                       T.C. Memo. 1997-166



                     UNITED STATES TAX COURT



     NATHAN P. AND GERALDINE V. MORTON, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket No. 26651-93.                   Filed April 1, 1997.


     James L. Kissire and Bob J. Shelton, for petitioners.

     John Repsis, for respondent.



          MEMORANDUM FINDINGS OF FACT AND OPINION

     WHALEN, Judge:        Respondent determined the following

deficiency in, and penalty on, petitioners' Federal income

tax for 1989:


            Deficiency              Sec. 6662 Penalty

                $296,702                 $59,340
                               - 2 -

Unless stated otherwise, all section references are to

the Internal Revenue Code as in effect for 1989.        After

               concessions, the issues remaining for decision

are:        (1) Whether the fair market value of the capital

stock of Soft Warehouse, Inc. ("SWI"), on June 30, 1989,

was $60.98 per share as petitioners contend, or $1,739.82

per share as determined by respondent; and (2) whether

petitioners are liable for the accuracy-related penalty

prescribed by section 6662(a).


Respondent's Motion in Limine

       As a preliminary matter, we must decide respondent's

motion in limine wherein she asks the Court to overrule

certain evidentiary objections reserved by petitioners in

the stipulation of facts.      Petitioners object to the

admission of the following joint exhibits:


       1.     A memorandum prepared by Dubin Clark &
              Co., Inc. ("Dubin Clark"), describing
              its 1989 purchase of SWI;

       2.     A memorandum prepared by Continental
              Illinois National Bank and Trust Co. of
              Chicago ("Continental Bank") for the
              purpose of approving financing for
              Dubin Clark's purchase and subsequent
              expansion of SWI;

       3.     A valuation of a noncontrolling equity
              interest in SWI as of March 31, 1990,
              prepared by KPMG Peat Marwick and dated
              June 14, 1990;
                            - 3 -

     4.   A confidential private placement
          memorandum dated October 1, 1990,
          prepared by Goldman, Sachs & Co. and
          Alex. Brown & Sons, Inc.; and

     5.   A prospectus for CompUSA (the successor
          company of SWI) dated December 17,
          1991, prepared by Kidder, Peabody &
          Co., Inc., and the First Boston Corp.


     Petitioners argue that these documents are irrelevant

to our determination of the value of SWI stock as of

June 30, 1989, insofar as they relate to events or

conditions arising after that date.    Petitioners maintain

that only events or conditions which are reasonably

foreseeable to a hypothetical buyer and seller on the

valuation date can be considered in determining the value

of the subject property on that date.    Petitioners also

argue that even if the documents are relevant, they should

not be admitted into evidence because they create an undue

risk of prejudice and confusion of the issues which

outweighs their probative value.    Respondent, on the other

hand, contends that the documents are relevant because they

represent subsequent evidence of the value of SWI stock on

the valuation date.   Respondent points out that all of the

documents were drafted by disinterested third parties

incident to a sale or issuance of SWI stock, and that

they were drafted for purposes other than litigation.
                              - 4 -

Respondent also maintains that the documents do not create

an undue risk of prejudice.

     The primary issue in this case is the fair market

value of SWI stock as of June 30, 1989.   Fair market value

is generally defined as the price at which property would

change hands between a willing buyer and a willing seller

on a fixed date, neither being under any compulsion to buy

or sell, and both having reasonable knowledge of relevant

facts.   See sec. 20.2031-1(b), Estate Tax Regs.; United

States v. Cartwright, 411 U.S. 546, 551 (1973); Krapf v.

United States, 977 F.2d 1454, 1457 (Fed. Cir. 1992);

Estate of Kaplin v. Commissioner, 748 F.2d 1109, 1111

(6th Cir. 1984), revg. T.C. Memo. 1982-440; Estate of

Brown v. Commissioner, 425 F.2d 1406, 1406-1407 (5th Cir.

1970), affg. T.C. Memo. 1969-91; Estate of Andrews v.

Commissioner, 79 T.C. 938, 940 (1982); Duncan Indus.

v. Commissioner, 73 T.C. 266, 276 (1979); Culp v.

Commissioner, T.C. Memo. 1989-517 (applying this standard

to section 83(b) election).

     Evidence is relevant if it has "any tendency to make

the existence of any fact that is of consequence to the

determination of the action more probable or less probable

than it would be without the evidence."   Fed. R. Evid. 401.

We agree with petitioners that unforeseeable events

occurring after the hypothetical date of sale which alter
                            - 5 -

the value of the property should not be considered in

fixing fair market value.   See First Natl. Bank of Kenosha

v. United States, 763 F.2d 891, 893-894 (7th Cir. 1985).

However, this Court has drawn a distinction between

subsequent events which affect the value of the property

and those which merely provide evidence of such value on

the valuation date.   See Estate of Jung v. Commissioner,

101 T.C. 412, 431 (1993).

     Subsequent events or conditions which affect the value

of the property can be taken into account only if they are

reasonably foreseeable on the valuation date.   Id.   For

example, the discovery of oil on real property after the

valuation date could affect what a willing buyer would pay

and what a willing seller would demand for the property on

the valuation date if the buyer and seller could foresee

the discovery.   If the discovery was unforeseeable on the

valuation date, then it could not affect the value of the

property on the valuation date and should not be considered

in determining the value of the property on that date.      See

id.; Estate of Hillebrandt v. Commissioner, T.C. Memo.

1986-560.

     Conversely, subsequent events which merely provide

evidence of the value of the property on the valuation

date can be taken into account regardless whether they

are foreseeable on the valuation date.   See id. Estate of
                            - 6 -

Jung v. Commissioner, supra.   In considering such events,

appropriate adjustments must be made for changes in

inflation, general economic conditions in the industry,

technological advances, and similar factors.   Id.    For

example, a subsequent arm's-length sale of the property

appropriately adjusted to take account of general economic

differences between the valuation date and the date of the

sale is relevant because it provides evidence of the value

of the property on the valuation date.   See id. at 431-432.

Indeed, this and other courts have recognized on many

occasions that:


     In determining the value of unlisted stocks,
     actual sales made in reasonable amounts at arm's
     length, in the normal course of business within
     a reasonable time before or after the valuation
     date are the best criteria of market value.
     [Duncan Indus. v. Commissioner, 73 T.C. 266, 276
     (1979) (citing Fitts' Estate v. Commissioner, 237
     F.2d 729 (8th Cir. 1956), affg. T.C. Memo. 1955-
     269. See also Estate of Jung v. Commissioner,
     supra; Estate of Andrews v. Commissioner, 79
     T.C. 938, 940 (1982); Estate of Campbell v.
     Commissioner, T.C. Memo. 1991-615.]


     In light of the foregoing, we find that each of the

items at issue except for the CompUSA prospectus is

relevant to our determination of the value of SWI stock as

of June 30, 1989.   The Dubin Clark memorandum describing

the terms of its purchase of SWI (item number 1 above) and

the memorandum prepared by Continental Bank for purposes
                              - 7 -

of approving financing for that transaction (item number 2

above) were both prepared prior to the valuation date.

Both documents were prepared in connection with Dubin

Clark's purchase of SWI, and neither describes subsequent

events which affected the value of the stock.   Accordingly,

these documents are directly relevant to our determination

of the value of SWI stock on the valuation date.   See

Estate of Jung v. Commissioner, supra.

     The valuation of a noncontrolling equity interest in

SWI prepared by KPMG Peat Marwick (item number 3 above) and

the confidential private placement memorandum prepared by

Goldman, Sachs & Co. and Alex. Brown & Sons, Inc. (item

number 4 above), were both prepared after the valuation

date.   However, both of these documents contain information

regarding the value of SWI stock within a reasonable time

after that date, and neither describes subsequent events

which affected the value of SWI stock.   Both documents also

represent valuations of SWI stock by third parties who were

not influenced by the biases of litigation.   The fact that

they were prepared after the valuation date is a factor

that we must consider in determining the probative value of

the evidence, but does not automatically make the documents

irrelevant.   See Krapf v. United States, 977 F.2d 1454,

1458-1459 (Fed. Cir. 1992).
                            - 8 -

     The CompUSA prospectus (item number 5 above), on the

other hand, is not relevant to our determination of the

value of the stock at issue.   This document describes a

public offering of SWI stock almost 2-1/2 years after the

valuation date.   Based upon the record of this case, we

cannot find that the public offering was sufficiently

foreseeable by the parties on the valuation date.    Accord-

ingly, we will sustain petitioners' objection insofar as

the CompUSA prospectus is concerned.

     We reject petitioners' argument that the items in

question should not be admitted into evidence because

Estate of Jung v. Commissioner, supra, and similar cases

only allow consideration of subsequent arm's-length sales

of the subject property.   As noted above, the first two

items describe conditions existing prior to the valuation

date.   Assuming that petitioners' restrictive reading of

Estate of Jung v. Commissioner, supra, is correct, the next

two items fit comfortably within that reading.   The

confidential private placement memorandum (item number 4)

was in fact prepared in connection with an arm's-length

sale of SWI stock.   Similarly, the valuation of a

noncontrolling equity interest in SWI (item number 3) was

requested by the board of directors to ascertain the price

at which SWI stock would change hands in an arm's-length

sale.   Accordingly, we find that these documents are
                             - 9 -

essentially indistinguishable from the events which were

determined to be relevant in Estate of Jung v.

Commissioner, supra.

     We also find that the documents in question do not

create an undue risk of prejudice or confusion of the

issues.   A court may exclude relevant evidence if "its

probative value is substantially outweighed by the danger

of unfair prejudice, confusion of the issues, or misleading

the jury, or by considerations of undue delay, waste of

time, or needless presentation of cumulative evidence."

Fed. R. Evid. 403.    Petitioners do not point to any

specific facts which indicate that the evidence at issue

would create an undue risk of prejudice or confusion of the

issues if admitted.    Rather, petitioners merely state that

"Respondent's documents would unduly prejudice Petitioners

and confuse the issues and should not be considered by this

Court in determining the value of the subject stock."     We

find petitioners' conclusory statement in this regard both

unsupported and unpersuasive.    The documents at issue are

highly probative and do not, in our estimation, create an

undue risk of prejudice or confusion of the issues.

Accordingly, we shall grant respondent's motion in limine

and overrule petitioners' objections to the admission of

the first four items listed above into evidence.    We shall

overrule respondent's motion in limine and sustain
                            - 10 -

petitioner's objection to the admission of the CompUSA

prospectus (item 5) into evidence.


                       FINDINGS OF FACT

     Some of the facts have been stipulated and are so

found.    The stipulation of facts, first supplemental

stipulation of facts, stipulation of settled issues, and

exhibits attached to each are incorporated herein by this

reference.    At the time they filed their petition in this

case, petitioners resided in Dallas, Texas.    References to

petitioner in this opinion are to Mr. Nathan P. Morton.

     Petitioner is a business executive who specializes in

retail marketing.    Prior to May 1989, he was senior vice

president of operations for Home Depot, Inc., a retailer

specializing in hardware and housewares.    When petitioner

joined Home Depot in 1984, it operated 21 stores.    When he

resigned in 1989, Home Depot had grown to approximately 100

stores.

     SWI was formed in 1984 by Messrs. Errol Jacobson and

Michael Henochowicz.    SWI sold computer hardware and

software through warehouse "superstore" outlets, by mail,

and through direct telemarketing.    By January of 1989, SWI

was operating two stores, one in Dallas, Texas, and one in

Norcross, Georgia, and was planning to open more.    Messrs.

Jacobson and Henochowicz believed that SWI could become a
                             - 11 -

dominant force in its market and wanted to expand the

company.    Although their corporate contacts and experience

in retail sales and distribution provided a significant

benefit to SWI, Messrs. Jacobson and Henochowicz were both

aware that they lacked the experience and capital necessary

to expand the company.    Accordingly, Messrs. Jacobson and

Henochowicz sold their SWI stock to Dubin Clark in January

1989, although they continued working for the company after

Dubin Clark's acquisition.

     Dubin Clark's purchase of SWI was structured as a

stock purchase followed by a merger.    Old SWI was merged

into new SWI, and new SWI was the surviving entity.    In

exchange for their stock in old SWI, the selling share-

holders were to receive a total of $5 million in cash, the

right to purchase approximately 27 percent of the stock of

new SWI for $60.98 per share, and contingent annual cash

payments for 5 years following the sale equal to 30 percent

of the company's operating profit in excess of $4 million

per year.    One-half of the contingent payments was

designated as "incentive compensation" to insure the

continuing involvement of the selling shareholders in the

management of SWI.    The other half was designated as "earn-

out" payments.

     SWI calculated the $60.98 price per share that the

former owners paid for the stock of new SWI by dividing
                            - 12 -

paid-in capital by the number of shares outstanding after

the acquisition (i.e., paid-in capital as of January 31,

1989, $439,056, divided by total shares outstanding on the

same date, 7,200).    The cash portion of the purchase price

was paid with retained earnings from old SWI and the

proceeds of debt incurred by new SWI.    Prior to the Dubin

Clark purchase, SWI had virtually no long-term debt.    After

the buyout, SWI had approximately $5 million in outstanding

debt.

     The Dubin Clark purchase was completed on January 31,

1989.   Messrs. Jacobson and Henochowicz received a total of

$279,000 in contingent payments based upon operating income

for the fiscal year ended on June 30, 1990.    In January

1991, SWI repurchased 1,423,787 of the shares held by

Messrs. Jacobson and Henochowicz for $4,416,000 in cash.

SWI also purchased Messrs. Jacobson's and Henochowicz's

rights to future contingent payments for a total of

$4,098,000 in cash.

     Dubin Clark was a sophisticated investor with a

proven record of successfully managing the growth of its

acquisitions.   After acquiring SWI, Dubin Clark implemented

a plan to expand the company.    Dubin Clark's original plan

was to open one or two new stores per year and become

dominant in certain regional markets.    This would have

allowed Dubin Clark to withdraw excess cash from the
                           - 13 -

business over the time it managed the company.     Dubin Clark

intended to take SWI public when sales reached $250 to $300

million, which they expected to take about 3 years.

     An important aspect of Dubin Clark's plan to expand

SWI was hiring experienced management.    In accordance with

this aspect of its plan, SWI approached petitioner in

March 1989 and offered him a position overseeing the

company's expansion.   Dubin Clark believed that

petitioner's expertise in assembling management teams,

building corporate infrastructure, and establishing plans

to facilitate corporate growth was essential to its plan to

expand SWI.

     Petitioner originally rejected Dubin Clark's offer

because he did not agree with its plan to make SWI a

dominant regional retailer.   Rather, petitioner believed

that SWI would be most competitive if it expanded into a

variety of geographical markets.    Dubin Clark eventually

agreed with petitioner's assessment and offered him the

position of president and chief operating officer of SWI.

     Petitioner accepted Dubin Clark's offer in April 1989,

but did not join the company immediately because he had

previously committed to assist Home Depot in a debt

offering.   Although he provided consulting services for a

short time before his actual starting date and attended the

opening of SWI's third store in Houston, Texas in April,
                             - 14 -

petitioner did not officially begin working for SWI until

May 31, 1989.   Because of his outstanding business

credentials, petitioner's employment with SWI increased the

value of SWI stock almost immediately.

     Dubin Clark realized that to attract desirable

managers to SWI, it needed to offer management candidates

ownership interests in the company.    Therefore, on June 1,

1989, SWI's board of directors adopted a "Share Compensa-

tion Plan" (hereinafter referred to as the stock plan).

This stock plan authorized the board of directors to allow

employees to purchase stock in SWI at a predetermined

price.   The stock plan did not require that the stock be

sold at fair market value.    In fact, Dubin Clark

contemplated that most of the shares would be sold for less

than fair market value.   Under the terms of the stock plan,

the price was originally set at $60.98 per share, and

SWI's board of directors was authorized to make subsequent

adjustments to this price.    Although the stock plan

provided that the price could not violate applicable State

law, it provided no other specific criteria for making

these adjustments.   No valuation of SWI's stock was made

at the time the stock plan was adopted.    At this time, it

appears that there were 7,100 shares of SWI capital stock

outstanding, and an additional 1,800 stock purchase

warrants held by two lending institutions.
                           - 15 -

     Petitioner believed that leaving a secure position

with Home Depot to join SWI was a risky move, and he would

not have joined SWI without obtaining a significant equity

interest in the company.   On July 13, 1989, after some

negotiation concerning the amount of stock petitioner would

receive pursuant to the stock plan, he and Dubin Clark

entered into a "Stock Purchase Agreement" (hereinafter

referred to as the agreement) under which petitioner agreed

to purchase 500 shares of SWI stock for $60.98 per share.

This is the same price that Messrs. Jacobson and

Henochowicz paid for their shares, and is the initial

price established under the stock plan.   Neither SWI nor

petitioner obtained an independent valuation of the stock

prior to or at the time of this purchase.   Petitioner

believed that the shares were fairly valuable and would

have purchased more if he had been given the opportunity.

     The stock petitioner purchased pursuant to the

agreement was subject to certain restrictions.    Petitioner

could not sell, assign, transfer, pledge, or dispose of the

stock to any person or entity other than SWI.    In addition,

all of the shares were initially "unvested".    However, 20

percent of the shares received were to become vested on the

anniversary of the purchase each year, so that all of the

shares would be vested 5 years from the date of sale.

The agreement also required SWI to repurchase all of
                             - 16 -

petitioner's shares within 90 days of any termination of

employment other than a voluntary termination by

petitioner.    The repurchase price for vested shares was

equal to the adjusted book value per share.    The price for

the unvested shares was set at the lesser of the adjusted

book value per share or the original purchase price.

     On or before August 12, 1989, petitioners filed with

the Internal Revenue Service a timely election under

section 83(b) regarding the SWI stock petitioner purchased

pursuant to the agreement.    In this election, petitioners

reported the fair market value of the SWI stock to be

$60.98 per share, the amount petitioner paid for the stock.

Thus, petitioners claimed that they realized no gross

income in 1989 from the purchase of the SWI shares.

Although petitioner received the subject stock on

July 13, 1989, the parties agree that June 30, 1989,

is the appropriate valuation date with regard to the

section 83(b) election.

     SWI experienced moderate expansion during the first

half of 1989.    Although it began the year with only two

superstores, it opened a third in Houston, Texas, in April,

and was preparing to open a fourth in Los Angeles by the

end of June.    In addition, its most successful store,

located in Dallas, had to be moved several times into

larger facilities.    Although the company was beginning to
                                       - 17 -

recruit experienced managers, petitioner was the only new

manager hired as of June 30, 1989.              SWI was generally

financially healthy at this time, but it had some fiscal

concerns, including the significant amount of debt assumed

to finance the buyout and expansion.              As of June 30, 1989,

SWI had long term debt of approximately $8.3 million and

current liabilities of approximately $13.2 million.                        SWI's

balance sheet as of June 30, 1989 was as follows:
                     Assets                                       Liabilities

                                                Current liabilities
                                                Accounts payable                   $11,290,720
Current assets                                  Accrued liabilities                  1,502,966
Cash and equivalents            $1,745,901      Income taxes payable                   259,550
Net accounts receivable          6,730,874      Current portion of
Inventory                        9,554,926        capital lease obligations             158,040
Prepaid Expenses                   555,899        Total                              13,211,276
  Total                         18,587,600
                                                Capital lease obligations               326,255
Property and equipment,
  at cost                                       Bank credit agreement                 3,070,462
Furniture, fixtures and
equipment                          738,733      Senior subordinated notes             4,912,341
Leasehold improvements             392,462
Property under capital                            Total long-term
  lease                            634,268      liabilities                         8,309,058
Capital projects in                               Total liabilities     99.81%     21,520,334
progress                            35,633
Less accumulated depreciation     (367,558)
Net property & equipment         1,433,538                    Shareholders' Equity
Net intangible assets &
  deferred charges, net          1,432,104      Warrants                               125,526
                                                Common stock                                71
Deposits and other                 108,583      Additional paid in capital             430,693
  total assets                  21,561,825      Retained Earnings                      109,674
                                                  Total                                666,054
                                                Carryover basis adjustment            (624,563)
                                                  Total shareholders' equity 0.19%
                                                                                        41,491

                                                Liabilities +                      21,561,825
                                                Shareholders' equity


       In the 5-month period ending on June 30, 1989, SWI

experienced total sales of $64 million, gross profit of

$16.9 million, and net income of $125,526.                During this

same period, SWI's gross profit margin decreased from 12.8
                                       - 18 -

percent to 11.2 percent.               SWI's future financial performance

was expected to be impacted by the approximately $1 million

in capital expenditures necessary to open each new store,

and the annual management fee that SWI was required to pay

Dubin Clark.           On June 30, 1989, SWI had 7,100 shares of

capital stock outstanding.                As mentioned above, an

additional 1,800 stock purchase warrants were held by two

lending institutions.

       SWI's growth is evidenced by its income statements for

the fiscal years 1987, 1988, and 1989, which are set out

below:

Fiscal Year Ending 6/30                               1987           1988              1989

Net sales                                        $32,124,000     $66,566,000     $137,457,598
Cost of sales                                     29,450,000      58,072,000      122,016,440
Gross profit                                       2,674,000       8,494,000       15,441,158

Selling, general and administrative expenses
Salaries and employee benefits                                                     11,812,357
Advertising                                        1,223,000       2,890,000
Rent                                                 488,000       1,503,000
Other expenses                                       107,000         199,000
Depreciation and amortization                        357,000         857,000
  Total                                                8,000          89,000          370,170
                                                   2,183,000       5,538,000       12,182,527
Operating income
                                                     491,000       2,956,000        3,258,631
Other income/expense
Interest income
Other income                                           6,000          45,000           53,391
Interest expense                                       5,000          26,000           33,729
  Total                                               (3,000)        (11,000)        (454,939)
                                                       8,000          60,000         (367,819)
Earnings before income taxes
                                                     499,000       3,016,000        2,890,812
Income taxes
Current
Deferred                                             213,000       1,087,000        1,204,472
  Total                                                5,000         (15,000)           --
                                                     218,000       1,072,000        1,204,472
Net income
                                                     281,000       1,944,000        1,686,340


     The above figures for 1987 and 1988 are taken from an audited statement attached to a
memorandum prepared by Dubin Clark describing its 1989 purchase of SWI. The figures for 1989
are a combination of old SWI's figures and new SWI's figures.
                            - 19 -

       On April 16, 1990, petitioners filed an application

for an automatic extension of time to file their

individual return for 1989 and paid the estimated tax

due.    On August 14, 1990, petitioners requested an

additional extension of time to file their return until

September 25, 1990.    Respondent granted this extension

application on August 30, 1990.      Petitioners' Form 1040,

U.S. Individual Income Tax Return, was signed on

October 15, 1990, and stamped received by respondent's

Austin, Texas, Service Center on October 22, 1990.        We

note that respondent did not determine an addition to tax

for late filing with respect to petitioners' 1989 return.

On their return, petitioners valued their SWI stock for

section 83(b) purposes at $60.98 per share.      Thus,

petitioners did not report any income on their 1989

return with respect to petitioner's purchase of

500 shares of SWI stock.

       On April 4, 1990, petitioner purchased an additional

25 shares of SWI stock for $60.98 per share.      Petitioners

thereafter made a section 83(b) election with respect to

these additional shares, in which they reported the fair

market value of the stock to be $2,600 per share.        This

second section 83(b) election is not at issue in this

case.
                             - 20 -

     In 1991, petitioners filed a Form 1040X, Amended

U.S. Individual Income Tax Return, with respect to their

1989 return.    In the amended return, petitioners claim to

have overpaid their 1989 income tax due to an accounting

error for an S corporation in which petitioners owned

shares.   This amendment is not at issue in this case.

     SWI did not obtain an independent valuation of its

stock until June 14, 1990.    Petitioner did not personally

obtain an appraisal of the subject stock until

preparation for trial.    SWI stock was not publicly traded

at any time during 1989.


                           OPINION

     The principal issue for decision in this case is

whether the value of the SWI stock petitioner purchased

was greater than the $60.98 per share he paid and

reported on his section 83(b) election.    Section 83(a)

provides generally that the value of property transferred

in connection with the performance of services must be

included in the gross income of the taxpayer who performs

the services.    The value of such property is included in

income in the first year in which the taxpayer's rights

in the property are transferable or are not subject to a

substantial risk of forfeiture, whichever is earlier.      At

such time, the excess of the fair market value of the
                          - 21 -

property over the amount, if any, that the taxpayer paid

for such property is included in the taxpayer's gross

income.

     Section 83(b) allows a taxpayer to elect to include

in gross income in the year of receipt the value of the

property transferred in exchange for services regardless

of whether his or her rights in the property are trans-

ferable or subject to a substantial risk of forfeiture.

Section 83(b) provides as follows:



     (b) ELECTION TO INCLUDE IN GROSS INCOME IN YEAR
     OF TRANSFER.--

          (1) In General.--Any person who performs
     services in connection with which property is
     transferred to any person may elect to include
     in his gross income, for the taxable year in
     which such property is transferred, the excess
     of--

               (A) the fair market value of
          such property at the time of transfer
          (determined without regard to any
          restriction other than a restriction
          which by its terms will never lapse),
          over

               (B) the amount (if any) paid for such
          property.

     If such election is made, subsection (a) shall
     not apply with respect to the transfer of such
     property, and if such property is subsequently
     forfeited, no deduction shall be allowed in
     respect of such forfeiture.
                             - 22 -

The parties agree that petitioners were eligible to make

an election under section 83(b) with regard to their SWI

stock.

     The sole dispute between the parties to this case is

over the fair market value of the stock at the time of the

purchase, June 30, 1989.    In their section 83(b) election,

petitioners claimed that the fair market value of the stock

was $60.98 per share, the price petitioner paid for his 500

shares.    In the notice of deficiency, respondent determined

that the fair market value of the stock was $1,739.82 per

share, and that petitioners' 1989 taxable income should

therefore be increased in the amount of $839,420 (i.e.,

$1,739.82 minus $60.98 times 500).    In a report prepared

for trial, petitioners' expert valued the stock at $55 per

share.    At trial, respondent's expert testified that the

stock was worth $1,798 per share.

     Generally, fair market value is "the price at which

the property would change hands between a willing buyer

and a willing seller, neither being 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) (quoting section 20.2031-1(b),

Estate Tax Regs.); see also Culp v. Commissioner, T.C.

Memo. 1989-517 (applying this standard to a section 83(b)

election).
                            - 23 -

       The determination of fair market value is a question

of fact to be resolved from a consideration of all rele-

vant evidence in the record and appropriate inferences

therefrom.    See Estate of Jung v. Commissioner, 101 T.C.

412, 423-424 (1993); Estate of Andrews v. Commissioner,

79 T.C. 938, 940 (1982); Duncan Indus. v. Commissioner,

73 T.C. 266, 276 (1979); Kaplan v. Commissioner, 43 T.C.

663, 665 (1965); Mandelbaum v. Commissioner, T.C. Memo.

1995-255, affd. without published opinion 91 F.3d 124

(3d Cir. 1996).    Petitioners bear the burden of proving

that the fair market value determined by respondent is

incorrect.    See Rule 142(a), Tax Court Rules of Practice

and Procedure; Estate of Jung v. Commissioner, supra at

424; Estate of Winkler v. Commissioner, T.C. Memo. 1989-

231.    All Rule references hereinafter are to the Tax

Court Rules of Practice and Procedure.

       Determining fair market value is often difficult

where, as here, the subject property is the capital stock

of a closely held corporation for which no public market

exists.    In these circumstances, an actual arm's-length

sale of the stock in the normal course of business within

a reasonable time before or after the valuation date is

the best evidence of fair market value.    See Estate of

Andrews v. Commissioner, supra at 940; Estate of Campbell

v. Commissioner, T.C. Memo. 1991-615, sec. 20.2031-2(b),
                           - 24 -

Estate Tax Regs.   In the absence of such sales, fair

market value is determined by considering, inter alia:


     (a)   The nature of the business and the history
           of the enterprise from its inception;

     (b)   The economic outlook in general and
           the condition and outlook of the
           specific industry in particular;

     (c)   The book value of the stock and the
           financial condition of the business;

     (d)   The earning capacity of the company;

     (e)   The dividend paying capacity [of the
           company];

     (f)   Whether or not the enterprise has
           goodwill or other intangible value;

     (g)   The size of the block of stock to be
           valued; and

     (h)   The market price of stock of
           corporations engaged in the same line
           or similar line of business having
           their stocks actively traded in a
           free and open market, either on an
           exchange or over-the-counter. [Rev.
           Rul. 59-60, sec. 4.01, 1959-1 C.B. at
           237, 238-239; see also sec. 20.2031-
           2(f), Estate Tax Regs.]


These factors are not intended to be all-inclusive, and

cannot be applied with mathematical certainty.     See Rev.

Rul. 59-60 sec. 3.01, 1959-1 C.B. at 238.   Because

petitioners made a section 83(b) election with respect

to the subject stock, and because the restrictions on the

stock were not perpetual, the value of the SWI stock for
                              - 25 -

section 83 purposes must be determined as though the

restrictions did not exist.     Sec. 83(b).

     There are three generally accepted methods of

determining the value of stock:        The market comparison

approach, the income approach, and the cost approach.

Fishman, "Valuation Termination and Methodology", in

Financial Valuation:   Businesses and Business Interests

par. 2.7 (Zukin ed. 1990).     Under the market comparison

approach, the value of stock is determined by comparison

to the stock of similar companies with publicly traded

stock.   Id. at par. 2.8.    Under the income approach, the

value of stock is equal to the present value of the

company's future income stream.        Id. at par. 2.9.   Under

the cost approach, the value of stock is equal to the

fair market value of the company's assets less the total

amount of liabilities.      Id. at par. 2.10.

     We note that we are not bound by the methods or

opinions of any of the experts who testify at trial, but

may use their opinions to assist in determining the value

of the subject property.     Chiu v. Commissioner, 84 T.C.

722, 734 (1985); Estate of Campbell v. Commissioner, T.C.

Memo. 1991-615.   One expert may be persuasive on a

particular element of valuation, and another may be

persuasive on another element.      Parker v. Commissioner,

86 T.C. 547, 562 (1986).     Thus, we may adopt some aspects
                           - 26 -

of an expert's testimony and reject others.   Helvering v.

National Grocery Co., 304 U.S. 282 (1938).

     Petitioners' expert, Mr. Robert Conklin of Ernst &

Young, relied solely on the income approach in valuing

the SWI stock.   Mr. Conklin did not use the market

comparison approach because he believed that there were

no sufficiently comparable companies in existence as of

the valuation date.   He did not use the cost approach

because he felt it "tends to minimize the value of assets

and fails to consider intangibles such as goodwill."

     Mr. Conklin utilized a "discounted cash flow

analysis" to calculate the fair market value of SWI

stock.   Under this analysis, the value of stock is equal

to the present value of the cash flow the company is

expected to generate in the future.   Mr. Conklin began

his analysis by estimating SWI's net income for the 10-

year period from 1990 to 1999, and what he described as a

"terminal year".   He calculated this net income figure by

estimating the total sales SWI could expect to generate

from each store and multiplying by the number of stores

SWI could be expected to operate each year.   Mr. Conklin

assumed that SWI would expand its operations rapidly from

1989 to 1994, and that it would open a constant number of

new stores each year thereafter until 1999, reaching a

total of 271 stores in that year.   He also assumed that
                            - 27 -

newly opened stores would generate revenues of $25

million per year, while mature stores would generate

$35 million.   Additionally, Mr. Conklin assumed that

SWI's gross profit margin would grow by 0.3 percent each

year, reaching an "industry norm" of 13 percent of sales

by 1999 to reflect improved management and economies of

scale.

     Mr. Conklin next reduced SWI's estimated total sales

by operating, pre-opening, capital, interest, tax, and

other expenses to arrive at a projected net income for

each year.   In calculating the amount of such expenses,

Mr. Conklin assumed that beginning operating expenses for

each store would equal 8.8 percent of net sales, and that

this figure would decrease by 0.1 percent per year over a

9-year period (beginning the second year) to reach a

minimum ratio of 8.0 percent.   He also assumed that

each new store opening required capital expenditures of

$1 million and pre-opening expenditures of $400,000.

     Mr. Conklin next estimated SWI's "debt-free residual

cash flow" for each year.   He calculated this figure by

reducing net income by "incremental working capital",

which he described as the amount of working capital

required to support accounts receivables and inventory.

Mr. Conklin assumed that this figure for each year would

equal 7 percent of the increase in sales over the
                            - 28 -

previous year.    He then added depreciation and deducted

capital expenditures to reach a final "debt-free residual

cash flow" for each year.

     Next, Mr. Conklin reduced "debt-free residual cash

flow" each year to present value, applying a discount

rate of 35 percent.    Mr. Conklin chose this discount rate

after examining the risk inherent in SWI's financial

structure and the risk associated with SWI's general

business enterprise.    According to Mr. Conklin, the

discount rate reflects the rate of return an investor

would require before devoting money to a particular

enterprise, considering its particular economic, market,

and industry risks.    In this regard, Mr. Conklin examined

the capital structure of the computer retailing industry,

as well as the economic, market, and industry risk on the

valuation date.    He believed that SWI presented a

particularly risky investment due to difficulties in

obtaining financing for expansion and a high degree of

risk in the computer and related markets.    Additionally,

Mr. Conklin believed that "The [discount] rates for

venture capital funds averaged between 30 to 60 percent

or more due to the business risk associated with SWI's

position."   He did not cite any authority for this

conclusion either in his expert report or in his

testimony at trial, nor did he state whether this rate of
                           - 29 -

return is generally required for venture capitalists or

is specific to an investment in SWI.    Mr. Conklin

believed that a 35-percent rate of return was necessary

not only to justify the high degree of risk involved in

Dubin Clark's investment in SWI, but also to allow Dubin

Clark to make an overall profit despite the failure of

other ventures.

     After calculating the present value of SWI's "debt-

free residual cash flow" for each year, Mr. Conklin

reduced the sum of these values by the book value of debt

outstanding in 1989 to arrive at the "fair market value

of equity, enterprise basis."   Finally, Mr. Conklin

divided this figure by the total number of shares

outstanding to reach the price per share.    Mr. Conklin

computed this value assuming 6 percent, 7 percent, and 8

percent "terminal growth rates".    This produced per share

values of ($72.38), $100.14, and $285.43, respectively.

Mr. Conklin then reduced these figures to reflect a

"minority and marketability discount" of 50 percent,

which he based on the Mergerstat Review 1989.    This

produced a range of values of ($36.19), $50.07, and

$142.72 per share.   Based on this range, Mr. Conklin

concluded that the fair market value of SWI stock as of

June 30, 1989, was $55 per share.
                             - 30 -

     We find petitioners' expert's valuation

unpersuasive.    First, the results of Mr. Conklin's

analysis fluctuate wildly with minor changes in basic

assumptions.    For example, minor changes in what

Mr. Conklin terms "Incremental Working Capital" cause

drastic changes in the overall value of the stock under

his analysis.    "Incremental Working Capital" is measured

as a percentage of the increase in sales over the prior

year.   Throughout his analysis, Mr. Conklin assumed that

SWI would require working capital each year equal to 7

percent of the increase in sales over the previous year.

However, a change in this figure of just 1 percentage

point to 6 percent, leaving all of Mr. Conklin's other

assumptions unchanged and applying a 7-percent growth

rate, causes the price per share to increase, by our

calculation, to $1,748.17.    This is troubling in light of

the fact that Mr. Conklin agreed on cross-examination

that 6 percent was a reasonable figure for incremental

working capital.    Given the importance of incremental

working capital to Mr. Conklin's valuation model, and the

volatile effect this figure has on his overall valuation,

we find troubling Mr. Conklin's concession as to the

reasonableness of using 6 percent.    Moreover, we note

that information contained in Mr. Conklin's report

suggests that SWI's incremental working capital had
                                       - 31 -

fluctuated between 1.7 percent and 7.58 percent during

the 4-year period from 1986 to 1989.                 Our computation of

those percentages is as follows:

In Thousands                    1985       1986       1987       1988      1989

Total sales                    $3,000     $11,739    $32,124   $66,566   $137,458
Change from previous year        --         8,739     20,385    34,442     70,892
Working capital                  --           211        347     1,777      5,376
Incremental working capital      --         2.41%      1.70%     5.16%      7.58%



      The discount rate employed in Mr. Conklin's valua-

tion model is also bothersome.              Mr. Conklin testified that

he chose a discount rate of 35 percent to reflect the rate

of return required by venture capitalists before devoting

money to a particular enterprise.                 Mr. Conklin testified

that venture capitalists generally require between 30- and

60-percent return, and that his 35-percent discount rate

was "conservative".           However, Mr. Conklin did not provide

any objective support, either at trial or in his expert

report, for selecting a discount rate in this range.

Moreover, the discount rate is another extremely

problematic variable in Mr. Conklin's model.                    Changing the

discount rate just 2 percentage points, from 35 to 33

percent, leaving all other variables the same and applying

a 7-percent growth rate, causes an increase in the overall

valuation from, by our calculation, $47.33 per share to

$1,161 per share.       A discount rate of 30 percent produces

a final value of $3,551 per share.                  Once again, the
                            - 32 -

volatile nature of Mr. Conklin's valuation model, along

with the lack of objective support for his assumptions,

causes us concern about the accuracy of his final

calculation.

     We are also not persuaded by petitioners' argument

that the $60.98 price per share established in the

original acquisition transaction and used in connection

with the Share Compensation Plan supports the accuracy of

petitioners' expert's valuation.     In consideration for

their shares in old SWI, Dubin Clark gave Messrs.

Jacobson and Henochowicz $5 million in cash, the right

to contingent payments of 30 percent of the company's

operating profit in excess of $4 million for the next 5

years, and the right to purchase approximately 27 percent

of the stock of new SWI for $60.98 per share.     We agree

with respondent that this price per share does not

accurately reflect the fair market value of the stock

after the acquisition transaction.     Indeed, as mentioned

above, the $60.98 price for the new SWI shares was

computed by dividing paid-in capital as of January 31,

1989, $439,056, by the number of shares of new SWI stock

outstanding at that time, 7,200.     It bears no necessary

correlation to the value of the SWI stock after the

acquisition transaction.   Furthermore, there is no

evidence that it was intended to reflect the value of the
                           - 33 -

new SWI stock after the transaction.   It was just one

component of the overall acquisition transaction in which

Dubin Clark acquired the interests of Messrs. Jacobson

and Henochowicz in old SWI, and was not a separate arm's-

length sale reflecting the fair market value of the

specific block of stock.   Accordingly, the price

established in the acquisition transaction does not

necessarily reflect the fair market value of the stock at

that time, or 6 months later when petitioner acquired the

stock at issue.

     Moreover, Dubin Clark established the Share

Compensation Plan for the express purpose of attracting

talented management to SWI.   One way to accomplish this

purpose was to offer prospective managers a significant

discount on the shares made available for purchase.    The

language of the stock plan itself confirms that the board

of directors contemplated selling stock at less than fair

market value.   Paragraph 4(a) of the stock plan provides

as follows:


     The purchase price for the shares of Common
     Stock to be offered and sold from time to time
     by the Company pursuant to this Plan shall be
     initially $60.98 per share and thereafter as
     determined from time to time by the Board. The
     Board is authorized to offer and sell shares of
     Common Stock pursuant to this plan at less than
     fair market value in order to compensate
     qualified employees, directors, officers,
     consultants and advisers of the Company * * *
                            - 34 -



Thus, the language of the stock plan itself suggests that

the initial purchase price of $60.98 per share was less

than the fair market value of the stock at the time the

stock plan was adopted.

     Further, petitioner himself testified at trial that

he believed the value of SWI increased at the moment he

joined the company.   Because petitioner purchased the

subject stock after he officially joined the company, the

value of the stock was, by his own admission, greater

than it was at the time the $60.98 price per share was

established.   Thus, we find that the price of $60.98 per

share established in the original acquisition transaction

and the Share Compensation Plan does not provide an

accurate measurement of the value of the stock.

     Events occurring after the valuation date provide

additional evidence that petitioner's stock in SWI was

worth more than $60.98 per share on June 30, 1989.

First, in a letter dated June 14, 1990, KPMG Peat Marwick

valued a noncontrolling interest in SWI at $2,500 to

$2,700 per share as of March 31, 1990, only 9 months

after the valuation date.   Second, in a confidential

private placement memorandum, Goldman Sachs & Co. and

Alex. Brown & Sons, Inc., determined this value to be

approximately $15,000 per share as of October 1, 1990.
                           - 35 -

Finally, petitioner himself reported the value of the

additional 25 shares of SWI stock he purchased on April

4, 1990, at $2,600 per share.   Taking into account

changes in general economic and other circumstances

between June 30, 1989, and the dates of these subsequent

valuations, we find respondent's valuation much more

reasonable than petitioners'.

     In light of the foregoing, we reject petitioners'

expert's valuation in its entirety.   Cf. Buffalo Tool

& Die Manufacturing Co. v. Commissioner, 74 T.C. 441, 452

(1980); see also Neely v. Commissioner, 85 T.C. 934, 944

(1985). Accordingly, we find that petitioners have failed

to satisfy their burden of proving that respondent's

determination of the fair market value of the subject

stock is erroneous.   See Rule 142(a).   We thus accept

respondent's determination in its entirety and find that

the stock purchased by petitioner had a fair market value

of $1,739.82 per share as of June 30, 1989.

     Next, we must decide whether petitioners are liable

for the accuracy-related penalty prescribed by section

6662.   Respondent determined that petitioners are liable

for the penalty with regard to the deficiencies

attributable to both the SWI stock and an unrelated

transaction involving stock in Home Depot, Inc.    Although

the amount of the deficiency arising from the transaction
                            - 36 -

in Home Depot stock was settled, the section 6662 penalty

was not.

     Section 6662 imposes a penalty equal to 20 percent

of any portion of an underpayment of tax attributable to

negligence or disregard of rules or regulations, or to a

substantial understatement of income tax.    Negligence is

defined as "any failure to make a reasonable attempt to

comply with the provisions of this title".    Sec. 6662(c).

Disregard is defined as "any careless, reckless, or

intentional disregard."   Sec. 6662(c).   Petitioners

bear the burden of proving that respondent's determina-

tion of negligence or intentional disregard of rules or

regulations is erroneous.   Rule 142(a); Forseth v.

Commissioner, 85 T.C. 127, 166 (1985), affd. 845 F.2d 746

(7th Cir. 1988), affd. sub nom. Mahoney v. Commissioner,

808 F.2d 1219 (6th Cir. 1987), affd. without published

opinions sub nom. Woolridge v. Commissioner, 800 F.2d 266

(11th Cir. 1986); affd. without published opinion sub

nom. Bramblett v. Commissioner, 810 F.2d 197 (5th Cir.

1987); affd. sub nom. Enrici v. Commissioner, 813 F.2d

293 (9th Cir. 1987).

     With regard to the deficiency arising from the SWI

stock, petitioners point to the fact that petitioner

engaged in "extensive discussions" with Dubin Clark

regarding his employment with SWI and his purchase of SWI
                              - 37 -

stock.   Petitioners argue that through these discussions,

petitioner made a reasonable effort to determine the

value of SWI, and that he had no reason to expect that

the stock was worth more than the $60.98 per share that

he paid.    Petitioners also argue that given petitioner's

business experience and expertise, this determination was

reasonable.    We disagree.

     Although petitioner is a successful businessman,

he is neither an accountant nor an expert in property

valuation.    The record indicates that petitioners

received professional assistance in preparing their tax

return for the year in issue.     However, there is nothing

in the record to show that petitioners relied on expert

advice in valuing the SWI stock, or that they provided

the return preparer with all of the information needed to

value the stock.    Under the circumstances, we find that

petitioners failed to do what a reasonable and ordinarily

prudent person would have done under the circumstances to

value the SWI stock.    See generally Neely v. Commis-

sioner, 85 T.C. 934, 947 (1985).       Accordingly, we find

that petitioners are liable for the penalty prescribed by

section 6662 for negligence with respect to the SWI

stock.     Sec. 6662(b)(1).   It is unnecessary to consider

whether they are liable for the same penalty by reason of
                            - 38 -

a substantial understatement of tax with respect to the

SWI stock.   See sec. 6662(b)(2).

     Petitioners have not challenged respondent's deter-

mination of negligence with respect to the understatement

attributable to the gains from a transaction involving

Home Depot stock.    Although the Stipulation of Settled

Issues states that petitioners concede underreporting the

gain as determined in respondent's notice of deficiency,

the stipulation is silent on the issue of the section

6662 penalty.    At trial, petitioners' counsel informed

the Court that this issue had not been resolved.

     Petitioners bear the burden of proving that they are

not liable for the penalty as determined by respondent.

Rule 142(a).    Petitioners have not met this burden with

respect to the understatement attributable to the

transaction involving Home Depot stock.    They introduced

no evidence disputing the section 6662 penalty, and

failed to raise any argument during trial or on brief as

to why the penalty is inapplicable.    Accordingly, we

sustain respondent's determination that petitioners are

liable for the section 6662 penalty with respect to such

understatement.

     In light of the foregoing, and to reflect

concessions and settled issues,
 - 39 -

     An appropriate order will

be issued granting respondent's

motion in limine in part, and

denying respondent's motion in

limine in part, and decision

will be entered under Rule 155.
