTS AND RESTRICTIONS DISREGARDED.

          (b) Exceptions.--Subsection (a) shall not apply to any
     option, agreement, right, or restriction which meets each of
     the following requirements:

                  (1) It is a bona fide business arrangement.

                 (2) It is not a device to transfer such property
          to members of the decedent’s family for less than full
          and adequate consideration in money or money’s worth.

                 (3) Its terms are comparable to similar
          arrangements entered into by persons in an arms’ length
          transaction.

     The estate contends that, in the event section 2703(a)

applies to the Modified 1981 Agreement, all three requirements of

section 2703(b) have been met.   Respondent disagrees.   For the

reasons set forth below, we agree with respondent.

     With respect to the requirement of section 2703(b)(2), the

beneficiaries of a below-market redemption of decedent’s BCC

shares were the remaining BCC shareholders, namely the ESOP
                              - 47 -

participants, who were BCC’s employees and not members of

decedent’s family.   We are persuaded that the ESOP participants,

who had no personal relationship with decedent outside of work,

were not the natural objects of decedent’s bounty.   Thus, the

Modified 1981 Agreement is not a device to pass decedent’s BCC

shares to either his family or the natural objects of his bounty

for less than adequate consideration, and the estate has

satisfied section 2703(b)(2).26

     We need not decide whether decedent’s designation of a

below-market redemption price for his shares in the Modified 1981

Agreement, which was based on his understanding of BCC’s

available cash after accounting for operational cash needs and

the obligation to repurchase the shares of the ESOP participants,

constitutes a bona fide business arrangement under section

2703(b)(1), because we conclude that the estate has not shown



     26
       Sec. 2703(b)(2) uses the term “family”, while sec.
25.2703-1(b)(1)(ii), Gift Tax Regs., uses the term “natural
objects of the transferor’s bounty” when referring to transferees
of property for less than adequate consideration. Sec. 20.2031-
2(h), Estate Tax Regs., also uses the term “natural objects
of * * * [the transferor’s] bounty”. Legislation amending sec.
2703(b)(2) to conform the statute’s language to the regulations
has twice been passed in the House of Representatives, but never
enacted. See 137 Cong. Rec. 35312, 35323 (1991); 138 Cong. Rec.
17691, 17729 (1992); H. Rept. 102-631, at 326 (1992). Because we
find that the ESOP participants were neither decedent’s family
nor the natural objects of his bounty, we do not reach the
question of whether these terms should be treated as synonymous
for purposes of sec. 2703.
                             - 48 -

that the terms of the Modified 1981 Agreement are comparable to

similar agreements entered into by persons at arm’s length, as

required by section 2703(b)(3).

     Section 2703(b)(3) provides that the terms of a buy-sell

agreement must be “comparable to similar arrangements entered

into by persons in an arms’ length transaction.”   Section

2703(b)(3) appears to contemplate a taxpayer’s production of

evidence of agreements actually negotiated by persons at arm’s

length under similar circumstances and in similar businesses that

are comparable to the terms of the challenged agreement.

     The legislative history supports this interpretation.   The

committee report from the Senate, where section 2703 originated,

states:

          In addition, the bill adds a third requirement,
     not found in present law, that the terms of the option,
     agreement, right or restrictions be comparable to
     similar arrangements entered into by persons in an
     arm’s length transaction. This requires that the
     taxpayer show that the agreement was one that could
     have been obtained in an arm’s length bargain. Such
     determination would entail consideration of such
     factors as the expected term of the agreement, the
     present value of the property, its expected value at
     the time of exercise, and the consideration offered for
     the option. It is not met simply by showing isolated
     comparables but requires a demonstration of the general
     practice of unrelated parties. Expert testimony would
     be evidence of such practice. In unusual cases where
     comparables are difficult to find because the taxpayer
     owns a unique business, the taxpayer can use
     comparables from similar businesses. [136 Cong. Rec.
     S15683 (daily ed. Oct. 18, 1990).]
                                - 49 -

Thus, Congress contemplated that business “comparables” that

established “the general practice of unrelated parties” would

constitute the evidence satisfying section 2703(b)(3), and that

“expert testimony” could be used for this purpose.

     The regulations under section 2703 also contemplate the

introduction of evidence of actual comparable transactions.

Section 25.2703-1(b)(4), Gift Tax Regs., provides in relevant

part:

             (4) Similar arrangement. (i) In general. A right
        or restriction is treated as comparable to similar
        arrangements entered into by persons in an arm’s length
        transaction if the right or restriction is one that
        could have been obtained in a fair bargain among
        unrelated parties in the same business dealing with
        each other at arm’s length. A right or restriction is
        considered a fair bargain among unrelated parties in
        the same business if it conforms with the general
        practice of unrelated parties under negotiated
        agreements in the same business. * * *

              (ii) Evidence of general business practice.
        Evidence of general business practice is not met by
        showing isolated comparables. * * * It is not
        necessary that the terms of a right or restriction
        parallel the terms of any particular agreement. If
        comparables are difficult to find because the business
        is unique, comparables from similar businesses may be
        used.

        In light of the statutory language, the legislative history,

and the regulations, we conclude that section 2703(b)(3) requires

a taxpayer to demonstrate that the terms of an agreement

providing for the acquisition or sale of property for less than

fair market value are similar to those found in similar
                               - 50 -

agreements entered into by unrelated parties at arm’s length in

similar businesses.   In the instant case, the estate must

demonstrate that the terms of the Modified 1981 Agreement are

similar to terms in agreements entered into by unrelated parties

in businesses similar to that of BCC.

     The only evidence proffered by the estate on this point was

the expert report and testimony of Mr. Grizzle.   Mr. Grizzle

opined that the terms of the Modified 1981 Agreement were

comparable to similar arrangements entered into at arm’s length

within the meaning of section 2703(b)(3) because the price

provided in the agreement for decedent’s BCC shares was fair

market value.27   His conclusion regarding BCC’s fair market value

was based upon an income approach in which he postulated that

BCC’s value was equal to a multiple of four times earnings.     He

claimed that such a multiple was commonly used to value

construction companies by those knowledgeable about the industry.

He further claimed that such a multiple was implicit in the sale

prices for three purportedly comparable companies he examined.

He did not present evidence of other buy-sell agreements or

similar arrangements, where a partner or shareholder is bought



     27
       Mr. Grizzle opined that $4 million was a fair market
value price for the shares as of either the date of execution of
the 1996 Agreement (Nov. 11, 1996) or the date of decedent’s
death (Sept. 21, 1997).
                               - 51 -

out by his coventurers, actually entered into by persons at arm’s

length.   Nor did he attempt to establish that the method decedent

used to arrive at his $4 million price was similar to the method

employed by unrelated parties acting at arm’s length.

     If Mr. Grizzle were correct regarding the fair market value

of decedent’s BCC shares, section 2703(a) would not be triggered,

insofar as it applies only to those agreements that set a price

below fair market value, and no evidence of similar arrangements

would be required.   For the reasons discussed below, however, Mr.

Grizzle has failed to persuade us that the purchase price for

decedent’s BCC shares set forth in the Modified 1981 Agreement

was a fair market price, either when selected or at decedent’s

death.    Rather, we are persuaded that the price set forth in the

Modified 1981 Agreement is far below fair market value.   Because

Mr. Grizzle has failed to provide any evidence of similar

arrangements actually entered into by parties at arm’s length, as

required by section 2703(b)(3), and his opinion is based solely

on his belief that the purchase price for decedent’s BCC shares

was set at fair market value, Mr. Grizzle’s conclusion that the

terms of the Modified 1981 Agreement are comparable to similar

agreements entered into by parties at arm’s length is

unsupportable.
                               - 52 -

     In determining BCC’s value, Mr. Grizzle relied solely on an

income-based approach.   Mr. Fodor, the estate’s other expert,

asserted that 25 percent of BCC’s value should be determined

using an asset-based approach.    Mr. Hitchner, respondent’s

expert, asserted that BCC’s value should be calculated by giving

significant weight to an asset-based approach.    We are persuaded

by their testimony that some weight should be given to an asset

approach.    BCC was an asset-rich company, with significantly more

cash than similar companies.     Decedent’s shares represented a

controlling interest in the company, thus allowing a purchaser to

control the retention or disposition of those assets.     Thus, Mr.

Grizzle’s reliance on an income-based approach alone, without

regard to the company’s assets, raises doubt about his valuation

judgments.

     Even if we assume that an income-based approach alone were

appropriate here, Mr. Grizzle excluded nonoperating assets from

his valuation, on the theory that, in actual transactions,

sellers do not sell nonoperating assets along with the operating

assets.   Thus, he envisioned decedent selling BCC’s operating

assets only, while retaining its nonoperating assets.     The

purchase price set forth in the Modified 1981 Agreement, however,

was for decedent’s interest in BCC’s operating and nonoperating

assets.   As discussed infra in Part II.C.3., BCC had
                              - 53 -

approximately $1.9 million of nonoperating assets (ignoring

insurance proceeds the company was due to receive on decedent’s

death).   Had Mr. Grizzle valued all of BCC’s assets, and not just

the operating assets, he would have valued BCC at over $6

million, as opposed to the $4.5 million value he calculated using

a multiple of four times adjusted cashflow.   With this adjustment

alone, Mr. Grizzle’s estimation of the fair market value of

decedent’s shares would rise from approximately $3.8 million to

over $5 million, thus undermining any claim that the $4 million

purchase price in the Modified 1981 Agreement was a fair market

value price.28

     In light of these concerns, we assign no weight to Mr.

Grizzle’s testimony that the $4 million purchase price set forth


     28
       In addition, we are unpersuaded regarding Mr. Grizzle’s
estimation of BCC’s fair market value because his purportedly
comparable companies differed significantly from BCC. For
instance, the cellular tower construction company he used as a
comparable was 2 years old with minimal cash and assets. It was
in a new industry that was rapidly evolving. Moreover, it
depended on three customers for 86 percent of its contract
revenues, with one customer accounting for 48 percent of those
revenues. This is a far cry from BCC, which had been in business
for more than 50 years, operated in a stable industry, obtained
business from numerous sources, and had significant cash and
assets. In two cases, Mr. Grizzle relied on financial data
generated after the companies were sold to determine the cashflow
multiple implicit in the sale prices. In each case, the use of
this data served to decrease the multiple he determined. Thus,
we are not persuaded by Mr. Grizzle’s conclusion that BCC should
be valued using the same multiple of cashflow reflected in the
sales of these companies or that the multiples he derived are
accurate.
                                - 54 -

in the Modified 1981 Agreement was a fair market price value.

Accordingly, his conclusion that the Modified 1981 Agreement

established a price comparable to those of similar arrangements

entered into at arm’s length by people in similar businesses is

flawed.

     While we do not doubt that a corporation’s redemption of a

shareholder’s stock that is subject to a restrictive agreement,

as here, might well occur at an arm’s-length price less than fair

market value, the failure of Mr. Grizzle’s proof leaves us only

to speculate as to what such a below-fair-market-value, yet

arm’s-length, price might be.    Decedent set a price in the 1996

Agreement that he believed was the most BCC could pay without

impairing its liquidity.   But this $4 million price was reached

between decedent and his controlled corporation, with the

remaining shareholder excluded.    The best evidence we have on

this record of an arm’s-length arrangement involving the BCC

stock is the unmodified 1981 Agreement, which was negotiated

between decedent and his brother-in-law when both were 50-percent

shareholders and neither knew who would survive the other.      The

redemption price set in that agreement was (i) book value or (ii)

whatever price these two shareholders, in relatively equal

bargaining positions, could annually agree upon.    Given the

disparity in the prices dictated in the 1981 Agreement versus the
                                  - 55 -

1996 Agreement, we have no confidence that the 1996 Agreement was

comparable to an arm’s-length bargain.

      Insofar as the estate has failed to persuade us that the

Modified 1981 Agreement has met the requirements of section

2703(b)(3), the Modified 1981 Agreement must also be disregarded

under section 2703(a) when determining the value of decedent’s

BCC shares for Federal estate tax purposes.

II.   Valuation of Decedent’s BCC Shares

      Having determined that the Modified 1981 Agreement cannot

control the value of decedent’s BCC stock for Federal estate tax

purposes, we turn next to the task of determining its fair market

value as of the valuation date.      In the notice of deficiency,

respondent determined that decedent’s 43,080 BCC shares had a

fair market value of $7,921,975.      The burden of proof rests with

the estate to demonstrate that respondent’s determination is

erroneous.29   See Rule 142(a).

      A.   Fair Market Value

      Valuation is a question of fact, and the trier of fact must

weigh all relevant evidence to draw the appropriate inferences.

Commissioner v. Scottish Am. Inv. Co., 323 U.S. 119, 123-125

(1944); Helvering v. Natl. Grocery Co., 304 U.S. 282,


      29
       The estate has not raised sec. 7491, which would shift
the burden of proof under certain circumstances. Accordingly, we
deem that issue waived.
                                 - 56 -

294-295 (1938); Anderson v. Commissioner, 250 F.2d 242, 249 (5th

Cir. 1957), affg. in part and remanding in part on other grounds

T.C. Memo. 1956-178; Estate of Newhouse v. Commissioner, 94 T.C.

193, 217 (1990); Skripak v. Commissioner, 84 T.C. 285, 320

(1985).

     Fair market value is defined for Federal estate tax purposes

as the price at which property would change hands between a

willing buyer and a willing seller, neither being under any

compulsion to buy or to sell and both having reasonable knowledge

of all the relevant facts.   United States v. Cartwright, 411 U.S.

546, 551 (1973); sec. 20.2031-1(b), Estate Tax Regs.; see also

Snyder v. Commissioner, 93 T.C. 529, 539 (1989); Estate of Hall

v. Commissioner, 92 T.C. 312, 335 (1989).

     B.   Expert Testimony

     Both parties submitted expert reports and testimony in

support of their asserted fair market values for decedent’s BCC

stock on the valuation date.30    When considering expert testimony

regarding valuation, we weigh the testimony in light of the



     30
       The estate proffered Mr. Grizzle as an expert both with
respect to the issue of compliance with sec. 2703(b)(3) and with
respect to the fair market value of decedent’s shares. For the
reasons outlined supra in Pt.I.C.2., we conclude that Mr.
Grizzle’s expert opinion concerning the value of decedent’s
shares is unreliable and assign it no weight. Our discussion
hereinafter considers only the fair market value opinions of
Messrs. Fodor and Hitchner.
                              - 57 -

expert’s qualifications and with due regard to all other credible

evidence in the record.   See Neonatology Associates, P.A. v.

Commissioner, 115 T.C. 43, 85 (2000), affd. 299 F.3d 221 (3d Cir.

2002).   An expert’s testimony is no more persuasive than the

convincing nature of the reasons offered in support of his

testimony.   Potts, Davis & Co. v. Commissioner, 431 F.2d 1222,

1226 (9th Cir. 1970), affg. T.C. Memo. 1968-257.   We may embrace

or reject an expert’s opinion in its entirety, or be selective in

choosing portions of the opinion to adopt.   See Helvering v.

Natl. Grocery Co., supra at 294-295; Silverman v. Commissioner,

538 F.2d 927, 933 (2d Cir. 1976), affg. T.C. Memo. 1974-285; IT&S

of Iowa, Inc. v. Commissioner, 97 T.C. 496, 508 (1991); Parker v.

Commissioner, 86 T.C. 547, 562 (1986); see also Pabst Brewing Co.

v. Commissioner, T.C. Memo. 1996-506.   We may reject an expert’s

opinion to the extent that it is contrary to the judgment we form

on the basis of our understanding of the record as a whole.     See

Orth v. Commissioner, 813 F.2d 837, 842 (7th Cir. 1987), affg.

Lio v. Commissioner, 85 T.C. 56 (1985); Silverman v.

Commissioner, supra; Estate of Kreis v. Commissioner, 227 F.2d

753, 755 (6th Cir. 1955), affg. T.C. Memo. 1954-139; IT&S of

Iowa, Inc. v. Commissioner, supra; Chiu v. Commissioner, 84 T.C.

722, 734 (1985); see also Gallick v. Baltimore & O.R. Co., 372

U.S. 108, 115 (1963); In re TMI Litig., 193 F.3d 613, 665-666 (3d
                                - 58 -

Cir. 1999).    Finally, because valuation necessarily involves an

approximation, the figure at which we arrive need not be directly

attributable to specific testimony if it is within the range of

values that properly may be derived from consideration of all the

evidence.     Estate of True v. Commissioner, T.C. Memo. 2001-167

(citing Silverman v. Commissioner, supra at 933).

C.   BCC’s Value Exclusive of Insurance Proceeds

     1.     Experts’ Concluded Value Exclusive of Insurance Proceeds

     Putting aside their treatment of the insurance proceeds on

decedent’s life, Messrs. Fodor and Hitchner determined BCC’s

value to be $6 million and $7 million, respectively.     Both used a

blend of income- and asset-based approaches.     For their income-

based approach, both experts used a capitalization of earnings

model, in which they estimated BCC’s net free cashflow capacity

for the year following the valuation date, capitalized that

figure to derive capitalized earnings, and then made various, but

different, additions to and subtractions from capitalized

earnings.     They relied primarily on BCC’s net asset value for

their asset-based valuations.

     Mr. Fodor determined that BCC had an income-based value of

$5,803,163 and an asset-based value of $7,928,805.     He weighted

the income-based approach at 75 percent and the asset-based

approach at 25 percent to arrive at his $6 million figure.
                                - 59 -

     Mr. Hitchner estimated the income-based value for BCC as

ranging from $4,803,513 to $6,403,513, without indicating where

in the range he believed the income-based value fell.    He also

provided a range of values under two different asset-based

approaches:   The adjusted book value and modified adjusted book

value approaches.   The values provided for the adjusted book

value approach were $8,891,024 and $8,478,254 for the fiscal

years ended 1997 and 1998, respectively.    The values provided for

the modified adjusted book value approach were $7,596,838 and

$7,052,766 for the fiscal years ended 1997 and 1998,

respectively.   As with the income-based approach, Mr. Hitchner

did not indicate where in the ranges he believed the asset-based

value fell.   To derive his final value for BCC, Mr. Hitchner

indicated that he gave the most weight to the modified adjusted

book value approach, and equal but lesser weight to the income

and the adjusted book value approaches.    He did not disclose the

precise weighting for each approach.     Mr. Hitchner’s “concluded”

value for BCC was $7 million.

     Upon a careful review of the entire record, we are persuaded

that, exclusive of their respective treatments of the proceeds

from decedent’s life insurance, each expert’s analysis contains a

miscalculation of sufficient magnitude that it requires

adjustment in reaching a final value.    With respect to Mr. Fodor,
                              - 60 -

as more fully discussed below we conclude that he has not shown

that a $750,000 downward adjustment in BCC’s value is required to

account for the obligation to repurchase BCC shares held by BCC’s

ESOP participants.   With respect to Mr. Hitchner, while we agree

with his analysis that BCC held cash and cash equivalents in

excess of business needs, and that such “excess cash” should be

accounted for as a nonoperating asset, we conclude for the

reasons outlined below that he overestimated the amount of BCC’s

excess cash by approximately $400,000, which caused his figure

for BCC’s nonoperating assets (exclusive of life insurance

proceeds) to be overstated by that amount.    Because, under Mr.

Hitchner’s approach, nonoperating assets were added to

capitalized earnings to derive an income-based value, Mr.

Hitchner’s income-based value is likewise overstated by

approximately $400,000 as a result of his overestimate of BCC’s

excess cash.

     2.   Mr. Fodor’s Adjustment for ESOP Repurchase Obligation

     Mr. Fodor adjusted both his income- and asset-based values

downward by $750,000 to account for the obligation to repurchase

BCC shares held by BCC’s ESOP participants.    Mr. Fodor derived

his $750,000 estimate of the present value of the obligation to

repurchase the ESOP participants’ shares by adopting the $750,000

estimate of BCC’s liability in the event of an ESOP plan
                               - 61 -

termination that BVS made in its 1997 appraisal of BCC for

purposes of the ESOP.    While Mr. Fodor provided an analysis at

trial in support of his use of the BVS termination liability

estimate for this purpose, neither his written report nor his

trial testimony offered any analysis of how BCC would satisfy any

ESOP repurchase obligation or how the method employed to satisfy

the obligation would affect the fair market value of BCC or

decedent’s BCC shares.

     According to a business valuation treatise on which both

parties relied in this case, there are two methods that companies

generally use to satisfy the obligation to repurchase the shares

of retiring ESOP participants:    (i) A so-called recycling

transaction, in which the ESOP purchases the shares of retiring

participants and “recycles” them to other participants, using

employer contributions to the ESOP to fund its purchases; or (ii)

a redemption transaction, in which the company directly purchases

(and then cancels) the shares of retiring participants.    See

Pratt et al., Valuing a Business 712-713 (2000).    Mr. Fodor does

not explain or even disclose which method he assumed BCC would

employ.   The available evidence in the record-–namely, the

Summary Plan Description for the ESOP-–indicates that BCC’s ESOP

was designed to employ the redemption method.    Assuming that is

the case, the redemption method’s “net effect on fair market
                              - 62 -

value should be negligible if the * * * [repurchase] transaction

occurs at fair market value”, id. at 713, because the percentage

ownership of all the remaining shareholders increases as a result

of the redemption and cancellation of the retiree’s shares, id.

Mr. Fodor has failed to take into account the proportionate

increase in the ownership interest of decedent’s shares, which

would be produced by the redemption of the ESOP’s shares, when

considering the impact of the ESOP repurchase obligation on the

fair market value of decedent’s BCC shares.31   Nor has he

demonstrated that the projected annual ESOP repurchase obligation

(as opposed to the present value figure he discussed) would

adversely affect BCC’s liquidity, thus potentially affecting fair

market value.32

     Alternatively, if it were assumed that BCC employed a

“recycling” method, Mr. Fodor has not explained whether or how


     31
       A simplified example will illustrate this point. If a
corporation has $100 in assets and two shareholders (A and B),
with A owning 80 percent of the stock and B, an ESOP, owning the
remaining 20 percent, a willing buyer of A’s shares would pay $80
for those shares, regardless of whether the corporation is
obligated to redeem B’s shares at their fair market value.
     32
        While Mr. Truono testified that he and decedent were
concerned when creating Pro Forma 15 that BCC have enough cash
available after the purchase of decedent’s shares to redeem
shares held by ESOP participants, this analysis was in the
context of determining how much cash the company could afford to
pay decedent’s estate to repurchase decedent’s BCC shares. Their
concerns do not suggest that the ESOP repurchase obligation would
have a significant impact on the fair market value of decedent’s
shares.
                              - 63 -

BCC’s annual contributions to the ESOP (which he elsewhere

accounted for as a deduction against earnings to be capitalized)

would be insufficient to satisfy some or all of the ESOP

repurchase obligation.   Indeed, Mr. Truono testified that the

ESOP repurchase obligation had never exceeded $100,000 in any

year.

     In sum, Mr. Fodor’s failure to address the foregoing issues

leaves us unpersuaded of his claim that BCC’s annual ESOP

repurchase obligation requires a $750,000 downward adjustment to

either the income- or asset-based valuation methods he chose.33

Instead, we are persuaded that, under the facts presented here,

Mr. Hitchner was correct in his position that any ESOP repurchase

obligation did not warrant the adjustments of the sort Mr. Fodor

advocated.

     Because Mr. Fodor’s $750,000 adjustment led to a dollar-for-

dollar decrease in both his income- and asset-based values, the

adjustment led to a dollar-for-dollar decrease in his final

blended estimate of BCC’s value.   Correcting Mr. Fodor’s

treatment of the ESOP repurchase obligation to remove the




     33
       Because of these shortcomings in Mr. Fodor’s analysis of
the need for an adjustment to account for an ESOP repurchase
obligation, we do not reach the separate question of whether Mr.
Fodor’s report may rely upon the 1997 BVS appraisal’s $750,000
figure without qualifying that appraisal as expert testimony.
                              - 64 -

$750,000 downward adjustment yields a value for BCC of $6.75

million, as compared to Mr. Hitchner’s $7 million estimate.

     3.   Mr. Hitchner’s Estimate of Excess Cash

     Mr. Hitchner calculated that BCC had nonoperating assets of

approximately $2.3 million.   This figure included $433,572 for

notes receivable and an idle asphalt plant, plus approximately

$1.9 million of “excess cash”; i.e., that portion of BCC’s cash

on hand that Mr. Hitchner considered to be in excess of BCC’s

working capital needs.   To determine excess cash, Mr. Hitchner

compared BCC’s ratio of cash to assets as of the valuation date

with the industry average ratio of cash to assets for SIC code

1611 (Contractors--Highway & Street Construction).   Using the

industry average ratio for 1997 and BCC’s assets, he determined

that BCC required $1,125,029 of cash and cash equivalents.    Since

the cash and cash equivalents BCC had on hand as of the valuation

date ($2,994,970) exceeded this industry average by $1,869,941,

Mr. Hitchner concluded that BCC had excess cash, approximately

equal to the latter figure, which he treated as a nonoperating

asset.

     We are persuaded that Mr. Hitchner’s reliance on industry

averages to measure BCC’s cash requirements produces an erroneous

estimate.   The uncontested testimony in this case establishes

that BCC required approximately $1.5 million in cash and cash
                              - 65 -

equivalents for its business needs, in particular to meet bonding

requirements without drawing on personal guaranties of its

owners.   The record does not disclose whether the paving

contractors covered by SIC code 1611 provided personal guaranties

to meet bonding requirements, but we are satisfied from the

record herein that personal guaranties would affect cash needs.

Given the unreliability of the industry average as applied to

BCC, we are persuaded that the $1.5 million actual cash

requirement of BCC, demonstrated in the record, is a better

benchmark for determining excess cash than Mr. Hitchner’s

approximately $1,125,000 derived from an industry average.    Thus,

we conclude that the proper measure of BCC’s excess cash is the

amount by which its cash and cash equivalents on hand on the

valuation date ($2,994,970 exclusive of life insurance proceeds)

exceeded $1.5 million.   Accordingly, we find that BCC had excess

cash of approximately $1.5 million, not the approximately $1.9

million calculated by Mr. Hitchner.    Consequently, Mr. Hitchner’s

computation of nonoperating assets, and his income-based value,

should be reduced by $400,000.

     4.   Conclusion

     Since Mr. Fodor’s $750,000 downward adjustment to account

for the ESOP repurchase obligation was made to both his income-

and asset-based values, elimination of that adjustment would
                              - 66 -

produce a $750,000 increase in his final blended value as well,

from $6 million to $6,750,000.   Mr. Hitchner’s error in computing

excess cash affected only his income-based value, inflating it by

$400,000.   As noted earlier, Mr. Hitchner did not disclose the

precise weight he attributed to his income-based value when

blending it with his asset-based values to reach a final blended

value of $7 million (exclusive of insurance proceeds), except to

point out that he gave greater weight to his “adjusted book

value” asset value and lesser but equal weight to his “modified

adjusted book value” asset value and income value.

     In these circumstances, while the precise impact on his $7

million blended value of a $400,000 decrease in his income-based

value cannot be ascertained, we are satisfied that the impact

would move Mr. Hitchner’s $7 million blended value significantly

closer to our corrected $6,750,000 value for Mr. Fodor.   We

accordingly find that $6,750,000 is a reasonable point in the

range of values derivable from the two experts’ analyses and

conclude that this is the correct figure for BCC’s fair market

value, exclusive of the impact of the life insurance proceeds

received with respect to decedent.

D.   Effect of Redemption Obligation on Insurance
     Proceeds

     We turn next to the question of how to account for the

$3,146,134 million in life insurance proceeds BCC was due to
                               - 67 -

receive on decedent’s death and BCC’s $4 million obligation to

redeem decedent’s shares, as set forth in the Modified 1981

Agreement.    Mr. Fodor excluded both the insurance proceeds and

the redemption obligation when determining BCC’s value on the

theory that the insurance proceeds were offset by the redemption

obligation.    In contrast, Mr. Hitchner included the insurance

proceeds in valuing BCC, adding their value to his $7 million

“concluded” value for BCC, while disregarding the redemption

obligation.

     Respondent argues that the insurance proceeds must be

included in BCC’s value as a nonoperating asset, relying on

section 20.2031-2(f), Estate Tax Regs., and Estate of Huntsman v.

Commissioner, 66 T.C. 861 (1976).    In contrast, the estate argues

that, while insurance proceeds might be a nonoperating asset,

under Estate of Cartwright v. Commissioner, 183 F.3d 1034 (9th

Cir. 1999), affg. in part and remanding in part T.C. Memo. 1996-

286, they must be offset by BCC’s obligation to redeem decedent’s

shares, and therefore do not affect BCC’s value.

     Estate of Huntsman makes clear that insurance proceeds are

treated like any other nonoperating asset when determining a

closely held corporation’s value.    Estate of Huntsman v.

Commissioner, supra at 874; see also sec. 20.2031-2(f), Estate

Tax Regs. (“consideration shall also be given to nonoperating
                               - 68 -

assets, including proceeds of life insurance policies payable to

or for the benefit of the company, to the extent such

nonoperating assets have not been taken into account in the

determination of net worth, prospective earning power and

dividend-earning capacity”).   Whether BCC’s $4 million obligation

to redeem decedent’s shares offsets the life insurance proceeds,

as the estate argues, is another question.   In Estate of

Huntsman, we reasoned that, because life insurance proceeds

should be treated like any other nonoperating asset, to the

extent such assets were considered in valuing a company, they

were subject to offset by corporate liabilities.   However, we

were not presented in that case with the question of whether a

corporation’s obligation to redeem the very shares that are to be

valued should be treated as a liability, offsetting corporate

assets.34   The estate here urges that we treat BCC’s enforceable

$4 million obligation to redeem the shares whose value is at

issue as a liability offsetting BCC’s assets (i.e., the

$3,146,134 life insurance proceeds plus almost $1 million in

other assets) in arriving at the value of the same shares.




     34
       The only redemption involved in Estate of Huntsman v.
Commissioner, 66 T.C. 861 (1976), was of a sufficient number of
the decedent shareholder’s shares to pay estate taxes. The
shares whose value was at issue in Estate of Huntsman were not
the subject of a redemption obligation of the corporation.
                              - 69 -

     We decline to do so for two reasons.   First, we have

concluded that the agreement under which BCC was obligated to

redeem decedent’s shares for $4 million must be disregarded under

both section 20.2031-2(h), Estate Tax Regs., and section 2703.

In such circumstances, the terms of the disregarded agreement are

generally not taken into account in determining the fair market

value of the shares subject to the agreement.   Estate of True v.

Commissioner, T.C. Memo. 2001-167; Estate of Lauder v.

Commissioner, T.C. Memo. 1994-527; see also Estate of Godley v.

Commissioner, T.C. Memo. 2000-242, affd. 286 F.3d 210 (4th Cir.

2002).   As we noted in Estate of Lauder, under these

circumstances, the willing buyer/seller analysis would be

distorted if we disregarded the buy-sell agreement for purposes

of fixing the value of the subject stock, yet allowed provisions

in the agreement to be taken into account when determining the

stock’s fair market value.   Thus, it would be improper here to

consider the redemption obligation in the disregarded buy-sell

agreement when determining the fair market value of the stock

covered by that agreement.

     Second, even if the impact of the redemption obligation on

BCC’s value were not disregarded under the principles of Estate

of Lauder and like cases, the redemption obligation should not be

treated as a value-depressing corporate liability when the very
                               - 70 -

shares that are the subject of the redemption obligation are

being valued.   To do so would be to value BCC in its

postredemption configuration; namely, after decedent’s shares had

been redeemed and BCC’s assets had been contracted by the $4

million redemption payment.    Valuing decedent’s 43,080 shares by

means of the hypothetical willing buyer/seller construct

necessarily requires that the corporation’s actual obligation to

redeem the shares be ignored; such a stance is inherent in the

fiction that the shares are being sold to a hypothetical third-

party buyer on the valuation date rather than being redeemed by

the corporation.   To the hypothetical willing buyer, decedent’s

43,080 BCC shares constituted an 83.2-percent interest in all of

the assets and income-generating potential of BCC on the

valuation date, including any assets that might be used to

satisfy the actual redemption obligation.   To treat the

corporation’s obligation to redeem the very shares that are being

valued as a liability that reduces the value of the corporate

entity thus distorts the nature of the ownership interest

represented by those shares.

     By contrast, a hypothetical willing buyer of BCC shares

other than decedent’s would treat the redemption obligation, on

the valuation date, as a corporate liability of BCC, but only in

connection with a simultaneous accounting of the impact of the
                               - 71 -

redemption of decedent’s shares on the ownership interest

inherent in the other shares not being redeemed.

     A simplified example will illustrate the fallacy behind the

estate’s contention that BCC’s obligation to redeem decedent’s

shares should be treated as a liability offsetting a

corresponding amount of corporate assets.    Assume corporation X

has 100 shares outstanding and two shareholders, A and B, each

holding 50 shares.    X’s sole asset is $1 million in cash.   X has

entered into an agreement obligating it to purchase B’s shares at

his death for $500,000.    If, at B’s death, X’s $500,000

redemption obligation is treated as a liability of X for purposes

of valuing B’s shares, then X’s value becomes $500,000 ($1

million cash less a $500,000 redemption obligation).    It would

follow that the value of B’s shares (and A’s shares) is $250,000

(i.e., one half of the corporation’s $500,000 value35) upon B’s

death.    Yet if B’s shares are then redeemed for $500,000, A’s

shares are then worth $500,000-–that is, A’s 50 shares constitute

100-percent ownership of a corporation with $500,000 in cash.

     It cannot be correct either that B’s one-half interest in $1

million in cash is worth only $250,000 or that A’s one-half


     35
       Among other simplifications, this example ignores the
existence of discounts or premiums attributable to the magnitude
of the ownership interest represented by corporate shares. We
note that the parties do not contend that any such discounts or
premiums are appropriate in the instant case.
                                - 72 -

interest in the remainder shifts from a value of $250,000

preredemption to a value of $500,000 postredemption.

     The error with respect to B’s shares in the example lies in

the treatment of X’s redemption obligation as a claim on

corporate assets when valuing the very shares that would be

redeemed with those assets.   With respect to A’s shares, a

willing buyer would pay $500,000 upon B’s death (not $250,000)

because he would take account of both the liability arising from

X’s redemption obligation and the shift in the proportionate

ownership interest of A’s shares occasioned by the redemption--

but never the former without the latter.36

     The estate’s reliance on Estate of Cartwright v.

Commissioner, 183 F.3d 1034 (9th Cir. 1999), is misplaced, as

that case is distinguishable.    Estate of Cartwright involved a

law firm (organized as a C corporation) that entered into a buy-

sell agreement with its majority shareholder.   The parties agreed

that the firm would purchase from the shareholder’s estate his

shares and his interest in the fees for the firm’s work in



     36
       In this simplified example, a willing buyer of A’s shares
would pay $500,000 for A’s shares whether the redemption
obligation existed or not. But that is only because, in this
example, X is obligated to redeem B’s shares at their fair market
value of $500,000. If X were obligated to redeem B’s shares at a
price greater or less than $500,000, then a willing buyer of A’s
shares would pay less than $500,000, or more than $500,000,
respectively, for A’s shares.
                               - 73 -

progress at his death.   The consideration for this purchase was

designated as the proceeds from two $2.5 million life insurance

policies on the shareholder’s life that the firm was required to

obtain under the agreement.

     Upon the shareholder’s death, the firm paid the $5,062,02937

insurance proceeds to the shareholder’s estate.   The taxpayer

took the position that the entire $5,062,029 was paid for the

shareholder’s stock, whereas the Commissioner determined that

approximately $4 million was paid for the shareholder’s interest

in work in progress (and, therefore, was income in respect of a

decedent).   Concluding that the insurance proceeds were

consideration for both the stock and the shareholder’s interest

in work in progress, this Court undertook to allocate the

consideration between the two by determining the stock’s fair

market value at the shareholder’s death, and treating the

insurance proceeds in excess of that fair market value as

consideration paid for the shareholder’s interest in work in

progress.    In determining the fair market value of the stock, we

rejected the taxpayer’s argument that the $5 million in insurance

proceeds should be treated as a nonoperating asset of the firm,



     37
       The policy proceeds that served as consideration for the
purchase were construed by the parties as comprising the two $2.5
million death benefits plus $62,029 in premium adjustments and
interest.
                              - 74 -

augmenting the value of its stock, on the grounds that the

insurance proceeds were offset by the firm’s obligation to pay

them over to the estate.   In so concluding, we relied on Estate

of Huntsman v. Commissioner, 66 T.C. 861 (1976), as follows:       “We

said in Estate of Huntsman that a buyer would not pay more for

stock based on the corporation’s ownership of life insurance if

the proceeds would be largely offset by the corporation’s

liabilities.   That is the case here.”    Estate of Cartwright v.

Commissioner, T.C. Memo. 1996-286 (citation omitted).    The Court

of Appeals for the Ninth Circuit affirmed our position that the

life insurance proceeds would not be considered by a hypothetical

willing buyer in these circumstances.     Estate of Cartwright v.

Commissioner, 183 F.3d at 1038.

     Estate of Cartwright is distinguishable.     The lion’s share

of the corporate liabilities in that case which were found to

offset the insurance proceeds were not obligations of the

corporation to redeem its own stock.     Rather, we determined that

approximately $4 million of the $5 million liability of the

corporation was to compensate the decedent shareholder for

services; i.e., for his interest in work in progress.    Thus, a

substantial portion of the liability was no different from any

third-party liability of the corporation that would be netted
                              - 75 -

against assets, including insurance proceeds, to ascertain net assets.

     Concededly, a portion of the liability in Estate of

Cartwright constituted an obligation to redeem stock being

valued.   Nonetheless, in contrast to the instant case, the buy-

sell agreement in Estate of Cartwright had not been disregarded

pursuant to section 20.2031-2(h), Estate Tax Regs., or section

2703; indeed, our principal task in Estate of Cartwright was to

construe the terms of the buy-sell agreement, which was fully

respected.   Given the disregarded status of the buy-sell

agreement at issue here, Estate of Cartwright has no

application.38

     Accordingly, we conclude that the $3,146,134 in insurance

proceeds due BCC upon decedent’s death should be treated as a

nonoperating asset of BCC and is not offset by BCC’s $4 million

obligation to redeem decedent’s shares.

E.   Accounting for Insurance Proceeds

     Having established that the life insurance proceeds are a

nonoperating asset that is not offset by BCC’s $4 million

obligation to redeem decedent’s shares, we turn next to the



     38
       Moreover, the life insurance proceeds in Estate of
Cartwright v. Commissioner, T.C. Memo. 1996-286, affd. in part
and remanded in part 183 F.3d 1034 (9th Cir. 1999), were
contractually earmarked and required to be paid over to the
decedent’s estate. No such requirement existed in the instant
case; BCC was free to use the insurance proceeds in any manner,
though it in fact paid them over in partial satisfaction of its
obligation to redeem decedent’s shares.
                                   - 76 -

question of how those proceeds should be taken into account when

valuing BCC.    Section 20.2031-2(f), Estate Tax Regs., provides

that “consideration shall also be given to nonoperating assets,

including proceeds of life insurance policies”.      As we stated in

Estate of Huntsman v. Commissioner, supra at 874, “it is * * *

obvious that the price paid by a willing buyer would not

necessarily be increased by the amount of the life insurance

proceeds.”     Rather, one applies “customary principles of

valuation” to determine the impact of life insurance proceeds on

corporate value.     Id. at 876.    Here both experts contend that

BCC’s value should be determined using a blend of income- and

asset-based approaches, and the impact of the insurance proceeds

on BCC’s value depends on how those proceeds are treated under

those approaches.

     Where a corporation has significant nonoperating assets, one

well-established method of accounting for those assets in an

income-based approach-–and the method proposed by Mr.

Hitchner-–is to add the value of those assets to capitalized

earnings.    See, e.g., Estate of Heck v. Commissioner, T.C. Memo.

2002-34; Estate of Renier v. Commissioner, T.C. Memo. 2000-298;

Estate of Ford v. Commissioner, T.C. Memo. 1993-580, affd. 53

F.3d 924 (8th Cir. 1995); Estate of Gillet v. Commissioner, T.C.

Memo. 1985-394; Estate of Clarke v. Commissioner, T.C. Memo.
                                - 77 -

1976-328.    As we stated in Estate of Gillet v. Commissioner,

supra:

          The segregated approach to valuation [i.e.,
     valuing operating assets by capitalizing the income
     they generate and then adding in the value of
     nonoperating assets] has been accepted by the courts
     where the evidence establishes that there was an
     accumulation by the corporation of assets in excess of
     business needs that would require separate evaluation.
     * * * [Citations omitted.]

This same principle holds true where the nonoperating assets in

question are life insurance proceeds to which the corporation

becomes entitled upon the death of the shareholder whose shares

are being valued.     See Estate of Clarke v. Commissioner, supra;

see also Estate of Heck v. Commissioner, supra.

     In the instant case, the record establishes that BCC had

significant nonoperating assets as of the valuation date,

including an idle asphalt plant, notes receivable, and

substantial amounts of cash in excess of its operational needs

(without regard to the life insurance proceeds).     Mr. Truono,

BCC’s chief financial officer, testified that BCC required $1.5

million in cash and cash equivalents to meet operating needs.

Mr. Fodor’s report indicated that BCC had over $2.5 million in

cash and cash equivalents on the valuation date.     Mr. Fodor’s

report further revealed that BCC had far more working capital, as

a percentage of revenues, than other companies in similar SIC

groups.     Mr. Hitchner persuasively demonstrated that BCC had

significantly more cash and cash equivalents, as a percentage of
                               - 78 -

assets, than companies in the SIC group most closely

approximating BCC.39   In these circumstances, we are persuaded

that adding the value of nonoperating assets, including life

insurance proceeds, to capitalized earnings, as Mr. Hitchner

proposed, is an appropriate measure of BCC’s income-based

value.40

     Because BCC had positive net assets, treating the life

insurance proceeds as a nonoperating asset also produces an

increase in the asset-based value of BCC, equal to the amount of

the proceeds, under all three asset-based approaches employed by

the experts herein.    Thus, because the life insurance proceeds

are added in both the income- and asset-based approaches, they

result in an increase in the final blended value of BCC equal to

the amount of the life insurance proceeds, regardless of the

respective weights given to the income- or asset-based approach.

Accordingly, we are persuaded that Mr. Hitchner was correct in


     39
       Although we concluded supra at Pt.II.C.3. that Mr.
Hitchner overestimated the extent of BCC’s excess cash, after our
adjustment BCC’s excess cash on the valuation date was still
approximately $1.5 million.
     40
       We note that even if we were to adopt Mr. Fodor’s
proposal regarding the necessary additions to capitalized
earnings to derive an income-based value, the life insurance
proceeds would still be added to capitalized earnings, and the
income-based value would increase dollar for dollar. Had he not
offset the life insurance proceeds with BCC’s obligation to
redeem decedent’s shares, those proceeds would have been an
addition to net working capital, which Mr. Fodor added to BCC’s
capitalized earnings in calculating an income-based value.
                                  - 79 -

his view that the life insurance proceeds should be accounted for

as a dollar-for-dollar increase in the value otherwise determined

for BCC.

     The estate contends that this treatment of life insurance

proceeds is inconsistent with Estate of Huntsman v. Commissioner,

66 T.C. 861 (1976), because it leads to an increase in BCC’s

value equal to those proceeds.      We disagree.   In Estate of

Huntsman v. Commissioner, supra at 874, we observed that “it is

* * * obvious that the price paid by a willing buyer would not

necessarily be increased by the amount of the life insurance

proceeds.”    (Emphasis added.)    We rejected the Commissioner’s

position in that case that life insurance proceeds, received by

the corporation upon the death of the shareholder whose shares

were being valued, produced a dollar-for-dollar increase in the

corporation’s value because his position “would treat the life

insurance proceeds differently than other nonoperating assets.”

Id. at 875.    The income-based valuation approach employed in

Estate of Huntsman multiplied earnings by a price-earnings ratio

without factoring nonoperating assets into the income-based

value.     The life insurance proceeds therefore did not affect the

income-based value; they were accounted for only as part of the

asset-based value.    Since the asset-based value produced only a

proportionate impact on the final blended value, the life
                              - 80 -

insurance proceeds (like all other nonoperating assets) had less

than a dollar-for-dollar impact on the final blended value.   See

id. at 878.

     In the instant case, Mr. Hitchner’s income-based approach,

in recognition of the fact that BCC had substantial nonoperating

assets, employed the well-established technique in such

circumstances of adding nonoperating assets (including life

insurance proceeds) to capitalized earnings.41   In contrast to

the valuation methods employed in Estate of Huntsman, this

approach treats all nonoperating assets alike and results in a

dollar-for-dollar increase in final value equal to the life

insurance proceeds, when used alone, see, e.g., Estate of Heck v.

Commissioner, T.C. Memo. 2002-34, and when blended with an asset-

based approach, see, e.g., Estate of Clarke v. Commissioner, T.C.

Memo. 1976-328.   Thus, whether life insurance proceeds produce a

dollar-for-dollar increase in final value depends upon the

valuation methods employed.   In observing that life insurance

proceeds “would not necessarily” increase value dollar-for-

dollar, Estate of Huntsman does not preclude this result.



     41
       As noted previously, but for his conclusion that the life
insurance proceeds were offset by BCC’s obligation to redeem
decedent’s shares, Mr. Fodor’s methodology would also have
dictated adding the life insurance proceeds to capitalized
earnings, because the proceeds would have been a component of his
computation of net working capital.
                               - 81 -

       Accordingly, for the foregoing reasons we conclude that the

$3,146,134 in life insurance proceeds should be added to the

$6,750,000 value previously determined, with the result that BCC

had a fair market value of $9,896,134 on the valuation date.

III.    Conclusion

       Both experts derived the value of decedent’s 43,080 shares

by multiplying their final blended values for BCC by decedent’s

83.2-percent ownership interest.    Neither applied any discounts

or premiums.    We are persuaded that this approach is appropriate

here.    Multiplying BCC’s total value of $9,896,134 by 83.2

percent yields a value for decedent’s 43,080 shares of $8,233,583

on the valuation date.

       Because we are persuaded by a preponderance of the evidence

that the fair market value of decedent’s BCC stock exceeded the

amount respondent determined, we sustain respondent’s

determination.

       To reflect the foregoing and the concessions of the parties,


                                          Decision will be entered

                                     under Rule 155.
