                             T.C. Memo. 2019-101



                       UNITED STATES TAX COURT



ESTATE OF AARON U. JONES, DONOR, DECEASED, REBECCA L. JONES
 AND DALE A. RIDDLE, PERSONAL REPRESENTATIVES, Petitioners v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 27952-13.                       Filed August 19, 2019.



      D. John Thornton and Kevin C. Belew, for petitioners.

      Kelley A. Blaine, Amy B. Ulmer, Erik W. Nelson, and Janice B. Geier, for

respondent.
                                        -2-

[*2]        MEMORANDUM FINDINGS OF FACT AND OPINION


       PUGH, Judge: In a notice of deficiency dated September 5, 2013,

respondent determined a deficiency in gift tax of $44,986,416.1 After

concessions,2 the issues for decision are the valuations, as of May 28, 2009 (the

valuation date), of the following equity interests transferred as gifts: (1) 10,267.67

limited partner units in Seneca Jones Timber Co. (SJTC), (2) 4,800 shares of class

B nonvoting stock in Seneca Sawmill Co. (SSC), (3) 5,456 shares of class B

nonvoting stock in SSC, and (4) 1,300 shares of class A voting stock in SSC.

                               FINDINGS OF FACT

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

facts are incorporated in our findings by this reference. Mr. Jones resided in

Oregon when the petition was timely filed. After Mr. Jones’ death on September

14, 2014, Mr. Riddle and Ms. Jones, who also resided in Oregon when the petition

was filed, were appointed as personal representatives of the estate.


       1
        Unless otherwise indicated, all section references are to the Internal
Revenue Code of 1986, as amended and in effect at all relevant times. Rule
references are to the Tax Court Rules of Practice and Procedure. All monetary
amounts are rounded to the nearest dollar.
       2
        Respondent conceded that the estate is not liable for accuracy-related
penalties under sec. 6662(h) and that the estate’s net-net gift arrangement is
permissible, subject to Rule 155 computations.
                                        -3-

[*3] I. History of the Seneca Companies

      A. Founding of Seneca Sawmill Co.

      Mr. Jones established SSC in Eugene, Oregon, in 1954 as an Oregon

corporation. SSC employed 25 people during its first year in operation and

manufactured 18 million board feet of dimensional lumber. SSC has significantly

expanded its operations since its organization. It built a lumber storage shed and

expanded its log pond in 1959, purchased an adjacent mill facility and built a

barker for its mills in 1961, and paved and expanded the lumber and log yards and

added a chipper in 1965 before remodeling the dimension sawmill in 1967. SSC

expanded its log yard twice more, in 1971 and 1980, and built a new mill in 1978.

SSC built its stud mill in 1988 and further expanded its log yard and eliminated its

log pond in 1990.

      B. Acquisition of Timberlands and Founding of Seneca Jones Timber Co.

      From its founding through the 1980s SSC was largely dependent on timber

from Federal lands. Mr. Jones began to consider acquiring timberlands in the

early to mid-1980s when environmental regulations put continued access to

Federal timberlands at risk. In 1989 when Mr. Jones became convinced that SSC

soon would be unable to rely on timber from Federal lands, he purchased
                                         -4-

[*4] approximately 25,000 acres of timberland from the Woolley family. In 1992

Mr. Jones purchased an additional 104,000 acres of timberland from Champion

International and 21,000 acres from Pope & Talbot.

      On August 25, 1992, Mr. Jones formed SJTC, an Oregon limited

partnership, to invest in, acquire, hold, and manage timberlands and real property

and to incur indebtedness, and he contributed the timberlands he purchased in

1989 and 1992 in exchange for an interest. Mr. Jones contributed the timberlands

to SJTC rather than SSC because of tax and liability concerns. SJTC’s

timberlands were intended to be SSC’s inventory.

      SSC and SJTC share headquarters in Eugene, which were built in 1996.

SSC owns a 10% interest in SJTC as the sole general partner. As general partner

SSC has broad powers to manage and control SJTC.

      In 1997 SSC continued expanding with the construction of its log

merchandiser complex. In 2000 SSC modified its stud mill to increase production

length capabilities and, in 2006, built a stud mill facility capable of handling

smaller logs--as small as four inches in diameter--called a hewsaw line.
                                        -5-

[*5] II. Operations and Management of the Seneca Companies

      A. SSC

      SSC considers itself to be among the best lumber manufacturers in the

world. SSC’s two mills--its dimension and stud mills--are technologically

advanced and enable it to deliver high-quality products quickly while demanding a

higher price than its competitors. Some of the technological advancements

featured in SSC’s mills were developed by Mr. Jones, and SSC owns more than 25

patents. The annual production capacities of the dimension mill and the stud mill

are 214 million board feet and over 160 million board feet, respectively. In 2008

the dimension mill produced 140 million board feet, and the stud mill produced

103 million board feet.

      SSC sells its lumber around the country although the bulk of its sales are

made in the Western United States. SSC’s customers can pick up their lumber

orders at the mills or have them shipped by truck or railroad flatcar, depending on

the size of the order. As of the valuation date SSC’s dimension and stud lumber

were used primarily to build houses and, therefore, its lumber sales were almost

completely dependent on housing starts.

      As of the valuation date SSC’s largest supplier of logs was SJTC, although

its production capacity required it to purchase additional logs elsewhere. In 2008
                                        -6-

[*6] SSC purchased 32% of the logs it milled directly from SJTC. Additionally, it

acquired 24% of its logs indirectly from SJTC, through timber trades with

Roseburg Forest Products (Roseburg). See infra pp. 9-10. SSC bought 30% of its

logs from third-party sellers and 14% was stumpage or purchased under

Government contract. Because SSC purchases Federal timber, it is prohibited

from selling its lumber outside the United States.

      SSC’s management team as of the valuation date was as follows:

       Name                                Position
     Aaron Jones           President, chief executive officer, and chairman of
                            the board
     Richard T. Re         Senior vice president, general manager, and assistant
                            secretary
     Dale A. Riddle        Senior vice president of legal affairs
     Gary Brokaw           Vice president, chief financial officer, secretary, and
                            treasurer
     Todd Payne            Vice president--timber management
     Scott Keep            Vice president--land and timber
     Ted Bennett           Superintendent--production
     Wayne Madsen          Logging manager
     Anita Rea             Controller
     Jody Jones            Senior vice president--property development
                                         -7-

[*7] As of the valuation date SSC employed 263 employees, who were classified

as executive, administrative, or manufacturing. SSC’s manufacturing employees

included approximately 115 to 120 skilled mill workers, 35 to 40 semiskilled

workers, and approximately 20 laborers. In 1986 SSC elected to be taxed as an S

corporation. It was on the valuation date, and continues to be, an S corporation.

      B. SJTC

      SJTC held approximately 1.45 billion board feet of timber over 165,000

acres in western Oregon as of the valuation date. Most of SJTC’s trees are located

in Lane and Douglas Counties, but some are located in Benton, Coos, Curry,

Josephine, and Linn Counties. Almost all of its timberland was acquired in the

three initial purchases in 1989 and 1992. SJTC sought, and continues to seek, to

add to its tree farms, but it has found it difficult to compete for acquisitions with

timber investment management organizations (TIMOs) and real estate investment

trusts (REITs).3

      The predominant species on SJTC’s timberlands was Douglas fir, although

SJTC’s timber also included Hemlock fir, Western Red Cedar, Red Alder, and


      3
         A TIMO is an investment manager that specializes in large investments in
timberland. TIMOs do not own timberlands; rather they typically find and
purchase timberland for clients as investments and then manage those investments
for their clients. TIMOs and REITs do not practice sustained yield harvesting.
                                         -8-

[*8] others. Timber is a long-term asset that increases in value as it grows, but

only to a point. The range of merchantability--during which the timber is of prime

harvesting maturity--for timberlands similar to SJTC’s typically begins at 40

years. SJTC typically harvested its trees when they were 50 to 55 years old.

      SJTC practiced sustained yield harvesting, which means it limited its

harvest to the growth of its tree farms. In doing so SJTC used a model that

projects out 50 years, assuming a 50-year growth term, to determine its annual

yield each year. SJTC also used computer programs, including geographic

information systems such as ArcGIS--which is targeted to tree farm needs--and a

timber inventory management system to create, map, chart, visualize, and analyze

data sets to optimize its operation. The land management practices employed by

SJTC often surpassed those mandated by the Sustainable Forestry Initiative

Program--in which SJTC is a participant--and the Oregon Forest Practices Act,

with respect to sustainable timber production, reforestation, wildlife protection, air

and water protection, road construction, and recreational activities.

      SJTC prepared its timberland soil and sites to maximize growth,

participated in cooperatives that produce high-quality seeds, selected high-quality

seedlings from several nurseries, planted the seedlings by hand, and protected the

seedlings from predators. SJTC protected its trees from bears and ensured that
                                         -9-

[*9] they had enough space, nutrients, and water to grow to maturity. SJTC’s road

maintenance staff oversaw the construction and maintenance of access roads. In

addition SJTC participated in State and local government water rehabilitation

efforts and in wildfire prevention and suppression efforts.

      SJTC’s management team was identical to that of SSC and was paid by

SSC. SJTC had 21 employees on the valuation date, composed of administrative

and forestry staff. SJTC relied on SSC for human resources, legal services, and its

controller, and it paid a $1.2 million annual fee for administrative services to SSC.

It also used independent contractors for most of its activities on the tree farm,

including planting seedlings, road construction, and harvesting trees. SJTC’s

forestry staff oversaw between 150 and 200 contractors to ensure that they

completed their tasks according to SJTC’s standards and objectives.

      In 2008 SJTC harvested 67,795,000 board feet of timber. Approximately

51% of the timber it harvested--34,756,000 board feet--was sold to SSC. SJTC

also traded logs from its tree farms that were closer to Roseburg’s mills for

Roseburg’s logs that were closer to SSC’s mills in order to reduce hauling costs.

Including the Roseburg trades, approximately 89% of SJTC’s harvested logs went

to SSC. SJTC charged SSC the highest price that SSC paid for logs on the open

market. The only logs that SJTC did not directly or indirectly sell to SSC were
                                        - 10 -

[*10] logs that SSC’s mills were not capable of processing. In 2008 SJTC made

trades with Roseburg equal to approximately 37% of the logs it harvested.

      In addition, SJTC had an agreement with Roseburg to engage in tax-

deferred timberland exchanges to improve the site class of the timberlands and to

acquire land that was easier to access. These exchanges involved extensive due

diligence.

      C. Third-Party and Intercompany Loans

      SJTC and SSC were joint parties to their third-party credit agreement. Bank

loans were reported on SJTC’s books because its property--its timber--served as

collateral. Without SJTC’s timber, SSC was not likely to be able to obtain

financing on its own. Management would apply borrowed cash where it was

needed, transferring it without restriction and documenting it as a loan from SJTC.

And when SSC generated revenue by selling processed logs, it transferred money

in the form of a loan or a receivable to SJTC to repay the bank loans that SJTC

had taken out against its timber. On the valuation date SSC held a $32.7 million

receivable from SJTC. The companies did not require collateral, and they charged

interest at the rate specified in their bank loan agreement.

      Mr. Brokaw completed financial projections at the end of each year to be

included in the annual statements provided to lenders. In preparing these
                                        - 11 -

[*11] projections, he gathered necessary information, such as log prices and tree

harvest and mill production numbers, from across the Seneca companies. The

annual projections were premised on the most likely outcome.

      D. Formation of Seneca Sustainable Energy

      During the mid-1990s SSC began to notice a shift in market preferences

from green lumber, which still has the natural moisture in trees, to dry lumber,

which has had the moisture removed. SSC produced green lumber almost

exclusively until the early to mid-2000s, at which point it became clear that it

would have to move from green to dry lumber. To produce dry lumber SSC had to

build dry kilns and a boiler, which it planned to power with the sawdust and bark

that remained after it cut the logs into lumber. SSC decided to take advantage of

Federal Government incentives and a vibrant energy market. It built a renewable

energy plant to create steam energy to heat its dry kiln and to sell onto the

electrical grid. In 2009 Mr. Jones formed a separate entity, Seneca Sustainable

Energy, LLC (SSE), to own and manage the renewable energy plant.

      The renewable energy plant was estimated to cost approximately $50

million. While SSC’s management planned for SSE to finance construction of the

plant by getting a construction loan from a bank, SSC was forced to borrow

against SJTC’s timberlands because the state of the economy made banks hesitant
                                       - 12 -

[*12] to make construction loans in 2009. SJTC advanced SSE $18,412,009 in

2009, growing to over $52 million by 2010.

      E. Symbiotic Relationship Between SJTC and SSC

      SJTC and SSC, while separate legal entities, operated in tandem in

furtherance of SSC’s sawmill business. SJTC’s formation and its subsequent

activities were for the benefit of SSC. Starting in 1989 Mr. Jones purchased what

would become SJTC’s timberlands after becoming convinced that SSC’s

continued access to Federal timberlands--its primary source of logs--was at risk.

SJTC, since its formation, has aimed to expand its timberland holdings under the

theory that making a steady stream of timber available to SSC allows SSC to avoid

having to fight for a limited supply of timber on the open market and gives it a

better chance to succeed and flourish. To this end, SJTC sells--either directly or

through trades--all of the logs it can to SSC, selling only logs incompatible with

SSC’s equipment to third parties.

      SSC’s ability to use SJTC’s timberlands to secure bank loans also has been

integral to SSC’s operations, particularly during the subprime mortgage crisis.

Even as SJTC reduced its harvest, and SSC was forced to cut back on staff hours,

SJTC’s timberlands allowed SSC to obtain loans to maintain cashflow and to
                                        - 13 -

[*13] finance the construction of the renewable energy plant at a time when

construction loans were not typically available.

      And aside from SSC’s 10% general partner interest in SJTC, the ownership

of SSC and SJTC as of the valuation date was virtually the same. Mr. Jones

owned the bulk of the shares or units and each of his daughters--Rebecca Jones,

Kathleen Jones, and Jody Jones--owned a small interest. SSC’s management team

managed SJTC and SJTC paid SSC a fee for administrative services, including

human resources, legal services, and accounting. And as noted above, SJTC and

SSC lent money back and forth, sending cash where it was most needed and

charging each other the interest rate they negotiated with institutional lenders.

III. Effects of Economic Crisis on Operations

      As of the valuation date the United States was experiencing severe

economic turmoil amidst the subprime mortgage crisis, especially in the housing

market. Housing starts, which measure new residential construction projects

during a given period, declined in the United States from 2.3 million units in early

2006 to 490,000 units in early 2009. The crisis required SSC to reduce

production. It also reduced the hours that its employees worked so that it could

avoid layoffs. The crisis also prompted SJTC to reduce its timber harvest between

2007 and 2009, minimizing the number of logs it sold at depressed prices while its
                                       - 14 -

[*14] unharvested timber continued to appreciate. Other companies in the area

that did not own timberlands were not able to survive the recession because they

were unable to generate sufficient cashflows or borrow money at affordable

interest rates.

       In the midst of the recession, in early 2009, Roseburg, a competitor with

neighboring timberlands, approached SJTC about a timberland exchange because

Roseburg was concerned about its compliance with loan covenants. SSC’s

management team completed revised financial projections for both SJTC and SSC

in April 2009 to assess their abilities to comply with their own loan covenants,

using the same process to complete the April 2009 projections that it used to

complete its regular, yearly financial projections. The April 2009 projections

showed more pessimistic results than the projections SJTC completed for 2009

and 2010 at yearend. SJTC agreed to the exchange to boost its revenue for

generally accepted accounting principles purposes to ensure compliance with its

own loan covenants and to improve its land access and site class.

IV. Ownership of Seneca Companies and Gifts

       A. SSC

       SSC had the authority to issue 10,000 shares of class A common stock and

90,000 shares of class B common stock. SSC shareholders were entitled to one
                                           - 15 -

[*15] vote per share of class A stock on matters voted on by shareholders.

Holding class B stock did not entitle shareholders to vote. As of the valuation date

SSC had issued all 10,000 shares of class A stock and 41,100 shares of class B

stock. Immediately before the gifts of SSC stock, the ownership of SSC was as

follows:

         Owner                         Class A shares             Class B shares
 Aaron U. Jones                            4,900                      39,468
 Dale A. Riddle1                             600                        -0-
 Rebecca Jones                             1,500                         544
 Kathleen Jones                            1,500                         544
 Jody Jones                                1,500                         544

         1
             Mr. Riddle was a shareholder as trustee of the Aaron U. Jones Children’s
Trust.

         SSC’s shareholders could not sell, give away, or transfer their SSC stock

unless they did so in compliance with the Buy-Sell Agreement. Any sale of SSC

stock that caused SSC to cease to be an S corporation would be null and void

under the Buy-Sell Agreement, unless SSC and shareholders of a majority of its

outstanding shares gave their consent. If an SSC shareholder intended to sell, give

away, or transfer SSC stock to a person other than a family member, the

shareholder had to notify SSC, which had the right of first refusal with respect to
                                        - 16 -

[*16] those shares. If SSC declined to purchase the shares, the other shareholders

were given the option to purchase them. If SSC or the other shareholders did

exercise their option to purchase shares, the purchase price was the fair market

value of the shares. Fair market value, for purposes of the Buy-Sell Agreement,

was to be mutually agreed upon or, if the parties could not come to an agreement,

determined by an appraisal. Under the Buy-Sell Agreement, the reasonably

anticipated cash distributions allocable to the shares had to be considered and

discounts for lack of marketability, lack of control, and lack of voting rights had to

be applied in determining the fair market value.

      B. SJTC

      SSC, as SJTC’s general partner, made all management decisions for SJTC

and had full control over its business. SSC’s broad powers as the general partner

of SJTC included the powers to buy, sell, and exchange timberlands and

partnership property; to plant trees, harvest timber, and sell logs; and to incur

indebtedness. Limited partners did not participate in the SJTC’s management,

although they had the right to vote on the continuation of SJTC, the appointment

of a successor as general partner, the admission of an additional general partner,

the dissolution of SJTC, and amendments to the partnership agreement. The

unanimous consent of all partners was required to admit an additional general
                                         - 17 -

[*17] partner or to dissolve SJTC. Immediately before the gifts of SJTC

partnership units, the ownership of SJTC was as follows:

        Owner                    General partner units        Limited partner units
 Aaron U. Jones                           -0-                       43,290.717
 SSC                                   5,550.092                        -0-
 Rebecca Jones                            -0-                        2,220.037
 Kathleen Jones                           -0-                        2,220.037
 Jody Jones                               -0-                        2,220.037

       Under SJTC’s partnership agreement, limited partners were restricted in

their ability to transfer their interests in SJTC. No transfer of SJTC partnership

units was valid if it would terminate the partnership for Federal or State tax

purposes. The consent of all partners was required for the substitution of a

transferee of SJTC partnership units as a limited partner. A transferee who was

not substituted as a limited partner would be merely an assignee of allocations of

partnership profits and loss. Limited partners were also subject to a Buy-Sell

Agreement, which restricted transfers of their interests in SJTC. It mirrored SSC’s

Buy-Sell Agreement: Any transfers that would terminate SJTC’s partnership

status for tax purposes were void; SJTC and then the other limited partners were

granted a right of first refusal before a limited partner transferred his or her units;

and a determination of fair market value had to take into account lack of
                                        - 18 -

[*18] marketability, lack of control, lack of voting rights of an assignee, and the

reasonably anticipated cash distributions allocable to the units.

      C. Gifts and Succession Plan

      In 1996 Mr. Jones began to create a succession plan to ensure that his

family businesses remained operational in perpetuity. As part of this plan, he

formed the following family and generation-skipping trusts on May 28, 2009, to

which interests in the companies would be transferred as gifts:

            Trust                     Trustee                  Beneficiary
 Aaron U. Jones Voting         Dale Riddle            Issue of Aaron Jones
  Stock Trust
 Kathleen Jones Hall           Kathleen Jones Hall Kathleen Jones Hall and her
  Family Trust                                      issue during her lifetime
                                                    and, after her death, her
                                                    children
 Jody Jones Family Trust       Jody Jones             Jody Jones and her issue
                                                       during her lifetime and,
                                                       after her death, her children
 Rebecca Jones Family          Rebecca Jones          Rebecca Jones and her issue
  Trust                                                during her lifetime and,
                                                       after her death, her children
 Kathleen Jones Hall Trust     Kathleen Jones Hall Kathleen Jones Hall
 Jody Jones Trust              Jody Jones             Jody Jones
 Rebecca Jones Trust           Rebecca Jones          Rebecca Jones
                                      - 19 -

[*19] On the valuation date, Mr. Jones gave blocks of stock in SSC in the

following amounts:

                 Trust                    Class A shares        Class B shares
 Aaron U. Jones Voting Stock Trust             1,300                  -0-
 Kathleen Jones Hall Family Trust               -0-                  4,800
 Jody Jones Family Trust                        -0-                  4,800
 Rebecca Jones Family Trust                     -0-                  4,800
 Kathleen Jones Hall Trust                      -0-                  5,456
 Jody Jones Trust                               -0-                  5,456
 Rebecca Jones Trust                            -0-                  5,456

In addition, Mr. Jones made gifts to each of his daughters--Rebecca Jones,

Kathleen Jones Hall, and Jody Jones--of blocks of 10,267.67 SJTC limited partner

units and 10,256 shares of class B nonvoting stock in Rifle Range Road Corp.

(Rifle Range).

      Immediately after the gifts were made, the ownership of SSC was as

follows:
                                           - 20 -

 [*20]               Owner                        Class A shares         Class B shares
 Aaron U. Jones                                       3,600                   8,700
 Aaron U. Jones Voting Stock Trust                    1,300                       -0-
 Dale Riddle1                                          600                        -0-
 Rebecca Jones                                        1,500                       544
 Kathleen Jones Hall                                  1,500                       544
 Jody Jones                                           1,500                       544
 Rebecca Jones Family Trust                            -0-                    4,800
 Kathleen Jones Hall Family Trust                      -0-                    4,800
 Jody Jones Family Trust                               -0-                    4,800
 Rebecca Jones Trust                                   -0-                    5,456
 Kathleen Jones Hall Trust                             -0-                    5,456
 Jody Jones Trust                                      -0-                    5,456

         1
             Mr. Riddle was a shareholder as trustee of the Aaron U. Jones Children’s
Trust.

Immediately after the gifts were made, the ownership of SJTC was as follows:

               Owner               General partner units           Limited partner units
 Aaron U. Jones                             -0-                        12,487.707
 SSC                                     5,550.92                           -0-
 Rebecca Jones                              -0-                        12,487.707
 Kathleen Jones Hall                        -0-                        12,487.707
 Jody Jones                                 -0-                        12,487.707
                                        - 21 -

[*21] Mr. Jones signed net-net gift agreements with each of his daughters in which

his daughters assumed liability for the gift tax and estate tax associated with the

transfers made on the valuation date.

      Mr. Jones timely filed his Form 709, United States Gift (and Generation-

Skipping Transfer) Tax Return, for the 2009 tax year, along with valuation reports

for SSC and SJTC prepared by Columbia Financial Advisors, Inc. (Columbia

Financial). Columbia Financial came to the following valuation conclusions:

            Shares/units             Value per share/unit        Value of block
 SSC class A (voting)                        $325                   $422,500
 SSC class B (nonvoting) 1                       315                1,512,000
 SSC class B (nonvoting) 2                       315                1,718,640
 SJTC limited partnership units                  350                3,593,685

      In the notice of deficiency, respondent made the following determinations

of value:
                                       - 22 -

 [*22]     Shares/units              Value per share/unit           Value of block
 SSC class A (voting)                       $1,395                   $1,813,032
 SSC class B (nonvoting) 1                   1,325                    6,359,568
 SSC class B (nonvoting) 2                   1,325                    7,228,709
 SJTC limited partnership units              2,511                   25,780,000
 Rifle Range class B1                           4.20                     43,075

      1
         The estate has not introduced any evidence or made any argument
regarding respondent’s adjustments to the block of Rifle Range stock transferred
as gifts. We therefore deem those conceded.

V. Expert Valuation Reports

      Both parties submitted expert reports providing valuations of the blocks of

SJTC limited partnership units transferred by Mr. Jones. The estate submitted an

expert report providing a valuation of the blocks of class A and class B SSC stock

transferred by Mr. Jones, and respondent submitted a rebuttal expert report

critiquing that valuation. We provide a summary of their conclusions and our own

conclusions as to their valuations below as part of our analysis.
                                        - 23 -

[*23]                                 OPINION

I. Introduction and Burden of Proof

        At issue are the values of Mr. Jones’ gifts of SSC class A and B stock and

SJTC limited partnership units. Ordinarily, the taxpayer bears the burden of

proving that the Commissioner’s determinations are erroneous. Rule 142(a);

Welch v. Helvering, 290 U.S. 111, 115 (1933). The estate asserts that it provided

complete and conclusive documentation and credible testimony of a correct

valuation of the interests in SJTC and SSC sufficient to shift the burden of proof

under section 7491(a).

        Under section 7491(a)(1), “[i]f, in any court proceeding, a taxpayer

introduces credible evidence with respect to any factual issue relevant to

ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B,

the Secretary shall have the burden of proof with respect to such issue.” See

Higbee v. Commissioner, 116 T.C. 438, 442 (2001) (“Credible evidence is the

quality of evidence which, after critical analysis, the court would find sufficient

upon which to base a decision on the issue if no contrary evidence were submitted

(without regard to the judicial presumption of IRS correctness).” (quoting H.R.

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

resolution of this issue does not depend on which party has the burden of proof.
                                       - 24 -

[*24] We resolve it on the basis of a preponderance of the evidence in the record.

See Knudsen v. Commissioner, 131 T.C. 185, 189 (2008), supplementing T.C.

Memo. 2007-340; Schank v. Commissioner, T.C. Memo. 2015-235, at *16.

      The SSC Class A and B stock and the SJTC units were valued at $325,

$207, and $230, respectively, on the gift tax return.4 The estate now asserts that

the interests’ fair market values are $390, $380, and $380, respectively, thus

conceding a small part of respondent’s deficiency. Respondent subsequently

increased his valuation of an SJTC limited partnership unit from $2,511 to $2,530,

and he bears the burden of proof with respect to the increased deficiency

attributable to that increase in valuation. See Anselmo v. Commissioner, 80 T.C.

872, 886 (1983), aff’d, 757 F.2d 1208 (11th Cir. 1985); Learner v. Commissioner,

T.C. Memo. 1983-122.

II. Gift Tax Valuation Principles

      Gift tax is imposed for each calendar year on the transfer of property by gift

during that taxable year by an individual. Sec. 2501(a). Gift tax ordinarily is to be

paid by the donor. Sec. 2502(c). The tax is computed on the basis of the taxable

gifts made in a calendar year. Sec. 2502(a). The term taxable gifts means the total


      4
       The estate’s reported values differ from the values at which Columbia
Financial arrived.
                                        - 25 -

[*25] amount of gifts made in the year, less certain deductions. Sec. 2503(a). The

total amount of gifts in the year is the sum of the values of the gifts made in the

year in excess of the exclusion amount in section 2503(b). Sec. 25.2503-1, Gift

Tax Regs. The value of a gift of property is determined as of the date it is given.

Sec. 2512(a).

      The fair market value of property transferred as a gift is the price at which it

would change hands between a willing buyer and a willing seller, neither under

any compulsion to buy or sell and both having reasonable knowledge of the

relevant facts. United States v. Cartwright, 411 U.S. 546, 551 (1973); Estate of

Newhouse v. Commissioner, 94 T.C. 193, 217 (1990); sec. 25.2512-1, Gift Tax

Regs. The willing buyer and seller are hypothetical persons, not any specific or

named person. Estate of Simplot v. Commissioner, 249 F.3d 1191, 1195 (9th Cir.

2001), rev’g and remanding 112 T.C. 130 (1999); Morrissey v. Commissioner, 243

F.3d 1145, 1148 (9th Cir. 2001), rev’g T.C. Memo. 1999-119; Estate of Kahn v.

Commissioner, 125 T.C. 227, 231 (2005).

      When determining the fair market value of unlisted stocks for which no

recent sales or bids have been made, several factors should be considered,

including: the company’s net worth, its earning power and dividend-paying

capacity, its good will, the economic outlook in the industry, its management and
                                        - 26 -

[*26] its position in the industry, the degree of control of the business represented

in the block of stock to be valued, and the value of stock in similar, publicly traded

companies. Sec. 25.2512-2(f)(2), Gift Tax Regs.; see also Estate of Adell v.

Commissioner, T.C. Memo. 2014-155, at *42; Rev. Rul. 59-60, sec. 4, 1959-1

C.B. 237, 238-242. When determining the fair market value of an interest in a

partnership, the value of the partnership’s assets may be considered, along with the

same factors considered in determining the fair market value of stock. Sec.

25.2512-3(a), Gift Tax Regs.

III. Expert Reports

      A. The Estate’s Expert

      The estate’s valuation expert, Richard Reilly, has performed approximately

100 business valuations of sawmills and timber product companies. Mr. Reilly

valued SJTC and SSC as going concerns and relied on an income approach--

specifically the discounted cashflow (DCF) method--and a market approach in

valuing the units of SJTC and SSC transferred as gifts.

      Mr. Reilly concluded that SJTC was worth $21 million on a noncontrolling,

nonmarketable basis, after adjustments and discounts, and he calculated a value of

$380 per unit on the basis of the number of outstanding partnership units. Using
                                       - 27 -

[*27] that valuation, the noncontrolling, nonmarketable value of the block of

limited partner units transferred by Mr. Jones to each of his daughters is

$3,901,715.

      Mr. Reilly concluded that SSC was worth $20 million on a noncontrolling,

nonmarketable basis, after adjustments and discounts, and he calculated a value of

$390 per share of class A voting stock on the basis of the number of outstanding

shares. He applied a 3% discount for lack of voting rights by relying on empirical

studies and arrived at a $380 value per share of class B nonvoting stock.

      B. Respondent’s Experts

      Respondent’s valuation expert, Philip Schwab, has performed several

privately held business valuations. Mr. Schwab valued SJTC as a going concern

and relied on an asset-based approach--specifically the net asset value (NAV)

method--and a market approach in valuing one SJTC limited partnership unit.

After applying adjustments and discounts, Mr. Schwab determined that the value

of SJTC on a noncontrolling, nonmarketable basis was $140,398,000. He

determined a value of $2,530 per limited partner unit on the basis of the number of

outstanding partnership units and a value of $25,973,611 for the block of units Mr.

Jones transferred to each of his daughters.
                                        - 28 -

[*28] John Ashbrook was respondent’s rebuttal expert with respect to Mr. Reilly’s

valuation of SSC stock. Mr. Ashbrook previously had reviewed and completed

several business valuations, including several sawmills. Mr. Ashbrook challenged

Mr. Reilly’s use of the April 2009 revised projections and his treatment of SSC’s

general partner interest in SJTC and the intercompany receivable it held.

      C. Valuation Issues

      When considering expert testimony, we have “broad discretion to evaluate

‘the overall cogency of each expert’s analysis.’” Sammons v. Commissioner, 838

F.2d 330, 334 (9th Cir. 1988) (quoting Ebben v. Commissioner, 783 F.2d 906, 909

(9th Cir. 1986), aff’g in part, rev’g in part T.C. Memo. 1983-200), aff’g in part,

rev’g in part T.C. Memo. 1986-318. We are not bound to follow the opinion of

any expert witness where it is contrary to our own judgment. Helvering v. Nat’l

Grocery Co., 304 U.S. 282, 295 (1938); Estate of Hall v. Commissioner, 92 T.C.

312, 338 (1989); Estate of Adell v. Commissioner, at *43. And we may adopt or

reject an expert’s opinion in whole or in part. Davis v. Commissioner, 110 T.C.

530, 538 (1998); see also Buffalo Tool & Die Mfg. Co. v. Commissioner, 74 T.C.

441, 452 (1980). Valuation is a question of fact, and the factors considered in

determining value should be weighed according to the circumstances in each case.
                                        - 29 -

[*29] Sammons v. Commissioner, 838 F.2d at 334; Rev. Rul. 59-60, sec. 5, 1959-1

C.B. at 242.

      Three generally accepted approaches are used to value equity interests in

closely held businesses: the income approach, the market approach, and the asset-

based approach. Exelon Corp. v. Commissioner, 147 T.C. 230, 244 (2016), aff’d,

906 F.3d 513 (7th Cir. 2018); Estate of Noble v. Commissioner, T.C. Memo.

2005-2, 2005 WL 23303, at *7. The income approach uses either the direct

capitalization method or the DCF method to convert the anticipated economic

benefits that the holder of the interest would stand to realize into a single present-

valued amount. Estate of Noble v. Commissioner, 2005 WL 23303, at *7. The

market approach values the interest by comparing it to a comparable interest that

was sold at arm’s length in the same timeframe, accounting for differences

between the companies by making adjustments to the sale price. Id. And the

asset-based approach values the interest by reference to the company’s assets net

of its liabilities. Id. When valuing an operating company that sells products or

services to the public, the company’s income receives the most weight. See Estate

of Andrews v. Commissioner, 79 T.C. 938, 944-945 (1982). When valuing a

holding or investment company, which receives most of its income from holding
                                        - 30 -

[*30] debt, securities, or other property, the value of the company’s assets will

receive the most weight. Id. at 945.

      The primary dispute between the parties is whether SJTC should be valued

using an income approach or an asset-based approach. The parties have several

other points of dispute: (1) the reliability of the 2009 revised projections, (2) the

propriety of “tax-affecting”, (3) the proper treatment of intercompany loans from

SSC to SJTC, (4) the proper treatment of SSC’s 10% general partner interest in

SJTC, and (5) the appropriate discount for lack of marketability. We consider

these in detail below.

IV. Valuing SJTC

      The estate contends that SJTC is an operating company that sells a product--

logs--and, therefore, should be valued as a going concern with primary

consideration to its earnings. See Rev. Rul. 59-60, sec. 5(a). Respondent, on the

other hand, contends that SJTC is a natural resource holding company and,

therefore, the value of its timberlands--its underlying assets--should be given

primary consideration in our valuation. See id. The estate rejects respondent’s

asset-based valuation because there is no likelihood of SJTC’s selling its

timberlands.
                                        - 31 -

[*31] A. Operating Versus Holding Company

      The parties do not dispute that SJTC is a going concern. Rather, they

disagree on whether SJTC is an operating company that sells a product or a natural

resource holding company that simply holds timber as an investment for its

partners. Not all companies are apt to be characterized as simply an operating

company or a holding or investment company. Estate of Andrews v.

Commissioner, 79 T.C. at 944. An example is a company whose assets, especially

its real property, play a significant role in its income-producing operations. See

Estate of Smith v. Commissioner, T.C. Memo. 1999-368, 1999 WL 1001184,

at *5. When valuing an interest in a company that has aspects of both an operating

company and a holding or investment company, we will not “restrict [our]

consideration to only one approach to valuation”. Estate of Andrews v.

Commissioner, 79 T.C. at 945.

      SJTC’s timberlands are its primary asset, and they will retain and increase in

value, even if SJTC is not profitable on a year-to-year basis. See id. at 944.

Therefore, it may be appropriate to consider an asset-based approach in valuing an

interest in SJTC. See Estate of Smith v. Commissioner, 1999 WL 1001184, at *5.

      SJTC also is an operating company that plants trees and harvests and sells

the logs. Cf. Harwood v. Commissioner, 82 T.C. 239, 243, 265 (1984) (holding
                                        - 32 -

[*32] that a timber company that simply acquired and held timberlands and timber

rights for use by its affiliated companies should be valued on the basis of its

assets), aff’d, 786 F.2d 1174 (9th Cir. 1986). It expends significant time and effort

to ensure that its operation is efficient, including selecting high-quality seedlings,

planting them properly, and protecting them once planted. It also practices

sustained yield harvesting, which requires the use of sophisticated software to

ensure that it could maintain its timberlands over the long term, even if selling the

land or harvesting all of the trees would be most profitable in the short term.

Thus, SJTC is different from TIMOs, REITs, and other holding or investment

companies, and an income approach may be appropriate in valuing an interest in

SJTC.

         We conclude that SJTC has aspects of both an operating company and an

investment or holding company. Because it does not fit neatly into either

category, a valuation that combines consideration of SJTC’s earnings and assets

and weights each appropriately may be necessary, so we must dig deeper into the

facts.
                                        - 33 -

[*33] B. Sale of Timberlands

      An asset-based approach necessarily assumes access to the value of SJTC’s

underlying assets--its timberlands--through a hypothetical sale. The likelihood

that SJTC would sell its timberlands goes to the relative weight that we give an

asset-based approach in valuing SJTC; the less likely SJTC is to sell its

timberlands, the less weight we should assign to an asset-based approach. See

Estate of Giustina v. Commissioner, 586 F. App’x 417, 418 (9th Cir. 2014)

(holding that no weight should be given to an asset-based valuation because the

assumption of an asset sale was a hypothetical scenario contrary to the evidence in

the record), rev’g and remanding T.C. Memo. 2011-141, 2011 WL 2559847.

      The parties disagree on two points that bear on whether SJTC would sell its

timberlands: (1) whether SJTC could sell its timberlands and (2) whether we

should consider SJTC separately or as a single business enterprise with SSC.

Respondent contends that circumstances may arise in which SJTC could and

would sell its timberlands. The estate argues that holders of blocks of SJTC

limited partnership units could not force a sale of its timberlands under the

partnership agreement and that SSC, which has the exclusive authority to direct

SJTC to make such a sale, would never exercise that authority. Respondent argues

that this inappropriately considers specific--rather than hypothetical--buyers and
                                        - 34 -

[*34] sellers. We disagree. SSC’s exclusive authority to exercise control over

SJTC under the partnership agreement, its interest in SJTC’s continued ownership

of the timberlands, see infra, and the restrictions imposed on limited partners

under the partnership agreement do not depend on how many limited partners

SJTC has or who they are. These restrictions apply to the interest because of the

partnership agreement and the rights held by SSC and would be taken into account

by any hypothetical buyer and seller of a limited partner interest.

      As further support for its position, the estate argues that we should consider

SJTC and SSC as a single business operation even though they are separate legal

entities. Respondent argues that because SJTC and SSC are separate legal entities,

we should ignore their interdependent relationship when valuing them. SSC’s

continued operation as a sawmill company depended on SJTC’s continued

ownership of timberlands and there was no likelihood that SSC, as SJTC’s general

partner, would direct SJTC to sell its timberlands while SSC continued operations

as a sawmill. In addition, they had almost identical ownership, and they shared

administrative staff. Therefore, on the basis of the facts we found above, we

conclude that SJTC and SSC were so closely aligned and interdependent that, in

valuing SJTC, it is appropriate to take into account its relationship with SSC and

vice versa. Contrary to respondent’s objection, this does not ignore the status of
                                         - 35 -

[*35] SJTC and SSC as separate legal entities but recognizes their economic

relationship and its effect on their valuations.

       We, therefore, conclude that an income-based approach, like Mr. Reilly’s

DCF method, is more appropriate for SJTC than Mr. Schwab’s NAV method

valuation. See Estate of Giustina v. Commissioner, 586 F. App’x at 418.

      C. Mr. Reilly’s DCF Method

      Respondent offered two principal criticisms of Mr. Reilly’s DCF method

valuation: (1) Mr. Reilly should not have relied on the April 2009 revised

projections and (2) Mr. Reilly should not have “tax-affected” SJTC’s earnings

before interest and taxes (EBIT) in projecting net cashflow.

             1. April 2009 Revised Projections

      Respondent argues that the April 2009 revised projections that Mr. Reilly

used in determining SJTC’s net cashflow were unreliable. These revised

projections were made less than two months after SJTC’s annual report out of

concern that SJTC was going to violate loan covenants.

      The companies’ management team completed the April 2009 revised

projections using the same process that they used to prepare the yearly projections

included in their annual reports. They were the most current projections and were

relied on for business decisions at the valuation date. In fact, respondent’s expert,
                                         - 36 -

[*36] Mr. Schwab, also used the revised projections in his guideline publicly

traded companies valuation. He averaged the revised projections with the

projections from the most recent annual report because he thought the revised

projections may have represented the worst-case scenario and were overly

pessimistic, not because he felt the projections were unreliable. The only ground

for challenging the reliability of the revised projections is that the volatile

economic conditions meant that they were not reliable for long. This is precisely

why management wanted the revised projections. As they were the most current

as of the valuation date, Mr. Reilly’s use was appropriate.

             2. “Tax-Affecting” the Valuation of SJTC

      In his DCF method Mr. Reilly “tax-affected” SJTC’s earnings. To do this

he used 38% as a proxy for the combined Federal and State tax burdens that

owners of SJTC would bear (treating SJTC in effect as a taxable C corporation,

albeit at an individual, not corporate, tax rate), and adjusted both the earnings he

used to calculate SJTC’s net cashflow and the cost of debt capital he used to

determine the appropriate discount rate. He then computed the benefit of the

dividend tax avoided by estimating the implied benefit for SJTC’s partners in prior

years and considering an empirical study analyzing S corporation acquisitions

cited in his report. In his guideline publicly traded companies valuation, he used
                                         - 37 -

[*37] the tax-affected earnings as well, although the metrics he used to compare

the companies to SJTC were pretax. Finally, he applied a 22% premium to SJTC’s

weighted business enterprise value (that is, his weighted DCF method and

guideline publicly traded companies method valuations) to reflect that benefit.

      Respondent contends that Mr. Reilly improperly adjusted SJTC’s value for

entity-level taxes even though it is a partnership and, therefore, is not liable for tax

at the entity level, and there is no evidence that SJTC would become a taxable C

corporation. He further argues that tax-affecting abandons the arm’s length

formulation of fair market value, in the absence of a showing that two unrelated

parties dealing at arms length would tax-affect SJTC’s earnings, because it

inappropriately favors a hypothetical buyer over the hypothetical seller.

Therefore, it understates the value of a limited partner interest in SJTC.

Respondent instead argues that a zero tax rate appropriately reflects SJTC’s

flowthrough status.

      The estate argues that a zero tax rate at the entity level would overstate the

value of an interest in SJTC. This, it contends, is because SJTC is a passthrough

entity, and its partners are taxed at their ordinary rates on their shares of

partnership income and gain whether or not SJTC distributes any cash, and a

hypothetical buyer would take this into consideration. And therefore, it contends,
                                        - 38 -

[*38] a valuation of SJTC must take into account the partners’ tax liabilities in

their expected return on their investment. The estate also argues that a

hypothetical buyer and seller also would take into account the benefit of dividend

taxes avoided by operating as a flowthrough.

      In support of its argument, the estate cites Bernier v. Bernier, 873 N.E.2d

216 (Mass. 2007). There, in the context of a divorce dispute involving an

S corporation, a Massachusetts State court held:

      [A]pplying the C corporation rate of taxation to an S corporation
      severely undervalues the fair market value of the S corporation by
      ignoring the tax benefits of the S corporation structure and failing to
      compensate the seller for the loss of those benefits. On the other
      hand, * * * we agree * * * that failure entirely to tax affect an S
      corporation artificially will inflate the value of the S corporation by
      overstating the rate of return that the retaining shareholder could hope
      to achieve. * * *

Id. at 221 (citing Del. Open MRI Radiology Assocs. v. Kessler, 898 A.2d 290,

327-328 (Del. Ch. 2006) (“Affording a remedy to the Kessler Group that denies

the reality that each shareholder owes taxes on his proportional interest in

Delaware Radiology would result in the Kessler Group receiving a higher per

share value from the court than it could ever have realized as a continuing

shareholder.”)); see also Franklin M. Fisher, Christopher F. Noe, & Evan Sue

Schouten, “The Sale of the Washington Redskins: Discounted Cash Flow
                                        - 39 -

[*39] Valuation of S-Corporations, Treatment of Personal Taxes, and Implications

for Litigation”, 10 Stan. J.L. Bus. & Fin. 18 (2005); Courtney Sparks White,

Comment, “S Corporations: A Taxing Analysis of Proper Valuation”, 37 Cap. U.

L. Rev. 1117 (2009).

      In effect, both parties argue that a hypothetical buyer and seller would take

into account SJTC’s business form when determining the fair market value of a

limited partner interest; they just disagree about how to do this. As we did in

Gross v. Commissioner, T.C. Memo. 1999-254, 1999 WL 549463, aff’d, 272 F.3d

333 (6th Cir. 2001), and subsequent cases, we decide this question of fact on the

basis of the record before us.

      While respondent objects vociferously in his brief to petitioner’s tax-

affecting, his experts are notably silent. The only mention comes in Mr. Schwab’s

rebuttal report, in which he argues that Mr. Reilly’s tax-affecting was improper,

not because SJTC pays no entity level tax, but because SJTC is a natural resources

holding company and therefore its “rate of return is closer to the property rates of

return”. They do not offer any defense of respondent’s proposed zero tax rate.

Thus, we do not have a fight between valuation experts but a fight between

lawyers.
                                        - 40 -

[*40] We do not find respondent’s arguments against Mr. Reilly’s methodology

convincing. While respondent correctly points out that we rejected the proffered

tax-affecting in Gross and later cases, he misconstrues our rationale. In Gross v.

Commissioner, 1999 WL 549463, at *10, we concluded that “the principal benefit

that shareholders expect from an S corporation election is a reduction in the total

tax burden imposed on the enterprise. The owners expect to save money, and we

see no reason why that savings ought to be ignored as a matter of course in

valuing the S corporation.” We then concluded that, on the record in that case, a

zero-percent corporate tax rate properly reflected those tax savings, rejecting the

expert’s offered justifications.5 More recently, in Estate of Gallagher v.

Commissioner, T.C. Memo. 2011-148, 2011 WL 2559847, at *12, supplemented

by T.C. Memo. 2011-244, we again rejected tax-affecting because the taxpayer’s

expert did not justify it but again acknowledged that the benefit of a reduction in

the total tax burden borne by S corporation owners should be considered when


      5
         Indeed in discussing the analysis by the Commissioner’s expert in Gross
we noted the importance of treating both cashflows and the discount rate
consistently, as Mr. Reilly did here. Gross v. Commissioner, T.C. Memo. 1999-
254, 1999 WL 549463, at *10-*11, aff’d, 272 F.3d 333 (6th Cir. 2001). In Gross
the expert applied a hypothetical 40% corporate tax rate to earnings but did not
apply any premium to reflect the benefit of avoided dividend tax. Thus the Court
was presented with a choice between a 40% or a 0% corporate tax rate. Id. That
is not the choice before us here.
                                        - 41 -

[*41] valuing an S corporation. And in Estate of Giustina v. Commissioner, 2011

WL 2516168, at *6, we rejected tax-affecting in the valuation of a partnership

because we found the taxpayer’s expert’s method to be faulty: He used a pretax

discount rate to present value posttax cashflow. The question in those cases, as

here, was not whether to take into account the tax benefits inuring to a

flowthrough entity but how.

      We find on the record before us that Mr. Reilly has more accurately taken

into account the tax consequences of SJTC’s flowthrough status for purposes of

estimating what a willing buyer and willing seller might conclude regarding its

value. His adjustments include a reduction in the total tax burden by imputing the

burden of the current tax that an owner might owe on the entity’s earnings and the

benefit of a future dividend tax avoided that an owner might enjoy. We are

mindful that the science of valuing closely held companies usually results in a

“gross terminal logical inexactitude” in the words of Winston Churchill. E.g.,

Maris v. Commissioner, T.C. Memo. 1980-444. And as we admonished in Buffalo

Tool & Die Mfg. Co. v. Commissioner, 74 T.C. at 452, “in the final analysis, the

Court may find the evidence of valuation by one of the parties sufficiently more

convincing than that of the other party, so that the final result will produce a

significant financial defeat for one or the other, rather than a middle-of-the-road
                                       - 42 -

[*42] compromise which we suspect each of the parties expects the Court to

reach.” Mr. Reilly’s tax-affecting may not be exact, but it is more complete and

more convincing than respondent’s zero tax rate.

      D. The Market Approach

      Both Mr. Reilly and Mr. Schwab also used the guideline public company

method for SJTC, which values an interest in a subject company by comparing it

to publicly traded companies in the same line of business, combining the resulting

value from that method with their other chosen method. Both experts conducted

database searches for guideline companies that produced similar groups of

companies. In his brief respondent accepted Mr. Reilly’s market approach

valuation. We do as well and recap it below.

      Mr. Reilly chose six guideline companies: Pope Resources, Plum Creek

Timber, Potlatch Corp., Rayonier, Weyerhaeuser, and Deltic Timber. He then

used four different measures to assess the differences between SJTC and the

guideline companies: (1) EBIT, (2) earnings before interest, taxes, depreciation,

depletion, and amortization (EBITDDA), (3) revenue, and (4) adjusted tangible

book value of invested capital (ATBVIC). ATBVIC is calculated by adding the

accounting book value of the interest-holder’s equity to the accounting book value
                                        - 43 -

[*43] of the interest-bearing debt, minus the accounting book values of intangible

assets and the timberlands, plus the estimated market value of the timberlands.

      Mr. Reilly relied on SJTC’s reported and projected earnings for the 2010

fiscal year, the last 12 months before the valuation date, and the historical five-

year average, and SJTC’s reported and projected revenue for the 2009 and 2010

fiscal years, the last 12 months before the valuation date and the historical five-

year average. And he relied on SJTC’s ATBVIC for the last 12 months before the

valuation date. The estate accepted the timberland valuation submitted by

respondent’s expert, Christopher Singleton, which concluded that the timberland

had a fair market value of $424 million as of the valuation date. Therefore, Mr.

Reilly used $424 million as the estimated market value of SJTC’s timberlands in

calculating ATBVIC.

      Mr. Reilly found that SJTC was significantly smaller than the median

guideline company measured by revenue and assets in the last 12 months before

the valuation date. He also found that SJTC was less profitable than all but one of

the guideline companies measured by projected EBITDDA for the 2009 fiscal

year, although it was more profitable than any of the guideline companies in terms

of the historical five-year average of EBITDDA. Finally, while SJTC projected

significant earnings growth between the 2009 and 2013 fiscal years, its revenue
                                      - 44 -

[*44] decreased at a faster pace than the median guideline company over the

previous five years.

      To account for the differences between SJTC and the guideline companies,

Mr. Reilly selected pricing multiples to apply to SJTC’s financial fundamentals for

EBIT and EBITDDA that were slightly above the guideline company low, for

revenue that was slightly under the guideline company low, and for ATBVIC that

was below the guideline company low. On the basis of the indicated enterprise

values for each measure, Mr. Reilly calculated a weighted enterprise value for

SJTC of $107 million on a noncontrolling, marketable basis.6

      E. Intercompany Debt

      Respondent argues that Mr. Reilly erred in his treatment of intercompany

loans from SSC to SJTC. Mr. Reilly regarded the intercompany debt as a clearing

account or “simply two pockets of the same pair of pants”, excluding the

receivable held by SSC and SJTC’s offsetting liability, while taking account of

SSC’s and SJTC’s intercompany interest income and expense. Respondent argues


      6
        Mr. Reilly gave a 10% weight to each of EBIT and EBITDDA projections
for the 2010 fiscal year, for the 12 months before the valuation date, and for the
historical five-year average. He gave a weight of 5% to each of the revenue
projections for the 2009 and 2010 fiscal years, the revenue for the 12 months
before the valuation date, and the historical five-year revenue average. And he
gave a 20% weight to the ATBVIC for the 12 months before the valuation date.
                                        - 45 -

[*45] that Mr. Reilly eliminated the intercompany debt because it would have left

SJTC with a negative value, an absurd conclusion that Mr. Reilly wished to avoid.

Respondent argues that, while Mr. Reilly treated SSC’s receivable from SJTC as

an operating asset, it is actually a nonoperating asset, the value of which should

have been added back into Mr. Reilly’s DCF method valuation at the end.

Respondent contends that the intercompany receivable is an investment in a

separate company rather than one made in the course of SSC’s business.

      SJTC would have a negative value only if we accepted respondent’s premise

that we should not consider SJTC and SSC as a single business enterprise. We

rejected respondent’s premise. Here, the size of the intercompany debt is directly

related to the connection between the two companies. SSC’s loan to SJTC was not

an investment in a separate company but rather an intercompany clearing account.

Management used these accounts to move cash across the Seneca companies, as

needed, assigning the cost of borrowing to the unit using the cash by charging

interest on intercompany transfers. While the interest rate was arm’s length in that

it reflected the rate the Seneca companies were charged by the third-party lender,

there was no indication that third-party loans would be available to SSC on those

terms without the security of SJTC’s timberlands. Rather the fact that SSC and

SJTC’s joint credit agreements are secured by SJTC’s timberlands is evidence that
                                       - 46 -

[*46] SSC could not obtain third-party loans. Similarly, the record does not

support a conclusion that SJTC would be able to borrow from third parties the

amounts of the outstanding loans from SSC on those terms, in addition to the

third-party debt it had outstanding. By eliminating SSC’s receivable and SJTC’s

payable and treating their intercompany interest income and expense as operating

income and expense, Mr. Reilly captured their relationship as interdependent parts

of a single business enterprise. Because SJTC’s intercompany interest income and

expense were accounted for in the DCF method valuation, the intercompany debt

need not be added in at the end as a nonoperating asset. See Estate of Heck v.

Commissioner, T.C. Memo. 2002-34.

V. Valuing SSC

      Respondent did not submit a valuation of SSC and largely accepted the

valuation methods and inputs Mr. Reilly used in his valuation of SSC.

Respondent has three criticisms of Mr. Reilly’s concluded values of $390 and

$380 per share for SSC voting and nonvoting stock, respectively: (1) Mr. Reilly

improperly treated SSC’s $32.7 million receivable from SJTC as an operating

asset, (2) Mr. Reilly improperly treated SSC’s general partner interest in SJTC as

an operating asset and improperly accounted for it in SSC’s value, and (3) Mr.

Reilly improperly tax-affected his DCF method valuation of SSC.
                                       - 47 -

[*47] A. Intercompany Debt

      Respondent objects to treatment of SSC’s intercompany receivable from

SJTC as an operating asset. As discussed above, SSC and SJTC were part of a

single business enterprise, and management used intercompany accounts to move

cash between the companies. SSC’s advances to SJTC were not investments; they

were cash transfers to the borrowing arm of the Seneca enterprise--SJTC--so that it

could pay down debt to third-party lenders. Mr. Reilly’s valuation properly

eliminated these intercompany clearing accounts and properly treated the

receivable as part of SSC’s operations that produced operating income.

      B. SSC’s General Partner Interest in SJTC

      Mr. Reilly accounted for SSC’s general partner interest in SJTC in his DCF

method by including a projected amount of partnership income in his projections.

For each year in the projection period Mr. Reilly added $350,000 in partnership

income, which he determined using the 5-year and the 10-year historical median

distributions from SJTC.

      Respondent contends that a valuation of SSC should account for the general

partner’s control over SJTC. He argues that Mr. Reilly understates the value of

SSC’s general partner interest in SJTC by limiting it to expected distributions. He

contends that the general partner interest is a nonoperating asset--an outside
                                        - 48 -

[*48] investment--that grants SSC exclusive control over the management of

SJTC. Respondent argues, therefore, that the value of SSC’s 10% general partner

interest in SJTC is better represented by 10% of the value of SJTC than by

projected annual distributions. But he has not offered an explanation as to how we

should take SSC’s control into account that also takes into account our finding that

SSC would not direct SJTC to sell its timberlands. We conclude instead that the

general partner interest is an operating asset. That controlling interest ensured that

SSC and SJTC could be operated as a single business enterprise. And respondent

agrees with the estate that SSC is an operating company and should be valued on

the basis of its earnings. In this light we find Mr. Reilly’s use of expected

distributions to represent the value of the general partner interest to SSC to be

reasonable. We, therefore, conclude that Mr. Reilly’s treatment of SSC’s 10%

general partner interest in SJTC was appropriate.

      C. Tax-Affecting the Valuation of SSC

      Mr. Reilly used the same methodology to tax-affect his valuation of SSC

except that he used a different rate for the dividend tax avoided because his

analysis of the implied benefit for SSC’s shareholders in prior years yielded a

different rate. We accept Mr. Reilly’s method of tax-affecting the valuation of

SSC for the same reasons we accepted it for the valuation of SJTC.
                                         - 49 -

[*49] VI. Discount for Lack of Marketability

         The two experts are only 5% apart on marketability discounts. Mr. Reilly

applied to his weighted business enterprise value a 35% discount for lack of

marketability, which he based on empirical studies of the discounts on transfers of

restricted shares of publicly traded companies and on private transfers before

initial public offerings (IPO). Mr. Schwab determined a 30% discount for lack of

marketability by analyzing the discounts applied in private sales of restricted

stock.

         Respondent contends that Mr. Reilly’s 35% discount for lack of

marketability was excessive and that he did not explain sufficiently how he arrived

at the discount. We disagree. Mr. Reilly attached an appendix to his report in

which he explained the reasoning behind the discount for lack of marketability. In

doing so, he explained in detail the common empirical models--studies on the

sales of restricted stock and on private, pre-IPO sales of stock--and the two

theoretical models--the option pricing model and the DCF model--summarizing

the methodology and results of individual studies. He then discussed the effect

that restrictions on transferability have on a discount, as well as the other factors

listed in Mandelbaum v. Commissioner, T.C. Memo. 1995-255, aff’d, 91 F.3d 124
                                        - 50 -

[*50] (3d Cir. 1996).7 Mr. Reilly arrived at a 35% discount on the basis of the

studies he previously discussed and on SJTC’s unique characteristics, such as its

Buy-Sell Agreement, its lack of historical transfers, a potentially indefinite

holding period, its reported loss in the 12 months before to the valuation date, and

the unpredictability of partner distributions.8 We conclude that Mr. Reilly’s

discount was appropriate and adequately explained.

      Mr. Schwab did not consider the restrictions on transferability in the SJTC

Buy-Sell Agreement, and he conceded at trial that it would likely increase the

discount by “something like 1%, 2%”. Because Mr. Schwab was guessing at




      7
         In Mandelbaum v. Commissioner, T.C. Memo. 1995-255, aff’d, 91 F.3d
124 (3d Cir. 1996), we examined our caselaw regarding marketability discounts
and distilled 10 factors that we may consider in determining the appropriate
discount: (1) the value of the company’s privately traded stock relative to the
value of its publicly traded stock; (2) an analysis of the company’s financial
statements; (3) the company’s capacity to make distributions, its history of paying
distributions, and amounts of prior distributions; (4) the nature of the company, its
history, its position in its industry, and its economic outlook; (5) the company’s
management; (6) the degree of control conferred by the interest transferred;
(7) restrictions on transferability; (8) the holding period required to realize a
profit; (9) the company’s redemption policy; and (10) the cost to make a public
offering. See Estate of Gilford v. Commissioner, 88 T.C. 38 (1987); N. Tr. Co. v.
Commissioner, 87 T.C. 349 (1986).
      8
        Although Mr. Reilly arrived at a discount of 35% in his report, the
appendix to his report says that he concluded a discount of 30%. It appears that
his conclusion in the appendix is a typo. His calculations used a 35% rate.
                                       - 51 -

[*51] changes to his discount during the trial to account for considerations that he

left out, we conclude that the proper discount for lack of marketability was 35%.

VII. Conclusion

      We summarize our conclusions as follows. First, we do not accept Mr.

Schwab’s NAV method for valuing SJTC because there was no likelihood of a

sale of SJTC’s timberlands and, thus, an asset-based approach was not appropriate

for valuing SJTC. Second, we find that Mr. Reilly’s use of the 2009 revised

projections in his valuation of SJTC was proper. Third, we accept Mr. Reilly’s

tax-affecting in his valuations of SJTC and SSC as more accurate than

respondent’s blunt zero-rate approach. Fourth, we conclude that Mr. Reilly

properly treated the intercompany loans from SSC to SJTC and SSC’s 10%

general partner interest in SJTC as operating assets. And finally, we find that Mr.

Reilly’s discount for lack of marketability was reasonable.

      We therefore adopt the valuations in Mr. Reilly’s report and find that the

noncontrolling, nonmarketable values of the blocks given as gifts as of the

valuation date were as follows:
                                        - 52 -

 [*52] Shares/units               Value per share/units           Value of block
 SSC class A (voting)                     $390                       $507,000
 SSC class B (nonvoting) 1                 380                      1,824,000
 SSC class B (nonvoting) 2                 380                      2,073,280
 SJTC limited partnership
  units                                    380                      3,901,715

      Any contentions we have not addressed we deem irrelevant, moot, or

meritless.

      To reflect the foregoing,


                                                 Decision will be entered under

                                       Rule 155.
