                      T.C. Memo. 2006-212



                     UNITED STATES TAX COURT



                  ROBERT DALLAS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 7493-04.               Filed September 28, 2006.



     John M. Elias, Peter J. Ulrich, Rita M. Danylchuk, and Laura

Lavie, for petitioner.*

     Wendy D. Gardner and Brian E. Derdowski, Jr., for

respondent.




     *
        Kenneth N. Laptook was substituted as counsel for John M.
Elias after trial, and all briefs except respondent’s response to
petitioner’s supplement to reply brief were filed.
                                - 2 -

               MEMORANDUM FINDINGS OF FACT AND OPINION


     COLVIN, Chief Judge:    Respondent determined deficiencies in

petitioner’s gift tax of $1,715,526 for 1999 and $823,160 for

2000.1

     Petitioner transferred about 55 percent of the nonvoting

stock of the Dallas Group of America, Inc. (DGA), an S

corporation the stock of which is not publicly traded, to trusts

established for the benefit of his sons (the trusts) in exchange

for cash and promissory notes signed by his sons.      The transfers

occurred on November 29, 1999 and 2000.    Petitioner and his sons

agreed to be bound by a value for DGA stock as estimated in a

third-party appraisal.    Each promissory note used to pay for the

stock at issue in 1999 provides it is deemed paid if petitioner

dies before it is paid.    Respondent determined that the

transactions were bargain sales and thus were gifts.     The issues

for decision are:

     1.    Whether the value of the DGA stock at issue on November

29, 1999, was $907 as respondent determined or $620 as petitioner

contends; and whether the value of the DGA stock at issue on

November 29, 2000, was $906 as respondent determined or $650 as

petitioner contends.    We hold that the fair market value of the




     1
          Amounts are rounded to the nearest dollar.
                                - 3 -

DGA stock was $751 per share on November 29, 1999, and $801 per

share on November 29, 2000.

     2.   Whether the value of each 1999 note was $2,232,000, as

petitioner contends, or $1,687,704 as respondent determined.    We

hold that it was $1,687,704.

     Unless otherwise specified, section references are to the

Internal Revenue Code as in effect for 1999 and 2000, and Rule

references are to the Tax Court Rules of Practice and Procedure.

                         FINDINGS OF FACT

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

A.   Petitioner

     Petitioner resided in Whitehouse, New Jersey, when he filed

the petition in this case.    He was 84 years old at the time of

trial.

B.   Dallas Group of America

     1.    Reagent Chemical & Research., Inc.

     In 1959, petitioner and Thomas Skeuse (Skeuse) formed

Reagent Chemical & Research, Inc. (Reagent), in Texas.    Reagent

initially processed elemental sulfur and later distributed

hydrochloric acid.   In the 1970s, Reagent expanded into the

ammonium chloride and magnesium silicate businesses.

     2.    Formation of Dallas Group of America, Inc.

     In February 1989, petitioner and Skeuse decided to split

their interests in Reagent.    Reagent spun off its ammonium
                               - 4 -

chloride and magnesium silicate divisions to form Dallas Group of

America, Inc. (DGA), the stock of which petitioner received in

exchange for his interest in Reagent.   DGA manufactures and

distributes ammonium chloride and synthetic magnesium silicate.

Its headquarters is in Whitehouse, New Jersey.   It is an S

corporation for Federal income tax purposes.

     DGA had nonoperating assets including 79 percent of Trenton

Liberty Insurance Co.,2 Unity Bankcorp, Inc. stock, land in New

Jersey, and split-dollar insurance receivables in 1999 and 2000.

     3.   Ammonium Chloride and Magnesium Silicate Production

     In the mid-1990s, DGA sold ammonium chloride to about 130

different distributors in volumes of at least one truckload.

Ammonium chloride is used as an ingredient in fertilizer, cattle

feed, cough medicine, and intravenous solutions, and in personal

products such as cosmetics and shampoo.   It is also used in

galvanizing metal, producing dry cell batteries, growing baker’s

yeast, and servicing oil wells.   As of September 1999, DGA

supplied about 90 percent of the ammonium chloride used in the

United States and Canada, or 18,000 tons per year, and exported

about 5,000 tons per year.   About 29 percent of DGA’s gross

revenue from 1998 to 2000 was from sales of ammonium chloride.




     2
        Trenton Liberty Insurance Co. was formed to provide
product liability insurance for DGA.
                                - 5 -

     DGA also manufactures synthetic magnesium silicate.     DGA is

the only manufacturer of synthetic magnesium silicate in the

Western Hemisphere.    It markets this product under the trade name

Magnesol.

     About 50 percent of DGA’s sales of Magnesol are to fast food

chains such as McDonald’s (DGA’s largest customer), which use

Magnesol to filter frying oil from other compounds to extend the

life of the frying oil.    About 40 percent of DGA’s sales of

Magnesol are for use in the manufacture of polymers.     Ten to

twenty percent of DGA’s sales of Magnasol are to international

food services and industries.    About 70 percent of DGA’s gross

revenue in 1999-2000 was from sales of Magnasol.

     4.     Financial Status and Senior Management

     Petitioner chairs DGA’s board.     His son, Robert Dallas II

(Robert), is president, his son, David Dallas (David), is chief

executive officer, and John Felowitz (Felowitz) is chief

financial officer and executive vice president.      David has worked

for Reagent or DGA since 1974, and Robert has worked for either

Reagent or DGA since 1972.    DGA paid petitioner and his two sons

salaries and bonuses in the following amounts in 1998, 1999, and

2000:
                                - 6 -

                             1998            1999          2000
     Petitioner
           Salary          $873,224        $983,164      $733,229
     Robert
           Salary           833,851         785,709       821,253
           Bonus            250,000              --            --
     David
           Salary           831,238        785,275        820,931
           Bonus            250,000             --             --
               Total      3,038,313      2,554,148      2,375,413

     Petitioner originally owned all of DGA’s series A voting

stock and series B nonvoting stock.     Paul Rosenberg (Rosenberg)

and Steven Holt (Holt) were petitioner’s estate planning counsel.

They recommended that petitioner use grantor retained annuity

trusts (GRATs) and an estate freeze as part of his estate plan.

     In 1992, petitioner and his wife, Fay Dallas (Fay), formed

two GRATs and contributed 4,100 shares of DGA’s series B stock to

each trust.   Petitioner transferred another 7,000 shares to Fay

in 1998.   Fay died on January 24, 1999.    At that time she owned

the 7,000 shares.

     Rosenberg recommended that Fay’s estate retain Empire

Valuation Consultants, Inc. (Empire), a business appraiser, to

appraise the stock as of the date Fay died.     Empire appraised the

stock in a report dated October 28, 1999.

     Empire used a capitalization of income approach to estimate

the value of DGA stock.   In doing so, Empire opined that a
                               - 7 -

reasonable buyer would assume that DGA’s net income would be

reduced by 40 percent due to tax-affecting.3

     Empire also assumed that executive compensation for

petitioner and his sons would be set at about $1.4 million per

year, causing DGA’s future annual earnings to increase.     Empire

applied a 15-percent discount for lack of control and a 35-

percent discount for lack of marketability.     Empire concluded

that the fair market value of a minority interest of DGA stock

was $610 per share as of January 24, 1999.

     The GRATs terminated in 1999, and 4,100 shares of DGA stock

were transferred to Robert and David.   Also in 1999, petitioner

acquired 78 additional shares of series B stock.

     DGA used retained earnings to expand.     DGA paid enough

dividends to its shareholders (petitioner, his sons, and the

trusts established for his sons) to pay income tax that resulted

from dividend distributions.




     3
        Generally speaking, in the context of valuation of stock
of an S corporation, “tax-affecting” is the discounting of
estimated future corporate earnings on the basis of assumed
future tax burdens imposed on those earnings, such as from the
loss of S corporation status and imposition of corporate-level
tax. See Gross v. Commissioner, T.C. Memo. 1999-254, affd. 272
F.3d 333 (6th Cir. 2001); Bogdanski, Federal Tax Valuation, par.
6.03[6][e][i], at S-36-38 (2006 & Supp. 2006).
                                - 8 -

C.   Stock Transfers to Petitioner’s Children

     1.    1999 Stock Transfers From Petitioner to His Sons

     On a date not stated in the record, Rosenberg advised

petitioner to transfer stock of DGA to trusts established for the

benefit of his sons in exchange for cash and notes signed by his

sons as trustees of the trusts for their benefit promising to pay

for the stock.    Petitioner wanted the notes to be deemed paid in

full if he died before all payments were made.4

     Rosenberg and Holt chose Empire to appraise DGA’s series B

stock to determine the price for a sale of the stock by

petitioner to the trusts.   Petitioner and his sons agreed that

the trusts would buy the stock at the price set by Empire.

     Empire prepared a report dated November 15, 1999, and sent

it to Felowitz.   Empire concluded that the fair market value of

the series B shares was $620 as of September 30, 1999.    Empire

used the same methodology that it had used to appraise the DGA

shares held by Fay’s estate.   See par. B-4, above.

     On November 29, 1999, petitioner transferred 4,000 shares of

series B stock to the trust established for the benefit of Robert

and 4,000 shares to the trust established for the benefit of

David.    In return, each trust transferred to petitioner $248,000

in cash and a promissory note for $2,232,000 (collectively the


     4
        If the notes were deemed prepaid when petitioner died,
the value of the notes would not be included in his estate.
                                - 9 -

1999 notes), on the basis of Empire’s estimate of the value of

the DGA stock at issue in 1999 ($620).

     Petitioner and his sons signed the sale agreements and

promissory notes.    The sale agreements included the following

share adjustment clause:

     In the event that the value of the Shares is finally
     determined in any IRS proceeding to be greater than
     $620 per share, the number of shares purchased and sold
     hereunder shall be reduced to the number which is the
     quotient of $2,480,000 divided by the value per share
     determined in such proceeding. In such event, Buyer
     shall transfer to Seller, for no additional
     consideration, the number of Shares which is equal to
     the difference between 4,000 minus the quotient
     determined under this Section 1.2.

The 1999 notes5 include the following self-canceling clause:

     In the event that Holder shall die before the Maturity
     Date, this note shall be deemed to have been paid,
     satisfied and discharged on the day before the date of
     the Holder’s death.

     In 1999, Fay’s estate distributed 544 shares of series B

stock to Robert and 544 shares to David.

     2.     2000 Stock Transfers From Petitioner to His Sons

     On November 29, 2000, Fay’s estate and the trusts signed an

agreement under which the estate transferred 2,956 shares of

series B stock to each of the trusts, and each trust transferred

to the estate $192,140 in cash and a promissory note for

$1,729,260 (collectively the 2000 notes), on the basis of



     5
          The maturity date of the 1999 notes is Nov. 29, 2004.
                               - 10 -

Felowitz’s estimate that the stock was worth $650 per share.6

Felowitz assumed that Empire had correctly valued DGA stock at

$620 per share as of November 29, 1999, and estimated that the

value had increased to $650 per share as of November 29, 2000.

     The 2000 sale agreements between Fay’s estate and the trusts

had the following share adjustment clause:

     In the event that the value of the Shares is finally
     determined in any IRS proceeding to be greater than
     $650 per share, the number of shares purchased and sold
     hereunder shall be reduced to the number which is the
     quotient of $1,921,400 divided by the value per share
     determined in such proceeding. In such event, Buyer
     shall transfer to Seller, for no additional
     consideration, the number of Shares which is equal to
     the difference between 2,956 minus the quotient
     determined under this Section 1.3.

The 2000 notes did not have a self-canceling clause.

     Respondent audited petitioner’s 1999 gift tax return in

2001.    During the audit, respondent’s tax examiner told Rosenberg

that the 1999 notes were self-canceling and thus were worth less

than face value because the notes were canceled if the holder of

the notes died before payment.

     On June 21, 2001, after respondent’s tax examiner told

Rosenberg about the self-canceling 1999 notes, petitioner and the

trustees of the trusts executed new promissory notes that were



     6
        The parties do not dispute that the transfers on Nov. 29,
2000, are treated as made by petitioner because the shares of DGA
transferred in the 2000 transaction would have passed to him if
Fay’s estate had not transferred them to the trusts.
                              - 11 -

substantially identical to the original notes except that they

did not contain the self-canceling clauses.

     After all of the above transactions, the 25,078 shares of

series B stock were owned as follows:

           Individual               Number of shares

          Petitioner                     1,878
          Robert                         4,644
          David                          4,644
          Robert’s trust                 6,956
          David’s trust                  6,956

D.   Respondent’s Determinations

     Respondent determined:   (1) The DGA stock at issue had a

fair market value of $907 per share on November 29, 1999, and

$906 per share on November 29, 2000; (2) each of the 1999 notes,

which had a face value of $2,232,000, had a fair market value of

$1,687,704; and (3) petitioner is liable for gift tax as a result

of these transfers because he received consideration worth less

than the fair market value of the transferred stock.

                              OPINION

A.   Contentions of the Parties

     Petitioner contends that the fact that the price paid for

the DGA stock at issue in November 29, 1999, was set by Empire,

an unrelated third-party appraiser, means the price was the fair

market value.   Petitioner also contends that testimony of his

expert witnesses supports Empire’s estimate of the value.

Respondent disagrees with petitioner’s contentions.
                                - 12 -

B.   Whether the Price for the DGA Stock at Issue Was an Arm’s-
     Length Price

     Petitioner points out that the 1999 price paid for the DGA

stock at issue was set by Empire and contends that the parties

properly structured and documented the sales of stock at issue as

arm’s-length transactions, thus establishing the fair market

value of the DGA stock at issue.    We disagree.

     Intrafamily transfers are presumed to be gifts.     Frazee v.

Commissioner, 98 T.C. 554, 561 (1992); Harwood v. Commissioner,

82 T.C. 239, 258 (1984), affd. without published opinion 786 F.2d

1174 (9th Cir. 1986).    While the presumption may be overcome with

evidence, see, e.g., Estate of Stone v. Commissioner, T.C. Memo.

2003-309, we conclude that petitioner has not done so.

     The transactions were designed by petitioner’s counsel to

serve petitioner’s estate planning goals.    The facts that payment

of the 1999 notes need not have been made if petitioner had not

survived until they were due7 and that the 1999 and 2000 notes

contain a share adjustment clause show that the transactions were

for estate planning purposes.

     Petitioner’s sons were not represented by their own counsel

in the transactions.    Petitioner’s sons did not negotiate the

terms of the agreements, and while that is not dispositive, see

Estate of Thompson v. Commissioner, 382 F.3d 367, 382 (3d Cir.


     7
          See discussion of the self-canceling clauses below at
par. D.
                               - 13 -

2004), affg. T.C. Memo. 2002-246, it is a factor suggesting the

lack of arm’s-length transactions in these circumstances.    See

Harwood v. Commissioner, supra at 259 (family transaction

structured by the family accountant with no arm’s-length

bargaining did not overcome the family transaction presumption);

cf. Estate of Stone v. Commissioner, supra (arm’s-length

transaction where each member of the Stone family negotiated the

transaction through his or her own independent counsel).

     We conclude that the prices petitioner’s sons agreed to pay

for the DGA stock at issue were not arm’s-length prices.

C.   Expert Testimony

     1.     Introduction

     We next consider the matters disputed by the expert

witnesses who testified as to the value of the DGA stock at

issue.    Empire and Management Planning, Inc. (MPI), each

submitted an expert report for petitioner.    Scott A. Nammacher

(Nammacher) testified for Empire, and Robert P. Oliver (Oliver)

and Joseph C. Hassan (Hassan) testified for MPI.    Appraisal

Economics, Inc. (AE), submitted an expert report for respondent.

T. Scott Vandervliet (Vandervliet) and Joseph G. Kettell

(Kettell) testified for AE.

     The primary points of disagreement among the expert

witnesses were:    (1) Whether to decrease the assumed income

stream from DGA because of tax burdens imposed on DGA or its
                             - 14 -

shareholders after the hypothetical sale (i.e., tax-affecting);

(2) whether to increase DGA’s assumed income stream on the

assumption that DGA’s executive compensation will decrease after

the hypothetical sale; and (3) whether, and if so, to what

extent, to apply discounts for lack of control, lack of voting

power, and lack of marketability.
                                      - 15 -

     The following chart summarizes the positions taken in the

expert reports:

                         Empire                  MPI                AE
                       (Nammacher)        (Oliver, Hassan)     (Vandervliet,
                                                                 Kettell)
Valuation methods   Capitalization of    Discounted cash     Capitalization of
                    income               flow; guideline     income; guideline
                                         company             company;
                                                             guideline
                                                             transactions
Capitalization      15.57% for 1999      16.5% for 1999;     16% for 1999; 15%
rates                                    15.5% for 2000      for 2000
Tax-affecting       Reduced net          Reduced net         None
                    earnings by 40%      earnings by 35%
Executive           Reduced expenses     None                Reduced expenses
compensation        by $1.4 million                          by $1.3 million
adjustment          for 1998;                                for 1999,
                    compensation                             compensation
                    adjusted 8% per                          adjusted 5% per
                    year for 1994-98                         year for 1994-
                                                             2000
Discounts           15% minority         40% lack of         20% minority
                    interest and lack    marketability; 5%   interest and lack
                    of control for       lack of voting      of control for
                    nonoperating         power               operating assets;
                    assets; 35% lack                         15% minority
                    of marketability                         interest and lack
                                                             of control for
                                                             nonoperating
                                                             assets; 20% lack
                                                             of marketability
1999 per-share      $620                 $528                $1,004
value
2000 per-share      None given           $584                $1,026
value



     We may accept or reject expert testimony according to our

own judgment, and we may be selective in deciding what parts of

an expert’s opinion, if any, we accept.          Helvering v. Natl.

Grocery Co., 304 U.S. 282, 295 (1938).          In general, we found AE’s

report and the testimony of Vandervliet and Kettell to be more
                                - 16 -

convincing than Empire’s and MPI’s reports and the testimony in

support of those reports.     AE’s report and the testimony of

Vandervliet and Kettell were cogent and thorough.     Vandervliet

and Kettell wrote the AE report and explained it clearly.

Empire’s letter report was, by its terms, limited.     Nammacher’s

testimony in support of Empire’s report was unconvincing for

reasons stated at paragraph C-2-b-ii, below.     MPI copied portions

of its report verbatim from the Empire report.

     2.   Tax-Affecting

          a.     Background

     Petitioner’s expert witnesses reduced DGA’s projected income

by 40 percent (Empire) and 35 percent (MPI) based on “tax-

affecting”.    Empire reduced DGA’s projected profits by 40 percent

on the assumption that, after a sale, the corporation will lose

its S corporation status.8    See, e.g., Gross v. Commissioner, T.C.

Memo. 1999-254, affd. 272 F.3d 333 (6th Cir. 2001).     MPI reduced

DGA’s projected profits by 35 percent because a shareholder is


     8
        The income of a C corporation is subject to income tax at
the corporate level, and shareholders are taxed on dividends paid
by a C corporation. Secs. 11, 61. In contrast, the income of an
S corporation generally is not taxed at the corporate level, but
is passed through to the shareholder and taxed to the shareholder
when earned, whether or not the corporation pays dividends. Sec.
1366.

     Nammacher’s testimony suggests that Empire tax-affected
DGA’s earnings on the assumption that DGA would lose its S
corporation status after or as a result of the hypothetical sale
of its stock. Oliver testified that this is why MPI tax-affected
DGA’s earnings.
                              - 17 -

liable for income tax on S corporation profits even if those

profits are not distributed to the shareholder.

          b.   Whether To Assume DGA Would Cease Being an S
               Corporation

     Petitioner points out that DGA’s S corporation election

could be ended at any time.   Petitioner also points out that some

potential buyers (e.g., C corporations) of DGA stock are not

qualified to be S corporation shareholders.   See secs.

1361(b)(1), 1362(d)(2).

     There is no evidence in the record that DGA expects to cease

to qualify as an S corporation.   DGA has a history of

distributing enough earnings for shareholders to pay their

individual income tax liabilities on DGA’s earnings.     There is no

evidence that DGA intends to change its practice of distributing

enough to cover individual income tax liability.9   See Davis v.


     9
        Petitioner contends that DGA’s practice of distributing
only enough to cover individual income tax liability
distinguishes this case from Gross v. Commissioner, T.C. Memo.
1999-254, in which the corporation distributed substantially all
of its income, and thus tax-affecting is appropriate here.
Whether tax-affecting applies turns on valuation principles
including consideration of the hypothetical willing seller and
buyer, the experts, and specific facts of the case, Gross v.
Commissioner, 272 F.3d at 351-352, and not necessarily on
formulas and opinions proffered by an expert witness, see
Anderson v. Commissioner, 250 F.2d 242, 249 (5th Cir. 1957),
affg. in part and remanding in part on another ground T.C. Memo.
1956-178; Estate of Newhouse v. Commissioner, 94 T.C. 193, 217
(1990); Estate of Hall v. Commissioner, 92 T.C. 312, 338 (1989).
In addition, petitioner misunderstands our analysis of the effect
of a shareholder-level tax in Gross v. Commissioner, supra. Our
analysis did not depend on the proportion of corporate income
                                                    (continued...)
                                - 18 -

Commissioner, 110 T.C. 530, 559 (1998).     The assumptions of

petitioner’s witnesses that a hypothetical buyer and seller would

assume without any supporting evidence that those events would

occur detracts from the credibility of their opinions.      See Gross

v. Commissioner, 272 F.3d at 351-355.

     Petitioner contends that the testimony of Oliver and

Nammacher establishes that a hypothetical willing buyer would

tax-affect earnings in valuing DGA stock.    We disagree.

                 i.   Oliver’s Testimony

     Oliver initially testified that MPI tax-affected DGA’s

earnings to apply C corporation tax rates and later testified

that MPI reduced DGA’s earnings to reflect individual income tax

rates.    Oliver was substantially unfamiliar with the MPI report.10

The MPI report contained passages lifted verbatim from the Empire

report.    We give Oliver’s testimony little weight.




     9
      (...continued)
distributed. We said that, in determining the present value of
an expected stream of earnings, any tax-affecting to reflect the
shareholder-level tax burden should be done equally (or not at
all) to both the discount rate and the expected cashflows, with
the result that, in either case, the present value determined
would be the same. That analysis is independent of the
proportion of earnings distributed.
     10
        Petitioner also called Hassan, another MPI employee, as
a witness. However, Hassan did not testify about tax-affecting,
executive compensation, or discounts.
                              - 19 -

               ii.   Nammacher’s Testimony

     Nammacher testified that:   (1) He has always tax-affected S

corporation income for the past 20 years;11 (2) an informal poll

at a recent conference showed 90 to 95 percent of responding

appraisers tax-affect S corporation income; (3) the American

Society of Appraisers (ASA) Board of Review rejects any

application for certification if the candidate submits test

answers or reports for review that do not tax-affect S

corporation income; (4) his experience is that all bankers,

investment bankers, and business brokers use tax-affecting in

estimating the value of S corporation stock; and (5) Empire uses

tax-affecting in valuing S corporation stock held by employee

stock ownership plans (ESOP) that it submits to the Department of

Labor.

     We give little weight to Nammacher’s testimony about an

informal poll at an unidentified conference held on a date not

stated in the record.   Nammacher admitted that ASA has never

issued an official directive or recommendation on tax-affecting S

corporations’ earnings.

     Nammacher’s claim that ASA’s Board of Review rejects test

answers or reports by a candidate applying for ASA certification



     11
        Nammacher’s testimony about whether the tax-affecting
adjustment was based on individual or corporate income tax rates
was vague and suggests that Empire applied tax-affecting based on
C corporation income tax rates.
                               - 20 -

which do not apply tax-affecting is unpersuasive because Kettell

testified that ASA’s Board of Examiners approved Kettell for ASA

certification even though he submitted a report to the board that

did not tax-affect S corporation income.    Respondent’s expert

witnesses do not automatically tax-affect all S corporation

earnings.

     Nammacher’s testimony about valuing ESOP stock for the

Department of Labor is not convincing because there is no

evidence that the Department of Labor’s definition of value is

similar to the definition of fair market value in this case.

            c.   Del. Open MRI Radiology Associates, P.A. v.
                 Kessler

     Petitioner contends that the reasoning in Del. Open MRI

Radiology Associates, P.A. v. Kessler, 898 A.2d 290 (Del. Ch.

2006), supports application of tax-affecting in this case.     We

disagree.    The issue in Del. Open MRI was whether the minority

stockholders of Delaware Open MRI Radiology Associates, P.A.,

received fair value of the going concern in a merger (fair merger

price).   Id. at 299, 310.   The court of chancery said the fair

merger price had to take into account the loss of the favorable

tax treatment for the S corporation shareholders.    Id. at 326.

The fair merger price reflected equitable considerations

including the possibility that in a merger minority shareholders

might be squeezed out.    Id. at 311-312.
                             - 21 -

     “Fair value” in minority stock appraisal cases is not

equivalent to “fair market value”.     Swope v. Siegel-Robert, Inc.,

243 F.3d 486, 492-493 (8th Cir. 2001); Union Ill. 1995 Inv. L.P.

v. Union Fin. Group, Ltd., 847 A.2d 340, 355 (Del. Ch. 2003); see

Cavalier Oil Corp. v. Harnett, 564 A.2d 1137 (Del. 1989); see

also JPMorgan Chase & Co. v. Commissioner, 458 F.3d 564, 569 (7th

Cir. 2006), affg. in part, vacating in part and remanding Bank

One Corp. v. Commissioner, 120 T.C. 174 (2003).     In Del. Open MRI

the court of chancery used a method to estimate the fair merger

price that considered the difference between the value that a

stockholder of Delaware Radiology would receive in Delaware

Radiology as a C corporation and the value that a stockholder

would receive in Delaware Radiology as an S corporation and

applied a type of tax-affecting.     Id. at 327.   However, the court

of chancery did not decide the price that a hypothetical willing

buyer would pay a hypothetical willing seller, both having

reasonable knowledge of all the relevant facts and neither being

under compulsion to buy or to sell that we use in this case.

          d.   Conclusion

     We conclude that there is insufficient evidence to establish

that a hypothetical buyer and seller would tax-affect DGA’s

earnings and that tax-affecting DGA’s earnings is not

appropriate.
                                - 22 -

     3.     Whether To Assume DGA Would Reduce Executive
            Compensation

     Respondent contends that DGA’s projected net income should

be increased on the assumption that the Dallas family officers

are receiving unreasonable compensation and that those amounts

would be reduced voluntarily or as a result of litigation brought

by a minority shareholder if a minority block of DGA shares were

sold to an unrelated investor.    Respondent relies on AE’s report

to support this position.    Petitioner contends that AE is

incorrect and that DGA’s compensation to petitioner and his sons

would not decrease after the hypothetical sale, leading to higher

income for DGA.

     The record does not contain the quality of factual analysis

customarily used by courts in deciding whether compensation is

reasonable.    Further, there is nothing in the record to suggest

that DGA is planning to change how it pays petitioner and his

sons.     See Davis v. Commissioner, 110 T.C. 530 (1998).   Thus, we

have no more reason to assume changes in DGA’s executive

compensation policies than we have to assume changes in dividend

paying policies or a change in its S corporation status.12     On

this record we, unlike AE and Empire,13 do not assume DGA’s


     12
        We disagree with petitioner’s expert Empire on all of
these points.
     13
           Empire’s position on executive compensation is more
                                                      (continued...)
                               - 23 -

projected profits will increase as a result of reduced

compensation to petitioner and his sons after the hypothetical

sale of DGA stock.14

     4.   Discount for Lack of Control or Minority Interest

          a.    Discount for Lack of Voting Power

     MPI did not apply a discount for lack of control or minority

interest because it estimated the value of a minority interest of

the DGA stock at issue.   However, MPI applied a 5-percent

discount for lack of voting power.      Petitioner contends that this

discount for lack of voting power is warranted because the stock

at issue is nonvoting stock.   Petitioner contends that nonvoting

stock is worth less than a minority interest because minority

shareholders could pool their votes to influence the S

corporation.   Any anticipation of minority shareholders’ pooling



     13
      (...continued)
favorable to respondent than MPI’s position and fairly similar to
AE’s position. One may ask whether respondent viewed Empire’s
analysis as a concession of the matter. The record makes clear
that respondent did not. At the start of the trial, petitioner’s
counsel listed valuation matters in dispute, including the
executive compensation issue. Respondent’s counsel concurred
that it remained in dispute. Thus, it is clear that both parties
understood that the executive compensation issue remained in
dispute and thus were on notice of the need to present evidence
relating to that issue.
     14
        We do not consider AE’s guideline company and
transaction methods because the application of those methods is
based on an incorrect assumption that adjustments must be made
for executive compensation. Thus, AE’s guideline companies and
transaction methods are not comparable to DGA and its methods.
                               - 24 -

their votes is speculative.   We conclude that no additional

discount is warranted for lack of voting power.

          b.   Minority Interest Discount for Nonoperating Assets

     AE and Empire estimated minority interest discounts of 15

percent for nonoperating assets.15   Petitioner does not dispute

the appropriateness of a minority interest discount of 15 percent

for nonoperating assets.

          c.   Minority Interest Discount for Operating Assets

     AE applied a 20-percent minority interest discount for

operating assets.16   Petitioner contends that amount is too low

because AE computed it using a formula based on a control

premium, and, in estimating the control premium, AE adjusted for

excessive executive compensation.    We disagree.   There is no

indication that AE based its selection of the control premium on

excessive executive compensation.

     5.   Discount for Lack of Marketability

     Each expert concludes that some discount for lack of

marketability is appropriate because there was no ready market

for DGA stock on the valuation dates.




     15
        MPI did not use a separate minority interest discount
for nonoperating assets because MPI used a net asset value
approach to value a minority interest and because MPI’s method
assumed that the DGA stock at issue was for a minority interest.
     16
        MPI did not use a minority interest discount for
operating assets because MPI’s method assumed that the DGA stock
at issue was for a minority interest.
                                - 25 -

     Respondent defends AE’s conclusion that a lack of

marketability discount of 20 percent is correct.       Petitioner

agrees with MPI that a lack of marketability discount of 40

percent is correct.     We disagree with petitioner.

     MPI compiled information from Private Equity Week, a weekly

newsletter, on comparable private placements in recent years and

found that the mean discount for lack of marketability for

restricted stock like DGA’s before 1990 was 34.2 percent, from

1990 to 1997 was 20.7 percent, and from 1997 to the present has

been 13 percent.     MPI used the 34.2-percent discount and adjusted

it to 40 percent because DGA stock had no prospect of becoming

public in more than 2 years.     We believe MPI should have used the

discount studies from the period that includes the transactions

at issue.     The valuation dates are in 1999 and 2000 when,

according to MPI, the median lack of marketability discount rate

was 13 percent.     We conclude that a 20-percent discount for lack

of marketability is appropriate.

     6.      Conclusion as to Fair Market Value of DGA Stock

     We calculated the fair market value of DGA stock as

follows:17



     17
        This computation is based on AE’s capitalization of
income approach adjusted for executive compensation. Earnings
before interest and tax (EBIT) are adjusted by $1,300 for 1999
and $1,100 for 2000 to correct the adjustment for executive
compensation. Each amount (other than percentages and number of
shares) in this calculation is multiplied by one thousand.
                              - 26 -

Total Equity
                                                1999      2000
Net sales                                     $30,867   $33,225
Adjusted EBIT:
  $4,600 less $1,300 for 1999                   3,300
    and $1,100 for 2000                                  3,500
Long-term growth rate                             3%        3%
EBIT (next 12 months)                          3,399     3,605
Less incremental operating working capital     (148)     (159)
Net operating cashflow for capitalization      3,251     3,446
Capitalization rate (16%-3%; 15%-3%)             13%       12%
Indicated enterprise value (excl.
  nonoperating assets)                         25,008    28,717
Indicated enterprise value (rounded)           25,000    28,700
Plus excess working capital                     1,108       623
Fair market value of business enterprise       26,108    29,323
Nonoperating assets                             3,253     3,199
Total equity value                             29,361    32,522
Total equity value (rounded)                   29,400    32,500

Discounted Equity

Total equity value                             29,400    32,500
Discounts for lack of control:
  Operating assets (20%)                      (5,222)   (5,865)
  Nonoperating assets (15%)                     (488)     (480)
As-if freely traded value                     23,690    26,155
Discount for lack of marketability (20%)      (4,738)   (5,231)
Fair market value of equity                   18,952    20,924

Fair Market Value Per Share

Number of shares                              25,250    25,328
Fair market value per share                      751       801

     The fair market value of the DGA stock at issue was $751 per

share on November 29, 1999, and $801 per share on November 29,

2000.

D.   Fair Market Value of the 1999 Notes

     Respondent determined that the fair market value of each of

the 1999 notes was $1,687,704, which is less than face value

because they were self-canceling.   Petitioner contends that the
                               - 27 -

value of each 1999 note was its face value of $2,232,00018 and the

self-canceling clauses should be given no effect.

     Petitioner contends generally that the promissory notes used

to pay for the stock were not self-canceling because they were

ambiguous on that point.    We disagree.   The notes unambiguously

provided that they were self-canceling.

     Petitioner contends that we should reform the 1999 notes

because inclusion of the self-canceling clauses was a drafting

mistake.   We disagree.   Rosenberg testified that he drafted the

1999 notes and that he meant for the self-canceling clauses to

require the 1999 notes to be deemed paid if petitioner died

before they were paid.    Holt testified that the intent of the

clauses was to treat the unpaid portion of the notes as a gift

from petitioner to his sons in the event of petitioner’s death.

Holt’s testimony is corroborated by a memorandum to his file

dated September 28, 1999.

     Petitioner cites cases which involve typographical errors.

See, e.g., Woods v. Commissioner, 92 T.C. 776 (1989); Buchine v.

Commissioner, T.C. Memo. 1992-36, affd. 20 F.3d 173 (5th Cir.

1994); Atkinson v. Commissioner, T.C. Memo. 1990-37.     Those cases

have no bearing here because this case involves no typographical

errors.    Petitioner may not disavow the self-canceling clauses.



     18
        Petitioner offered no evidence about the value of the
1999 notes.
                               - 28 -

They are not the result of mistake, undue influence, fraud, or

duress.

     We conclude on the basis of the foregoing that the self-

canceling clauses must be given effect, and that the value of

each of the 1999 notes is $1,687,704 as determined by

respondent.19   To reflect the foregoing,


                                                Decision will be

                                            entered under Rule 155.




     19
        In the opening brief, respondent contended that the
share adjustment clauses are void because they are against public
policy. Petitioner did not respond to respondent’s argument.
We deem this issue conceded because petitioner made no argument
about it on brief. See Chevron Corp. v. Commissioner, 104 T.C.
719, 758 (1995); Remuzzi v. Commissioner, T.C. Memo. 1988-8,
affd. without published opinion 867 F.2d 609 (4th Cir. 1989).
