                                                       United States Court of Appeals
                                                                Fifth Circuit
                                                             F I L E D
                      REVISED JULY 31, 2006
                                                               July 11, 2006
           IN THE UNITED STATES COURT OF APPEALS
                   FOR THE FIFTH CIRCUIT         Charles R. Fulbruge III
                                                         Clerk


                         No. 02-60912


                MICHAEL T. CARACCI, ET AL.,


                                       Petitioners - Appellants,

                            versus

             COMMISSIONER OF INTERNAL REVENUE,


                                       Respondent - Appellee.
____________________________________________________________

      STA-HOME HEALTH AGENCY OF CARTHAGE, INC.; STA-HOME
      HEALTH AGENCY OF GREENWOOD, INC.; MICHAEL CARACCI;
  VICTOR CARACCI; CHRISTINA C. MCQUILLEN; JOYCE P. CARACCI;
VINCENT E. CARACCI; STA-HOME HEALTH AGENCY OF JACKSON, INC.,

                                       Petitioners - Appellants,

                            versus

             COMMISSIONER OF INTERNAL REVENUE,

                                              Respondent - Appellee.


                Appeal from the Decision of
                 the United States Tax Court


Before JOLLY and WIENER, Circuit Judges, and ROSENTHAL,
District Judge.*

PER CURIAM:

      The Commissioner of Internal Revenue issued deficiency

notices requiring the taxpayers, three privately held home-

healthcare agencies and the family that owns and operates them,

to pay over $250 million in excise taxes under 26 U.S.C. §

4958.    The Commissioner based the deficiency notices on an

internal valuation of assets and liabilities transferred when

the agencies converted from exempt to nonexempt status, finding

that the taxpayers received a “net excess benefit” in the

amount   of    $18.5   million.   The    taxpayers   challenged   the

deficiency notices in the Tax Court.        During a two-year audit

and nearly two years of litigation, the Commissioner insisted

that the deficiency notices and underlying valuations were

correct.      At the trial before the Tax Court, the Commissioner

for the first time conceded that the deficiency notices were

both excessive and erroneous.         The Tax Court recognized that

the Commissioner’s deficiency notices were wrong.           The Tax

Court also found that the valuation expert the Commissioner

presented at trial—the only support the Commissioner presented



  *
     District Judge for the Southern District of Texas, sitting by
designation.

                                  2
for imposing excise taxes—also committed significant errors in

his   analysis.     The   Tax   Court   nonetheless   affirmed    the

Commissioner’s decision to impose excise taxes, finding that

the fair market value of the assets transferred from the exempt

entities to the newly created nonexempt entities exceeded the

value of the liabilities and debts assumed as consideration by

over $5 million.

      In this appeal, the Commissioner does not dispute that the

deficiency notices were erroneous.          The Commissioner also

concedes that the Tax Court made a $1.78 million mistake in its

valuation analysis. The Commissioner nonetheless insists that

the Tax Court correctly found that the taxpayers received a

“net excess benefit” of over $5 million in the conversion from

exempt to nonexempt status and collectively owed $69,702,390

in excise taxes under I.R.C. § 4958(a) and (b).1

      The taxpayers contend that the Tax Court made numerous

factual and legal errors in valuing the assets transferred in

the conversion from exempt to nonexempt status.       We agree.    As

explained below, the Tax Court erred as a matter of law in

affirming the Commissioner’s decision to impose excise taxes



  1
     The Tax Court entered separate orders as to each taxpayer; these
cases were consolidated in the Tax Court and remain so in this court.

                                  3
after the Commissioner failed to meet his burden of proving

that the taxes were correctly assessed; erred as a matter of

law in selecting the method to value the assets and liabilities

transferred; and made clearly erroneous fact findings          in

applying that valuation method.     We reverse and render because

the record establishes as a matter of law that the taxpayers

did not receive any “net excess benefit” and therefore are not

liable for the excise taxes assessed.

I.   Background

     In 1976, Joyce Caracci, an experienced nurse, her husband,

Victor Caracci, and a third person started the Sta-Home Health

Agency, Inc. to provide home health care in a geographically

large and primarily rural part of Mississippi.     A year later,

Joyce and Victor Caracci and the third individual formed two

other Sta-Home agencies, Sta-Home Health Agency, Inc., of

Forest, Mississippi and Sta-Home Health Agency, Inc., of

Grenada,   Mississippi.   The     shareholders,   directors,   and

officers of the Sta-Home entities were Caracci family members

who also worked for the agencies.

     The three Sta-Home entities were nonstock, tax-exempt

corporations formed under Mississippi law.     To comply with the

Medicare regulations in place when the Caraccis began their

                                4
business, the agencies had to be tax-exempt under the Internal

Revenue Code § 501(c)(3) (26 U.S.C. § 501(c)(3)).             In the

1980s, the law changed to permit agencies such as Sta-Home to

be formed as nonexempt corporations.

     The Sta-Home agencies served the rural poor in a large

area in northeast Mississippi.          The agencies were intended to

provide home healthcare as an alternative to what Joyce Caracci

believed from her long professional experience was unacceptable

institutional care available from nursing homes and other

facilities in the region.       A large majority of the patients

Sta-Home served depended on Medicare and Medicaid.               It is

undisputed that between 95 and 97 percent of Sta-Home’s income

consisted of Medicare and Medicaid reimbursements.

     In 1995, Medicare reimbursed home-healthcare providers the

lesser of the actual reasonable cost or the customary charge,

up   to   a   maximum   per-visit   “cost    cap.”    Medicare    paid

retrospectively, sending a “periodic interim payment”—known as

a PIP—every two weeks. Home-healthcare agencies also submitted

quarterly and annual cost reports, which Medicare used to

adjust disparities between interim payments made and actual

costs reported by reimbursing the provider for any underpayment

or requiring the provider to remit any overpayment.         Under the


                                    5
Medicare reimbursement system, home-healthcare agencies like

Sta-Home   effectively   had   no       ability   to   realize   profits.

Medicare did not even reimburse all of the costs expended, but

only costs it deemed “allowable.”            If Sta-Home submitted a

claim for reimbursement that Medicare denied, the result for

Sta-Home was a negative cash outflow.             On average, Medicare

disallowed .7 percent of Sta-Home’s submitted annual costs.

As a result, the greater the volume of Sta-Home’s business—the

more care Sta-Home provided patients and the more revenue it

received—the more money it lost.

      Sta-Home generated increased revenue and commensurately

increased losses from 1992 through 1995.          Financial statements

revealed that the Sta-Home corporations’ expenses exceeded its

revenues every year.     Not only did Sta-Home sustain repeated

net operating losses, its capital deficit increased every year

from 1991 through 1995.     At the end of fiscal year 1995, the

combined assets and stated liabilities of the three Sta-Home

exempt agencies was a negative $1.4 million.2

      To ease this precarious financial situation, Sta-Home

required its newly hired employees to forgo pay for the first

  2
     The net income for each respective year from 1991 to 1995 was:
-$63,660; $27,757; -$45,554; -$258,729; and -$433,390. The total
deficit Sta-Home ran for the same period was: $583,526; $555,771;
$729,145; $901,535; and $1,408,248.

                                    6
month of employment.       Sta-Home paid this amount only when

employees left the company.    Sta-Home also underpaid salaries

and wages during the year, using year-end “bonuses” to make up

unpaid compensation amounts. Sta-Home also deferred or accrued

contributions to employee benefit plans. These efforts to ease

cash-flow   difficulties   affected   all   Sta-Home’s   employees,

including the Caracci family members.

    During this period, Mississippi was the highest-ranking

state in the country in payments per Medicare recipient.        As

noted, during 1995, over 95 percent of the services Sta-Home

provided went to Medicare beneficiaries.       State law required

home-healthcare agencies in Mississippi to operate under a

Certificate of Need (CON).      In 1983, Mississippi imposed a

moratorium on the issuance of new CONs, which prevented new

competitors from entering the industry unless they purchased

an existing CON.   The combined Sta-Home entities had CONs in

nineteen Mississippi counties.        The Sta-Home corporations

ranked first or second in market share in 14 of the 19 rural

Mississippi counties they served.     “Sta-Home” was a recognized

name in home healthcare in Mississippi and enjoyed a strong

reputation among the state’s elderly.       In 1993, Sta-Home was

the first freestanding agency to be accredited by the Joint


                                7
Commission on Accreditation of Healthcare Organizations, which

required achieving or exceeding certain regulatory standards,

including standards regulating the quality of patient care.

      During 1994 and 1995, a change in the Medicare regulations

was proposed, under which certain healthcare entities accepting

Medicare payments would change from the retrospective PIP

system to a prospective payment system to be known as “PPS.”

Under PPS, healthcare providers would file a claim for each

service rendered and then wait for it to be processed and

paid.3 Concerned about the impact of this system on Sta-Home’s

already fragile cash flow, the Caraccis consulted an attorney,

Thomas Kirkland.    He recommended converting Sta-Home into for-

profit corporations, which Medicare regulations had permitted

since the 1980s.        The conversion to nonexempt status would

allow Sta-Home to borrow money that lenders were unwilling to

provide   to   exempt    entities.     Kirkland’s     law   firm   had

represented many home-healthcare agencies in Mississippi, and

Kirkland was a recognized expert in the legal issues relating

to such agencies.       He advised all his tax-exempt healthcare-

agency clients to convert to nonexempt status.               Most of



  3
     Congress ultimately passed the system in 1997.   Medicare fully
implemented the PPS system in 2001.

                                  8
Kirkland’s clients followed his advice.         The primary form of

conversion used was a transfer of assets from the old exempt

corporations    to    the   newly   formed   nonexempt     subchapter-S

corporations,    in    exchange     for   assuming   the    debts   and

liabilities of the exempt corporations.

       Sta-Home took a careful and conscientious approach to the

conversion.     Not only did Sta-Home consult with an attorney

knowledgeable in the area, it also retained a tax attorney

whose accounting firm obtained two contemporaneous appraisals

of Sta-Home’s assets and liabilities.        These appraisals showed

that Sta-Home’s liabilities exceeded the value of its tangible

and intangible assets. The appraisals specifically showed that

the value of the intangible assets—including the CONs—would not

result in a positive fair market value because the assets had

been    consistently    unprofitable.        These   appraisals     were

consistent with the Caraccis’ conclusion that unless they did

something to provide more cash and capital, they would likely

not be able to continue to operate.

       Before Sta-Home changed from tax-exempt to nonexempt

status, it investigated other alternatives to meet its need for

improved cash flow and access to capital in light of the

anticipated change from a PIP to a PPS Medicare reimbursement


                                    9
system.    Sta-Home looked for a hospital in its service area

that could purchase the agencies, to provide capital and

additional patient referrals.        The search proved fruitless.

Sta-Home   discovered   that   the    potential   purchasers   were

uninterested; the most likely candidate had acquired a home-

healthcare agency the prior year.         With no prospective or

potential buyer, Sta-Home decided to convert to nonexempt

status.

    On July 11, 1995, Sta-Home’s board of directors authorized

the conversion of the tax-exempt entities into nonexempt

subchapter-S corporations.     Sta-Home Health Agency, Inc. was

converted to Sta-Home Health Agency of Jackson, Inc.; Sta-Home

Health Agency, Inc., of Forrest, Mississippi was converted to

Sta-Home Health Agency of Carthage, Inc.; and Sta-Home Health

Agency, Inc., of Grenada, Mississippi was converted to Sta-Home

Health Agency of Greenwood, Inc.         The exempt corporations

transferred their tangible and intangible assets to the for-

profit corporations in exchange for the assumption of, and

indemnification against, liabilities.        The contemporaneous

appraisals performed in support of the conversion showed that

the consideration for the assets—the agreement to assume the

debts and liabilities—exceeded the value of the assets, which


                                10
had been unprofitable for the previous five years.           It is

undisputed that after the conversion, the Sta-Home entities

continued to operate as before, providing the same services to

the same patients in the same manner, subject to the same

Medicare limits on profit.

    In 1999, after an extended audit period, the Commissioner

issued deficiency notices to the Caracci family and the Sta-

Home agencies.   The Commissioner determined that the value of

the assets transferred to the nonexempt Sta-Home corporations

exceeded the value of the liabilities and debts assumed by

approximately $18.5   million.      Based solely on that valuation

analysis, the Commissioner concluded that the transfer provided

an “excess benefit” to the newly created nonexempt corporations

and the Caracci family, in violation of I.R.C. § 4958, which

imposes a 25 percent and a 200 percent penalty in the form of

excise taxes on “excess benefit transactions.”      The deficiency

notices asserted that the taxpayers owed excise taxes totaling

$256,114,435.

    The Commissioner based the deficiency notices on a brief

internal   memorandum.       This     memorandum   stated:   “This

intermediate determination of value should not be considered

final until issuance of the final economic report.”            The


                                 11
deficiency notices were not based on a final economic report,

instead using the figures from the “intermediate determination

of value” in stating that the conversion from exempt to

nonexempt     status   resulted   in   a   net   excess   benefit   of

$18,543,694 and triggered excise taxes and penalties of over

$250 million.     Sta-Home and the Caracci family filed timely

petitions in the United States Tax Court challenging the

determination of their tax liabilities.

       In the Tax Court, the taxpayers pointed out that one

problem with the deficiency notices was that the valuations

made no adjustment for the liabilities that the nonexempt

corporations assumed as consideration for acquiring the assets

from the exempt corporations.      The taxpayers moved for partial

summary judgment based on this problem in the deficiency

notices.      The Commissioner responded that the notices were

correct, filing affidavits in opposition to the partial summary

judgment motion swearing to the validity of the deficiency

amounts and the consequent excise tax amounts.            It was not

until the trial before the Tax Court that the Commissioner

acknowledged that the deficiency notices were wrong. On cross-

examination, the Commissioner’s own expert witness admitted

that    the    notices   were     “excessive,”    “incorrect,”      and


                                  12
“erroneous.”

    On May 22, 2002, the Tax Court affirmed the finding that

the conversion resulted in a “net excess benefit” triggering

excise taxes and penalties, but reduced the amount of the

benefit and the resulting amounts that Sta-Home and the Caracci

family owed.   The Tax Court found that the value of the exempt

former Sta-Home entities’ debts and liabilities that the newly

formed nonexempt Sta-Home entities assumed was $13.5 million.

The parties do not challenge this valuation on appeal. The Tax

Court found that the newly formed nonexempt Sta-Home entities

received assets from the exempt former entities worth $20.8

million, exceeding the value of the assumed liabilities by $5.1

million.   In so finding, the Tax Court rejected both the $20

million figure the Commissioner had asserted as the amount of

the net excess benefit in its deficiency notices and also

rejected the amount that the Commissioner’s expert presented.

    Both Sta-Home and the Commissioner presented detailed

expert   testimony   on   the   fair   market   value   of   Sta-Home’s

tangible and intangible assets at the time of the conversion

from nonexempt to exempt status. The expert witnesses for both

the taxpayers and the Commissioner agreed that traditional

valuation methodology uses three approaches: (1) income; (2)


                                  13
cost; and (3) market.     An income approach assigns value based

on determining how much money an owner will derive from the

business in the future.      A cost approach values a business by

determining how much it would cost to replace the entity’s

tangible and intangible assets.4           A market approach tries to

establish the market value of a company, usually by comparing

sales or transfers of similar companies. The experts disagreed

on how to value Sta-Home’s assets and what assumptions should

be used.    The Tax Court agreed with neither expert, instead

selecting aspects from the Commissioner’s expert to piece

together its own valuation result.

      Sta-Home’s   expert,   Allen    D.    Hahn,   is   a   director   at

Pricewatershouse Coopers Northeast Region Corporation Valuation

Consulting Group.    He has written extensively on valuing home-

healthcare agencies. The Commissioner unsuccessfully attempted

to hire Hahn for this case, recognizing his expertise.                  To

prepare his analysis of the Sta-Home conversion, Hahn spent


  4
     Assets in accounting are items of worth to a company,
categorized as tangible (for example, property) and intangible (for
example, community goodwill). A company’s assets are equal to its
liabilities and ownership equity combined. Margaret A. Gibson, The
Intractable Debt/Equity Problem: A New Structure for Analyzing
Shareholder Advances, 81 NW. U. L. REV. 452, 482 n.216 (1987).
Liabilities (debt) and equity are the principal methods of financing
a company. Id. at 456–57. Under debt financing, a corporation
borrows funds; while under equity financing, a corporation raises
funds by issuing stock. Id.

                                 14
eight weeks in Mississippi, studying the assets and liabilities

transferred in the conversion and analyzing the home-healthcare

industry in the area.

    The Commissioner, unable to retain Hahn, hired Charles

Wilhoite.   Although Wilhoite is a certified public accountant

and codirector of the Portland, Oregon office of Willamette

Management Associations, a business valuation firm, he had no

prior experience with the home-healthcare industry.          Wilhoite

spent only two days in Mississippi to study the Sta-Home

entities in order to value their assets and liabilities and

spent one of those days in a hotel room tracking down lost

luggage.    Lacking detailed or thorough knowledge about the

home-healthcare   industry   in    general   or   in   the   part   of

Mississippi where Sta-Home operated, and about Sta-Home itself,

Wilhoite instead relied on his general valuation knowledge and

experience and the information learned in the single day he

spent interviewing Sta-Home’s chief financial officer.              In

short, neither the Commissioner nor his expert witness did the

work necessary to perform an asset-valuation analysis of the

Sta-Home entities throughout the extended audit period or




                                  15
during the Tax Court litigation.5

      Hahn’s analysis carefully took into account the economic

realities of home-healthcare agencies that depended almost

entirely on Medicare reimbursements rather than on private

payers, lost an average of .7 percent annually on their

operating costs, did not offer specialized services that could

generate profits, and had a capital deficit.           Hahn used an

“adjusted balance sheet” method to value the Sta-Home assets,

adjusting the values identified on the companies’ balance sheet

to their fair market value equivalent.6       Hahn prepared both a

“base case” and a “best case” scenario, developing a range of

fair market values for Sta-Home’s assets ranging between $10.5

million and $11.5 million. Hahn specifically valued Sta-Home’s

intangible assets, attributing between $2.1 million and $3.4

million to the CONs and the workforce.         Hahn found that the

Sta-Home entities’ total liabilities ranged between $12 million

and $12.5 million, concluding that these liabilities exceeded

  5
     The Commissioner faults Sta-Home for failing to provide access
to more information about the corporations, but this argument ignores
the discovery tools that the Commissioner had available and ignores
the fact that it is the Commissioner’s burden to show that the tax it
imposed was correct, not the taxpayers’ burden to show that the
Commissioner was wrong.
  6
     A company’s balance sheet documents the historical cost of its
assets, liabilities, and ownership equity. Shannon P. Pratt et al.,
Valuing Small Businesses and Professional Practices 366 (3d ed.
1998).

                                 16
the value of Sta-Home assets by $.5 million to $2 million.

    To check this asset valuation, Hahn also used a market

approach, comparing the Sta-Home transactions to thirteen

private transactions involving home-healthcare agencies engaged

in by publicly traded companies.          Hahn cautioned that the

market approach was only a secondary indication of value

because transactions involving other home-healthcare providers

were too dissimilar to the Sta-Home transactions used to effect

the conversion from exempt to nonexempt entities to serve as

the basis for a stand-alone valuation.               Hahn noted that

although Sta-Home provided only traditional home healthcare,

publicly traded companies often used home-healthcare agencies

as part of a broader mix of healthcare businesses.            Sta-Home’s

heavy dependence on Medicare reimbursements also made                 it

difficult to compare with publicly traded companies offering

services to a mix that included a much larger number of private

payers and far fewer Medicare patients than Sta-Home.                The

Commissioner’s expert conceded that home-healthcare agencies

serving   private-pay   patients    can   make   a   profit    on   those

services if they are run well; by contrast, healthcare agencies

cannot make a profit on serving Medicare patients.            Hahn also

noted that sales of home-healthcare agencies that provided


                                   17
sophisticated treatments could not be included as comparables

because    these     treatments      attracted    higher   payments      and

reimbursements than the services provided by Sta-Home.

      Based    on   the   adjusted    balance    sheet   method    and   the

corroboration provided by the comparable market approach, Hahn

concluded that the liabilities the Sta-Home nonexempt entities

agreed to assume from the nonexempt entities exceeded the value

of the assets received by $600,000 to $2,350,000, resulting in

no net excess benefit and therefore no excise tax liability.

Hahn reached this result without applying a minority stock

discount, reasoning that the shares represented interests in

a loss corporation,7         and without a discount for lack of

marketability,8 concluding that the unattractive healthcare

market    in   Mississippi    was    already     incorporated     into   his

adjusted balance sheet valuation.

      The Commissioner’s expert, Wilhoite, lacked the specific

information about the Sta-Home entities necessary to value



  7
     When an individual has less than 50 percent ownership interest
in a company, it is deemed a “minority” ownership interest and
discounted to reflect the holder’s lack of control of the business.
Pratt, Valuing Small Businesses at 426–30.
  8
     “Marketability” is the ability to convert property to cash
quickly. When companies are not traded on the public market, they
are less marketable and therefore valued less. Pratt, Valuing Small
Businesses at 446–48.

                                      18
their assets, particularly the intangible assets.                Wilhoite

assumed that those intangible assets had significant value to

potential purchasers, despite Sta-Home’s history of losses,

because several home-healthcare agencies acquired in recent

transactions incurred losses just before those agencies were

purchased for large amounts.9            Wilhoite used market-based and

income-based approaches to assign values to all Sta-Home’s

assets in general, without valuing any of Sta-Home’s assets in

particular.

       For   both   the   market   and    income   approaches,   Wilhoite

determined the “market value of invested capital” (MVIC), which

represents the market value of ownership equity plus debt

invested in a company.        The MVIC is commonly used in valuing

private companies because it minimizes differences in capital

structure between private and public corporations.10             Wilhoite

assumed that this method could be applied to value the Sta-Home

entities’ assets, despite the fact that method is designed to

value a company’s invested capital, not its assets, and the



  9
     As discussed below, this assumption violated the Commissioner’s
own valuation rules.
  10
     Public companies tend to have greater equity than do private
companies, which are often owned by small groups. See Hollis v.
Hill, 232 F.3d 460, 467 (5th Cir. 2000) (outlining the differences in
equity ownership between public and private companies).

                                    19
Sta-Home agencies did not have invested capital.

       Wilhoite calculated the MVIC for the Sta-Home entities by

extracting a “revenue pricing multiple” (RPM), a percentage

that when multiplied by a company’s annual revenues yield’s

that company’s MVIC.       To derive the RPM, Wilhoite identified

two    categories   of   “comparable”   entities,   one   made      up   of

publicly traded companies and one made up of merged or acquired

entities.    Wilhoite found the median RPM of publicly traded

companies    operating    home-healthcare   agencies      to   be    .61.

Because Sta-Home had been nonprofit, Wilhoite reduced that RPM

by 50 percent to reflect a lower return on invested capital.

When multiplied by Sta-Home’s 1995 revenues, this RPM led to

an MVIC of $13,563,000.          Wilhoite ran the same analysis

comparing merged and acquired companies and arrived at an RPM

of .25 and an MVIC of $11,302,000.

       Wilhoite’s income approach calculated the value to a

potential buyer that Wilhoite assumed would result from the

buyer’s ability to use a “cost-shifting” strategy.11           Wilhoite

determined that the annual value of cost-shifting, based on a

  11
     This attribute of Medicare business enables a buyer to shift
some of its overhead costs to Medicare’s cost reimbursement system.
If a home-healthcare agency sought less than the maximum
reimbursement allowed by Medicare, a buyer could shift its overhead
costs to the agency and Medicare would reimburse it to the extent
there was room under the cost cap.

                                  20
historical “cost-cap gap”12 of .5 percent, was $1,408,168.

Wilhoite applied a capitalization rate of 12.8 percent and

calculated $11,001,000 as the present value of Sta-Home to a

potential buyer.

          Wilhoite also assigned a weighted percentage to each of

the three values he derived.             He assigned the largest weight

to        the   income   approach,   followed      by   the   publicly   traded

comparables market approach, followed by the merged or acquired

comparables market approach, yielding a weighted-average MVIC

of $11,604,000. Wilhoite then subtracted the amount of deficit

that a buyer of the Sta-Home companies would have to pay for

current liabilities and added the value of those current

liabilities.          Based on the accounting rule that the asset side

and liability side of a company’s balance sheet must be equal,

Wilhoite reasoned that Sta-Home’s MVIC (long-term liabilities

and        owners’    equity)   plus    current     liabilities       would    be

equivalent to the value of the assets.                  Wilhoite valued Sta-

Home’s 1995 assets transferred from the nonexempt to the exempt

entities         at   $20,858,000,     over   $7   million     more   than    the

$13,511,000 of liabilities assumed by the nonexempt entities.


     12
     The “cost-cap gap” is the difference between the reimbursement
amount sought by a home-healthcare provider and the maximum amount of
reimbursement permitted by Medicare.

                                        21
    The Tax Court rejected Wilhoite’s income method—the method

that Wilhoite viewed as deserving the greatest weight—stating

that the value of the cost-shifting strategy included “too many

imponderables.” Caracci v. Comm’r, 118 T.C. 379, 406 (2002).

The Commissioner does not challenge this rejection of its

expert’s method.   The Tax Court adopted only one part of one

of Wilhoite’s market-value approaches, making adjustments and

filling in gaps to reach its own conclusion as to value.

    The   Tax   Court   adopted   the    part   of   the   MVIC-Revenue

approach that used publicly traded companies as comparables.

In so doing, however, the Tax Court recognized that even the

publicly traded companies Wilhoite used as “comparables” were

in fact not comparable to the Sta-Home entities.               Sta-Home

operated in a much less advantageous market than many of the

publicly traded companies, was much more heavily dependent on

Medicare reimbursements than these companies, and did not offer

the sophisticated and profitable therapies that many of these

companies did. Id. at 405-06.          Elsewhere in the opinion, the

Tax Court recognized these important aspects of Sta-Home’s

operations and finances that distinguished it from the publicly

traded companies Wilhoite used as comparables.             For example,

the Tax Court recognized Sta-Home’s dependency on Medicare

                                  22
reimbursements for over 95 percent of its revenues and the fact

that    Medicare   disallowed   .7    percent   of    Sta-Home’s      costs

annually.    But the Tax Court did not discuss these aspects in

analyzing whether the publicly traded healthcare companies were

sufficiently similar to Sta-Home to be “comparables,”                   as

Wilhoite’s MVIC-Revenue valuation method required.              Instead,

although the Tax Court recognized that the publicly traded

companies Wilhoite selected as comparables were different from

Sta-Home in critical aspects, the Tax Court accounted for the

differences by simply reducing the multiplier from .3 to .25

percent.    The Tax Court did not explain the basis for reducing

the multiplier by the amount it selected or why that reduction

accounted    for   the   differences    between      the   publicly   held

companies and the Sta-Home agencies.

       The Tax Court rejected Hahn’s primary adjusted balance

sheet    valuation   analysis   and    his   secondary      market-value

analysis.    In rejecting Hahn’s secondary analysis, the Tax

Court failed to recognize that Hahn used it only to confirm his

primary valuation method, because Hahn himself recognized that

the publicly traded healthcare companies were not sufficiently

similar to the Sta-Home entities to serve as comparables in a

stand-alone valuation analysis.         The Tax Court also rejected


                                 23
Hahn’s adjusted balance sheet approach, believing that it

undervalued Sta-Home’s intangible assets.             The Tax Court

justified its reliance on part of Wilhoite’s analysis and its

rejection of all of Hahn’s analysis and conclusion—despite the

fact that only Hahn had detailed information about how Sta-

Home’s   operations     and   finances   worked   under   the   complex

Medicare regulations—by its belief that Sta-Home had “the

potential to generate income and thus demonstrate a substantial

fair market value.” Id. at 405.          The primary reason the Tax

Court gave for this belief was that in 1995, the Sta-Home

entities had generated nearly $45 million in revenues but had

reported an operating loss that year, in part because the

entities deducted depreciation for their automobile fleet and

in part because they had declared employee bonuses, without

which    they   would    have   reported    “nontaxable    income   of

approximately $1,785,000, or, in other words, more than enough

to eliminate the accumulated deficit in net asset value.” Id.

On appeal, the Commissioner concedes that the Tax Court was

simply wrong in this statement, but insists that the error is

harmless.

    Having rejected most of Wilhoite’s analysis and all of

Hahn’s, the Tax Court put together its own valuation analysis

                                  24
with the little that remained of Wilhoite’s methodology. Using

an RPM of .25—its own modification of Wilhoite’s RPM of .3—the

Tax Court calculated an MVIC of $11.3 million.              The court then

adjusted that amount by excluding four weeks of employees’

deferred    compensation         from   the   current    liabilities      that

Wilhoite    had     added   to    the    MVIC   and    increasing    current

liabilities to reflect a reserve for disallowed Medicare

claims.13   Adding current liabilities to the adjusted MVIC, the

Tax Court arrived at a fair market value of $18,675,000 for the

tangible and intangible assets that the new nonexempt Sta-Home

entities received from the old exempt Sta-Home entities.                   The

court subtracted the liabilities the old                  exempt    Sta-Home

companies        transferred     to     the   newly     created    nonexempt

entities—$13,511,000—from the fair market value of the assets,

leaving     an     excess   of     $5,164,000.        Because     Sta-Home’s

transferred assets “far exceeded” the consideration paid by the

Sta-Home     nonexempt      corporations—the          assumed     debts   and

liabilities—the Tax Court found a violation of I.R.C. § 4958

and ordered the taxpayers to pay $69,702,390 in excise taxes.


  13
     The court reasoned that these four weeks of deferred payment
were in fact long-term loans to the company for the duration of the
employees’ employment. The court classified the deferred salary as
part of Sta-Home’s invested capital (specifically as long-term
liabilities). Id. at 407.

                                        25
This appeal followed.

II. Discussion

       A.   The Legal Standards

       Section   4958   of   the    Internal   Revenue   Code   prohibits

certain acts of self-dealing between private foundations and

company insiders.       The statute imposes a 25 percent tax on

“excess benefit transactions,” defined as follows:

            “[E]xcess benefit transaction” means any
            transaction in which an economic benefit is
            provided by an applicable tax-exempt
            organization directly or indirectly to or
            for the use of any disqualified person if
            the value of the economic benefit provided
            exceeds the value of the consideration
            (including the performance of services)
            received for providing such benefit.

I.R.C. § 4958(c)(1)(A).            “Disqualified persons” include any

person in a position to exert “substantial influence” over the

organization’s affairs before the transaction, or any member

of such person’s family.            Id. at § 4958(f)(1)(A)–(B).14     If

taxes imposed under the statute are not corrected within the

taxable period, an additional tax equal to 200 percent of the

excess benefit is assessed.          Id. at § 4958(b).

       Whether the transfer of Sta-Home’s assets qualifies as an


  14
     The parties do not dispute that the Sta-Home for-profit entities
and the Caracci family are “disqualified persons.”

                                      26
“economic benefit” depends on the fair market value of the

companies’ assets and liabilities.        Fair market value is the

price that a willing buyer would pay a willing seller, both

having reasonable knowledge of all relevant facts and neither

being under any compulsion to buy or sell.           United States v.

Cartwright, 411 U.S. 546, 551 (1973); Dunn v. Comm’r, 301 F.3d

339 (5th Cir. 2002).        The willing buyer and seller are

hypothetical    persons   rather   than   specific    individuals   or

entities, and their characteristics are not necessarily shared

by the actual seller or particular buyer.      Estate of Bright v.

United States, 658 F.2d 999, 1005–06 (5th Cir. 1981).          At the

same time, the valuation method must take into account, and

correspond to, the attributes of the entity whose assets are

being valued.    Dunn, 301 F.3d at 356–57.

    The Tax Court’s factual determinations are reviewed for

clear error and its conclusions of law are reviewed de novo.

Dunn, 301 F.3d at 348.    The determination of fair market value

is a mixed question of fact and law; “the factual premises

[are] subject to review on a clearly erroneous standard, and

the legal conclusion[s are] subject to de novo review.”             Id.

(quoting In re T-H New Orleans, Ltd. P’ship, 116 F.3d 790, 799

(5th Cir. 1997)).     Although the mathematical computation of

                                   27
fair market value is an issue of fact, the determination of the

appropriate valuation method is an issue of law.                 Dunn, 301

F.3d at 348 (citing Powers v. Comm’r, 312 U.S. 259, 260

(1941)).

    B.      Analysis

    The conclusion is inescapable from the description of the

background of this case.          There are so many legal and factual

errors—many of which the Commissioner acknowledges—infecting

this case from the outset that reversal must result.

    The Commissioner began the cascade of errors by issuing

deficiency notices based on a brief, intermediate internal

analysis.      That analysis stated on its face that it was

intermediate    and    that   a    final    economic   study    had   to    be

performed.    Ignoring this disclaimer, the Commissioner issued

valuation-based deficiency notices asserting § 4958 excise tax

penalties against the Sta-Home entities and the Caracci family

totaling     $250,729,866     (plus        interest)   and     income      tax

deficiencies and penalties totaling $8,330,064 (plus interest),

and retroactively revoking the exempt status of the Sta-Home

exempt agencies.       Internal IRS documents reveal that the IRS

issued the notices on the basis of an intermediate rather than

final economic study to prevent the Caraccis from correcting

                                     28
what the IRS viewed as prohibited transactions, which would

have reduced the § 4958 “intermediate sanction” penalties. The

second reason the IRS issued these premature notices was its

concern over the statute of limitations.           The IRS blamed the

taxpayers for that problem.        One of the IRS employees working

on this case stated in an affidavit that the agency asked the

taxpayers to consent to extend the limitations period and

“informed [the taxpayers] that if the statute was not extended,

statutory notices would be issued based on the best available

information that [the IRS] had at that point,” despite the fact

that the IRS economist needed more time to analyze the case.

Even   more   disturbing,    the    record   reveals      that   despite

recognizing the tentative and incomplete nature of the analysis

used as the basis for the deficiency notices, the Commissioner

defended the correctness of those notices for several years

into   this   litigation   and   only   conceded   that    the   notices

overstated the Commissioner’s tax claim when the trial began

in the Tax Court.      In issuing the deficiency notices, the

Commissioner did not adjust the analysis by the amount of

liabilities the taxpayers assumed.           As a result, the 1999

deficiency notices greatly overstated the excise tax liability.

Despite this error, the Commissioner insisted throughout a two-


                                   29
year    audit   and     nearly    two     years    of    litigation     that   the

deficiency notices were correct.                  It was not until March 5,

2001, in the opening statement before the Tax Court and in the

cross-examination of the Commissioner’s sole expert witness,

that the Commissioner acknowledged that the 1999 deficiency

notices    were    excessive        and      erroneous.       This     court   has

recognized that when, as here, the Commissioner persists in

taking a position in litigation that is

           so incongruous as to call his motivation
           into question, . . . [i]t can only be seen
           as one aimed at achieving maximum revenue
           at any cost, . . . seeking to gain leverage
           against the taxpayer in the hope of
           garnering      a    split-the-difference
           settlement—or,   failing    that,  then   a
           compromise judgment—somewhere between the
           value returned by the taxpayer . . . and
           the    unsupportedly     excessive    value
           eventually proposed by the Commissioner.

Dunn,    301    F.3d    at   349.       In     Dunn,    the   result    that   the

Commissioner obtained in the Tax Court was rejected.                       As in

Dunn, the result in this case cannot stand.

       The legal effect of the Commissioner’s concession of error

in the Tax Court is clear.                     “In a Tax Court deficiency

proceeding,      once    the     taxpayer       has     established    that    the

assessment is arbitrary and erroneous, the burden shifts to the

government to prove the correct amount of any taxes owed.”

                                          30
Portillo v. Comm’r, 932 F.2d 1128, 1133 (5th Cir. 1991).    The

Tax Court, however, did not place the burden of proof on the

Commissioner.   Instead, the Tax Court stated that while the

parties disputed who bore the burden of proving “the central

issue in this case; namely, the value of the transferred

assets, . . . [w]e do not decide this dispute.” Caracci, 118

T.C. at 382 n.4.   Instead, the Tax Court rejected most of the

only support the Commissioner provided for the net excess

benefit finding, the testimony of the Commissioner’s valuation

expert.   At that point, the Commissioner failed to meet his

burden of proof.    At that point, the Tax Court should have

found in the taxpayers’ favor. Its failure to do so was error,

as a matter of law.

    In rejecting most, but not all, of the Commissioner’s

valuation expert’s opinions, the Tax Court made a number of

errors in the valuation method it selected and in the facts it

found in selecting and applying that method.    The Tax Court’s

use of Wilhoite’s modified MVIC-Revenue method for valuing Sta-

Home’s assets, particularly its intangible assets, is wrong as

a matter of law.      Wilhoite had no experience in appraising

healthcare companies and knew very little about the Sta-Home

entities or their assets and liabilities.      Wilhoite did not

                               31
value Sta-Home’s specific assets, but instead used a variation

on an invested-capital valuation method to do a general and

indirect valuation of Sta-Home’s assets. The Tax Court adopted

a modified version of Wilhoite’s valuation approach, which is

designed to value invested capital—not assets—to value the

assets of a company that had no capital.     The Tax Court did so

with no legal support for the use of such a method to value the

assets of these agencies, over the recognition of both Wilhoite

and Hahn that this method was inferior to, and less rigorous

than, an asset-valuation method. The Tax Court then compounded

this error by deriving the invested-capital multiple it applied

to the Sta-Home entities using the seven public companies

Wilhoite selected as “comparables.” Put simply, they were not.

    The   Tax   Court   considered   the   Commissioner’s    expert

testimony against a record of stipulated or undisputed facts.

Those facts included that between 95 and 97 percent of Sta-

Home’s revenues came from Medicare, compared to a national

average of 38 percent, and that Medicare only reimbursed up to

actual costs and disallowed .7 percent of Sta-Home’s annual

costs, thereby ensuring that the       Sta-Home   entities   would

continue to build liabilities, not assets, and could not

profit.   The more patient care the Sta-Home entities provided,


                               32
the more revenues they generated, and the more their losses

grew.   The parties did not dispute that the liabilities of the

Sta-Home exempt entities exceeded assets for every year from

1987 through 1995.    The parties did not dispute that the Sta-

Home exempt agencies had $13.5 million in debts and liabilities

that the newly created nonexempt entities assumed. The parties

did not dispute that the Sta-Home exempt entities had sustained

progressively larger net operating losses and capital deficits

for the previous five years.    The parties did not dispute that

there was no likely potential buyer for Sta-Home.         Despite

these undisputed facts, the Tax Court’s valuation method used

an invested-capital valuation method that compared the Sta-Home

entities    with   solvent,   publicly   traded   companies    with

significant equity and a present ability to generate profits.

This aspect of Wilhoite’s analysis, accepted by the Tax Court,

excluded distressed companies from the “comparables.”         Six of

the seven “comparable” companies were generating profits at the

time of Wilhoite’s comparison and the seventh had substantial

equity.    Sta-Home had neither equity nor a record of profits.

The Commissioner’s expert erred when he stated to the Tax Court

that two of the “comparable” public companies had operating

losses; in fact, one of those companies was Sta-Home.           The


                                33
Commissioner’s expert also erred in telling the Tax Court that

one of the public “comparables” had negative stockholder’s

equity; the only negative equity entry was Sta-Home. On cross-

examination, the Commissioner’s expert conceded that some of

the “comparables” provided infusion services, which are fee-

based and thus capable of turning a profit, and that some

“comparables” provided respiratory services, which are also fee

based.    The Commissioner’s expert further conceded that other

“comparables”     that   provided     residential      medical     services,

pediatric care, adult day care, and companion care services

either were fee-based or may have been; he did not know.                  The

Commissioner’s     expert      also    admitted      that   many    of   the

“comparables” were far less Medicare-dependent than Sta-Home.

       A “comparable” must be substantially similar to the entity

or asset that is at issue. Van Zelst v. Comm’r, 100 F.3d 1259,

1263 (7th Cir. 1996); Estate of Palmer v. Comm’r, 839 F.2d 420,

423 (8th Cir. 1988).          As noted, none of the publicly traded

entities Wilhoite chose were similar to Sta-Home.                  They were

publicly traded.     See Dunn, 301 F.3d at 350 (recognizing that

public companies generally cannot be compared with private

companies).      They had capital.         They were profitable.         They

were     not   limited   to    offering     basic,    and   unprofitable,

                                      34
therapies. Most important, they did not depend on Medicare for

over 95 percent of their revenues, were not limited to recovery

of actual costs, and did not have a portion of their actual

costs    disallowed     every   year.       For    these    publicly   traded

“comparables,” added revenue would logically create added

value.       For Sta-Home, the overwhelming dependence on Medicare

reimbursements        meant     that    added      revenue     meant    added

unreimbursed costs, which in turn generated greater losses.

The    Tax    Court   recognized    some    of    these    differences,   but

assumed—without explanation—that the publicly traded entities

could still be used as “comparables” as long as the amount of

the multiple derived was adjusted.                 The Tax Court did not

explain how it arrived at the amount of the adjustment or how

that    amount    transformed      fundamentally     different    financial

entities into “comparables.”

       Using an adjusted version of the Wilhoite MVIC-Revenue

invested capital method, the Tax Court concluded that the value

of the assets the nonexempt Sta-Home entities received exceeded

the value of the $13.5 million in liabilities and debts they

assumed by $5.1 million.         As the taxpayers point out, the Tax

Court concluded that a willing buyer would assume $13.5 million

in liabilities and pay $5.1 million to acquire the right to


                                       35
lose money on an ongoing basis.          The Tax Court explained why

it believed this apparently illogical conclusion made sense:

it found that Sta-Home had the potential to make a profit,

which demonstrated that its assets had substantial fair market

value.     This finding was clearly erroneous.

     The Tax Court based its finding that the Sta-Home entities

had the potential to make a profit on the finding that if Sta-

Home had not paid a year-end bonus to its staff in 1995, it

would have reported nontaxable income of approximately $1.78

million, “more than enough to eliminate the accumulated deficit

in   net   asset   value.”    Caracci,     118   T.C.   at   405.      The

Commissioner concedes that this statement is simply error. The

statement ignores the fact that under the Medicare system that

accounted for between 95 and 97 percent of Sta-Home’s revenues,

there is no reimbursement unless there is an actual expense

incurred.    If Sta-Home had not paid the bonuses, the Medicare

reimbursements it received would have been reduced by an equal

amount, leaving the same level of company losses.               The Tax

Court did not take into account this effect of the Medicare

reimbursement      system    on   the    Sta-Home   entities,       despite

acknowledging it earlier in the opinion.            The Tax Court also

overlooked the reason for the bonuses and what they revealed

                                    36
about the Sta-Home entities’ finances.                  These “bonuses” were

unpaid,    deferred    employee     pay,       rather     than     discretionary

bonuses. The deferred wages for existing employees, along with

deferred first-month wages for newly hired employees, were

mechanisms the taxpayers used to continue to operate despite

their     perennial         cash-flow        problems,        their    lack    of

profitability, their increasing operating losses, and their

increasing deficits. The Commissioner acknowledged before the

Tax Court that the salaries and bonuses were neither excessive

nor   unreasonable.          Moreover,       the    Caracci     family   members

withheld    their     own    compensation          in   the   same    manner   as

compensation    for    the     other    employees.            In   short,   these

“bonuses” evidenced the unprofitable nature of the Sta-Home

entities, not the potential for profitability, as the Tax Court

erroneously stated.

      The Tax Court also criticized Sta-Home—in the same section

of the opinion that discussed its profit potential—for taking

a large motor-vehicle depreciation deduction.                      The Tax Court

ignored the fact that a home-healthcare agency providing

services to a predominately rural population dispersed over a

geographically large area necessarily has a heavily used fleet

of vehicles.    The Tax Court’s suggestion that the taxpayers


                                        37
were improperly exploiting the depreciation ignored the fact

that it represented a very real cost that could not be annually

expensed because of the Tax Code’s specifications for the

depreciable life of such personal property.                  See generally

I.R.C. § 168.     Indeed, stipulated facts in the record make it

clear that far from exploiting the tax consequences of their

corporate form, the Caracci family had been unable to take

advantage of the income tax exemption the agencies “enjoyed”

before 1995, because the agencies had consistently incurred net

operating losses.

    The Tax Court stated that the Sta-Home agencies had not

profited from their business because of the entities’ previous

“tax-exempt”     status.   Caracci,     118    T.C.   at    385-86.    This

statement further reflects a          misunderstanding of Sta-Home’s

business and the regulatory regime under which it operated.

The Sta-Home exempt agencies did not profit because they were

virtually entirely dependent on Medicare reimbursements and the

Medicare    reimbursement       system        prohibits     profit-taking,

regardless of an agency’s tax status.                 As the Tax Court

recognized elsewhere in its opinion, the Sta-Home entities

continued   to   operate   in   the     same    manner—at    a   loss—after

converting to nonexempt status.

                                   38
    The Commissioner concedes that the Tax Court’s statement

that the Sta-Home entities could have reported nontaxable

income of $1.78 million had it not declared a bonus in 1995 was

wrong.    Yet the Commissioner insists on this appeal that the

error was harmless.     The Tax Court opinion itself defeats this

argument.    The Tax Court reasoned from the mistaken assumption

that the Sta-Home agencies could have generated positive net

income by eliminating the 1995 employee “bonus” to the mistaken

finding that the agencies had demonstrated a “substantial fair

market value.” Id. at 405.              This mistaken statement was

immediately followed by the Tax Court’s decision to use an

invested-capital method to value Sta-Home’s assets and to use

profitable public companies as “comparables” to derive the MVIC

multiple as part of that method.           If the Tax Court had not

found that the Sta-Home entities had the potential to generate

a positive net income and “thus demonstrate substantial fair

market value,” the Tax Court’s decisions to use an invested-

capital method for valuing assets and to use profitable public

companies    as   comparables   for     unprofitable   privately   held

agencies, would be not only erroneous but illogical.             The Tax

Court’s $1.78 million error was anything but harmless.

    The     Tax   Court’s   erroneous    finding   that   the   Sta-Home

                                  39
entities had shown a potential for profitability and thus

demonstrated that their assets had “substantial fair market

value” is also the only apparent explanation for the decision

to discredit the opinions provided by the taxpayers’ expert

witness, Hahn.    As noted, in marked contrast to Wilhoite, Hahn

had spent months in Mississippi analyzing the Sta-Home agencies

and was a recognized authority on the home-healthcare industry.

In marked contrast to Wilhoite, Hahn did the work to value the

actual   assets   of   the   Sta-Home   entities.   Hahn   used   the

valuation method that both he and Wilhoite agreed was the

preferred and more rigorous approach to value assets.       Neither

the Tax Court nor the Commissioner disputed Hahn’s tangible

asset valuations, which attributed values between $8.4 and $8.7

million.    The Tax Court rejected Hahn’s intangible asset

valuations, which attributed approximately $2.7 million to the

workforce, including the certificates and licenses, because

Hahn’s conclusion that the value of the assets the nonexempt

entities received from the exempt entities was less than the

$13.5 million in liabilities they assumed was inconsistent with

the Tax Court’s (erroneous) finding that the Sta-Home entities

had “demonstrated substantial fair market value.”

    The Tax Court’s mistaken belief that Sta-Home’s intangible


                                  40
assets had substantial fair market value led it to ignore its

own   long-recognized        position   that      unprofitable      intangible

assets do not contribute to fair market value unless those

assets produce net income or earnings.                  Revenue Rule 59-60

requires     the   IRS   to    assign      zero     value    to   unprofitable

intangible assets.       See Rev. Rul. 59-60, 1959-1 C.B. 237 (“The

presence of goodwill and its value, therefore, rests upon the

excess of net earnings over and above a fair return on the net

tangible assets.”).      The Tax Court (and reviewing courts) have

recognized this.      See Fox River Paper Corp. v. United States,

65 F. Supp. 605, 607 (E.D. Wis. 1946), aff’d 165 F.2d 639 (7th

Cir. 1948); Rosen v. Comm’r, 62 T.C. 11 (1974), aff’d 515 F.2d

507 (3d Cir. 1975).       The Tax Court clearly erred and violated

its own prior rulings in failing to recognize that the Sta-Home

exempt agencies’ unprofitable intangible assets—including the

workforce, the licenses, the CONs, the Medicare-dependent

client base, and the aging and largely uncollectible accounts

receivable—had little or negative market value.

      Hahn   established       the   value     of    the     Sta-Home     exempt

agencies’ tangible assets at a range between $8,421,977 and

$8,787,492.        Neither    the    Commissioner      nor    the   Tax   Court

challenged this figure. The parties agreed that the for-profit

                                      41
entities assumed roughly $13.5 million in liabilities. The Tax

Court concluded that the Sta-Home exempt agencies’ total asset

value was $18,675,000, meaning that the agencies’ intangible

asset value had to be approximately $10,000,000.        The parties

agree that the Tax Court clearly erred in including the $1.78

million in “bonus” money as an intangible asset.       Setting this

error aside, there is no basis to assign over $8 million to the

Sta-Home exempt agencies’ remaining intangible assets, the

largest of which—its patients—would only enable the agencies

to lose money for the indefinite future. The CON was similarly

of little or no value as an intangible asset because it

provided Sta-Home access to the same Medicare-dependent group

of patients; neither Sta-Home (or another buyer) could raise

prices on the services provided to these patients to generate

revenue because Medicare precluded profit.        Even if the Tax

Court assigned a significant value to the Sta-Home exempt

agencies’   other   intangible   assets,   such   as   its   trained

workforce (which would need to be paid, representing further

liabilities as well as future profits), and goodwill, the Tax

Court would have had to find these remaining intangible assets

were worth approximately $5 million to conclude that the

taxpayers realized any net excess benefit from the transaction,

                                 42
assuming that the Sta-Home nonexempt agencies assumed $13.5

million in liabilities from the exempt entities and that the

exempt entities assumed approximately $8.5 million in tangible

assets from the exempt agencies.         There is no legal or factual

basis for assigning a $5 million value to these intangible

assets.

     This case began and ends with the Commissioner’s refusal

to   recognize    the   legal   effect   of   its   own   errors.   The

Commissioner issued erroneous and excessive deficiency notices,

yet persisted in defending them for nearly two years of

litigation before the Tax Court.              After the Commissioner

admitted his erroneous deficiency notices, he failed to meet

his burden of proving that the excise taxes he sought to

collect were correct. The Commissioner presented an expert who

used an inappropriate valuation method and lacked basic factual

information essential to the asset valuation he was called on

to provide.      The Tax Court erred as a matter of law when it

failed to find for the taxpayers after it rejected much of the

Commissioner’s expert’s opinion and instead proceeded to use

bits and pieces from that opinion to value the Sta-Home assets

transferred to the newly created nonexempt entities.            The Tax

Court erred as a matter of law in the valuation method it


                                   43
selected.    In the process of arriving at and applying that

method, and in struggling to make that method make sense, the

Tax Court made a number of clearly erroneous factual findings.

These errors led the Tax Court to reject the taxpayers’ expert,

whose adjusted balance sheet valuation method provided the only

rational and justifiable valuation available in the record, and

to find that a willing buyer would have paid $18.6 million for

the Sta-Home exempt agencies despite their unprofitability.

These errors require this court to reverse and render.

IV. Conclusion

    The Commissioner failed to perform a legitimate asset

valuation    analysis   throughout   the   audit,   discovery,   and

litigation of this case.     The Tax Court erred as a matter of

law in failing to hold the Commissioner to his burden of proof

and in selecting an inappropriate and incorrect method to value

the assets of the Sta-Home entities and made clearly erroneous

factual findings in applying this valuation method.        The Tax

Court’s errors do not require remand because the record makes

it clear that the Commissioner cannot meet his burden of proof

under 26 U.S.C. § 6213, Portillo, and Dunn.         The Tax Court’s

decision is reversed and judgment is rendered in favor of the

taxpayers.

                                44
REVERSED AND RENDERED




                        45
