                        T.C. Memo. 1999-43



                      UNITED STATES TAX COURT



           ESTATE OF HELEN BOLTON JAMESON, DECEASED,
    NORTHERN TRUST BANK OF TEXAS N.A., INDEPENDENT EXECUTOR,
   Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 2322-96.              Filed February 9, 1999.



     S. Stacy Eastland, John W. Porter, and Margaret W. Brown,

for petitioner.

     Melanie R. Urban and Lillian D. Brigman, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GALE, Judge:   Respondent determined a deficiency in

petitioner's Federal estate tax of $4,241,832.   After

concessions, the issues for decision are:

     1.   Whether, at the time of her death, Helen Bolton Jameson

(decedent) owned 80,485 shares of Johnco, Inc. (Johnco) common

stock, as petitioner contends; 81,251 shares, as respondent
                                - 2 -


contends; or some other amount.    We hold that decedent owned

81,641 shares at the time of her death.

     2.   Whether, for purposes of computing the taxable estate

of decedent, the fair market value of the shares of Johnco common

stock included in decedent's gross estate was $4,100,000 ($50.94

per share) as petitioner contends, at least $6,278,899 ($77 per

share) as respondent contends, or some other amount.    We hold

that the fair market value was $5,784,477 ($71 per share).

     3.   Whether the method prescribed for the computation of

the Federal estate tax transforms any part of such tax into a

direct tax which has not been apportioned in accordance with the

Constitution.    We hold that it does not.

     Unless otherwise noted, all section references are to the

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

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

and Procedure.    All amounts have been rounded to the nearest

whole dollar.    Some of the facts have been stipulated and are

incorporated herein by this reference.



                          FINDINGS OF FACT

I.   Decedent

     Petitioner is the Estate of Helen Bolton Jameson, deceased

(the Estate), who died testate on September 22, 1991.    Northern

Trust Bank of Texas (Northern Trust) is the independent executor

of the Estate.    Decedent was a resident of Texas at the time of

her death.   Decedent was predeceased by her husband, John B.
                                  - 3 -


Jameson, Jr. (John), who died on May 24, 1990, also as a resident

of Texas.      Decedent was survived by two children, Andrew B.

Jameson (Andrew), born in 1949, and Dinah B. Jameson (Dinah),

born in 1952.

      At the time of her death, decedent owned that portion of the

82,865 shares of common stock in Johnco held by John at his death

which had not been bequeathed by John to Andrew.      The value and

number of shares of stock included in decedent's estate is the

basis of the present controversy.

II.   Johnco

      Johnco was incorporated in Texas in 1968 by John.     Upon

Johnco's formation, John transferred to it the following:      (1) A

one-third interest in Jameson, Lord & Jameson (JLJ), a

partnership owned by John and his two siblings; (2) an undivided

one-third interest in 11,415 acres of timberland in Evangeline

Parish, Louisiana; and (3) an undivided one-third interest in

5,090 acres of timberland in Rapides Parish, Louisiana.      In 1986,

JLJ was dissolved and the foregoing real property interests were

divided among the partners.      As a consequence, Johnco acquired

5,405 acres of timberland in Evangeline Parish, Louisiana (the

Timber Property).

      A.    The Timber Property

      At the time of decedent's death, Johnco's principal asset

was the Timber Property.      Johnco also owned some unimproved land

in Tanglewood, a residential section of Harris County, Texas,

near Houston (Harris County Real Estate), as well as cash and
                                  - 4 -


marketable securities.     As stipulated, the fair market value and

tax basis of Johnco's assets as of September 22, 1991, were as

follows:

           Asset       Fair market value       Tax basis

     Cash                   $25,000             $25,000
     Investments            492,000             492,000
     Building and
       equipment            196,000             196,000
     Timber Property      6,000,000             217,850
     Harris County
       Real Estate          240,000             110,740
     Other                   19,000              19,000

     Subtotal             6,972,000           1,060,590
     Liabilities            (14,000)

     Net Asset Value      6,958,000

     The Timber Property was well managed and highly productive.

Of the 5,405 acres, 5,097 acres were wooded with mature timber,

primarily 27- to 33-year-old slash pine, but also bottomland

hardwoods and loblolly pine.      An additional 108 acres of pine

were premerchantable and ranged in age from 2 to 7 years in 1991.

The remaining acres consisted of lakes and ponds, improvement

sites, a road right-of-way, and a nontimberland area.         Based on

soil type and quality, and its site index,1 the Timber Property

was considered to be extremely productive.

     Because of the Timber Property's productivity, desirable

location, and contiguous nature, decedent's Johnco stock would be




     1
       Site index as defined by the        U.S. Department of
Agriculture is a designation of the        quality of a forest site
based on the height of the dominant        stand at a designated age.
Site index is essentially a measure        of the productive capacity of
a timberland site.
                               - 5 -


an attractive investment for a timber products company2 or a

pension fund.   The Timber Property was a large, contiguous,

privately owned timberland parcel, located within an extremely

competitive timber market.3   Large portions of timberland in the

area were owned either by timber products companies for their own

use or by the U.S. Forest Service.     The U.S. Forest Service had

provided a constant supply of timber products to the timber

industry nationwide but had recently begun to reduce sales of

timber from public lands in response to environmental concerns,

which had the effect of increasing prices and demand for

privately owned timber and timberland.    Privately owned

timberland is generally held in small parcels; the average-sized

privately owned parcel is 80 acres.

     The contiguous nature of the Timber Property offered a

number of advantages in protecting and managing the timber that

would appeal to a timber products company or pension fund buyer.

In comparison to noncontiguous holdings, a contiguous parcel like

the Timber Property had smaller borders and required less travel

time to inspect the property, allowing greater control over the

property, including the control of theft, wildfire, insects, and

poachers.   As a contiguous parcel, no portion of the Timber


     2
       As used herein, “timber products company” refers to an
operating company that is in the business of manufacturing
lumber, paper, and other products made from timber. Johnco, in
contrast, was a holding company and was not in the business of
producing timber products.
     3
       The Timber Property was within a 50-mile radius of several
corporate sawmills, plywood plants, and pulp and paper mills.
                               - 6 -


Property was landlocked and dependent on private access rights;

the Timber Property had an internal road system and direct access

to public roads.

     B.    Holding Company Status

     In its 1990 and 1991 Forms 1120, U.S. Corporation Income Tax

Return, Johnco was designated a personal holding company,

consistent with the nature of Johnco's business.    Johnco had only

one employee, Andrew, who served as its president and chief

operating officer.   Over 80 percent of Johnco's gross revenue was

derived from the sale of timber.    Johnco harvested timber from

the Timber Property very conservatively.    The amount of timber

harvested annually was limited to an amount approximately equal

to, or less than, the Timber Property's annual growth.4    Johnco

did not actually cut the timber that was harvested or employ

personnel or own any of the equipment necessary to harvest

timber.   Potential buyers placed bids with Johnco to purchase

timber and were responsible for its cutting and transportation

off the Timber Property.   Although Andrew was the sole employee

of Johnco, management of the timber on the Timber Property was

generally handled by an outside consulting forester, who

monitored the property and advised Johnco regarding the specifics

of harvesting timber, for a commission based on timber sales.

Until late 1990, Johnco's outside consulting forester had been


     4
       Limiting the annual harvest to annual growth is referred
to as "sustainable yield"; this method maintains an approximately
constant volume of timber in place. Harvesting less than annual
growth results in an increase in timber volume on a given tract.
                                 - 7 -


Harold Elliott.     Mr. Elliott first became acquainted with the

Timber Property as a child--his father, a logging contractor, had

managed a 15,000-acre tract of timberland owned by JLJ (the JLJ

Property) that included the Timber Property.     After college, Mr.

Elliott was employed by a forestry consulting firm that was

managing the JLJ Property, and in 1964 he became the general

manager and forester of the JLJ Property and continued to manage

the Timber Property when it was transferred to Johnco after the

dissolution of the partnership.

     Mr. Elliott had considerable latitude in the management and

harvesting of timber from the Timber Property during his tenure.

Subject to John's approval, Mr. Elliott would determine what

timber to harvest, based upon his assessment of timber growth,

growing conditions, and prevailing market prices.     Trees likely

to be cut were those that would command the highest market

prices5 and trees in areas that required thinning to promote

maximum timber growth.     Harvesting decisions were conservative,

tilted towards future growth rather than current realization of

income.

     C.      Section 631(a) Election

         On the valuation date, Johnco had made a valid election

under section 631(a), pursuant to which it treated the cutting of


     5
       As a tree matures, its value may increase not only because
it contains a greater volume of wood, but because the tree's
timber is suitable for a more valuable use. Telephone poles, for
example, require tall, straight trees; timber suitable for
producing telephone poles commands a much higher price than
immature or crooked trees used in the production of paper.
                                - 8 -


timber as a sale or exchange of property used in a trade or

business.    On the valuation date, Johnco's section 631(a)

election could be expected to apply to all subsequent taxable

years.

     D.     Liquidation Prospects

     It was stipulated that no liquidation of Johnco was

contemplated as of decedent’s date of death or at the time of

trial.

III. Johnco Stock Includable in Decedent's Estate

     A.     Bequests by John B. Jameson, Jr.

     At the time of his death, John owned 82,865 of the 83,000

issued and outstanding shares of Johnco as separate property;

Andrew owned the remaining 135 shares.    In Article VI of his

will, John made a specific bequest of his remaining available

unified credit amount (computed as $299,850) to his two children,

Andrew and Dinah (the unified credit bequest), as follows:

     I give, devise and bequeath to my two children, DINAH
     BOLTON JAMESON and ANDREW BOLTON JAMESON, in equal
     shares of ½ each, so much of my property, in cash or in
     kind, or partly in cash and partly in kind, as
     necessary to use the maximum unified estate tax credit
     as allowed under Federal Estate Tax Law as defined in
     26 USCA 2010. * * *

Article VI further provided that Andrew's share of the unified

credit bequest “shall be first satisfied out of the shares of

JOHNCO, INC. common stock which I own, as such shares exist and

are valued by independent appraisal as of my date of death.”

Under the will, John’s residuary estate passed to decedent.      The

residuary estate included all of the shares of Johnco common
                               - 9 -


stock that were not apportioned to Andrew under Article VI of

John's will.   Thus, at the time of her death, decedent's interest

in Johnco stock consisted of the 82,865 shares held by John at

his death, less however many shares were required to fund

Andrew's share of the unified credit bequest.

     Decedent was named the initial executrix of John's estate

and served in that capacity until her death.    As executrix,

decedent timely filed an estate tax return Form 706, Estate (and

Generation Skipping Transfer) Tax Return, for John's estate,

reporting a value of $7,192,967 ($86.80 per share) for the Johnco

stock passing through his estate.   At the time of her death,

decedent had not yet funded the unified credit bequest to Andrew

and had not obtained an independent appraisal of the Johnco

stock.

     B. Number of Shares and Value Reported on Decedent's
Form 706

     Following decedent’s death, in addition to serving as

independent executor of the Estate, Northern Trust was appointed

successor independent administrator of John’s estate.    In

December 1992, at the request of Northern Trust, Clyde Buck of

Rauscher Pierce Refsnes, Inc. (RPR), a Dallas, Texas, investment

banking firm, performed two appraisals of Johnco stock:    (1) The

value of decedent's Johnco stock on her date of death (Decedent

Appraisal); and (2) the value of the Johnco stock held by John on

his date of death (John Appraisal).    The record in this case

contains the Decedent Appraisal but not the John Appraisal.      The
                              - 10 -


Decedent Appraisal, however, makes express reference to the John

Appraisal and its conclusions.

     On December 21, 1992, Northern Trust filed decedent's

estate’s Form 706 and reported on Schedule B thereof that on her

date of death decedent owned 79,730 shares of Johnco common stock

(a 96-percent interest), after taking into account the unified

credit bequest.   The number of shares so reported was computed on

the assumption that on John’s date of death, the 82,865 shares

held by him had a value of $3.7 million, or $44.65 per share.

The $44.65 per share value was based upon the John Appraisal and

was utilized notwithstanding the fact that John’s date-of-death

value for such stock was reported on John’s Form 706 as $86.80

per share, or $7,192,967 for 82,865 shares.   The Form 706 filed

by John’s estate has not been amended.   The Estate further

assumed, apparently based on additional information regarding

John’s lifetime gifts, that Andrew's share of the unified credit

bequest was equal to $140,000, and funding this amount with

Johnco stock at an assumed value of $44.65 per share would

require 3,135 shares, leaving 79,730 shares in the Estate.

     Relying on the Decedent Appraisal, the Estate reported the

value of the 79,730 shares on decedent's date of death as $3.5

million ($43.90 per share).   According to the Decedent Appraisal,

Johnco had a liquidation value of $4.2 million, and 96 percent of

Johnco's common stock, after reduction to reflect minority

shareholder discounts (of approximately 13 percent), was worth

$3.5 million on decedent’s date of death.
                                    - 11 -


     For purposes of Schedule B of the Estate's Form 706, the

liquidation value of Johnco was reported as follows:

                                                           Built-in
          Asset          Fair market value   Tax basis   capital gains

     Cash                     $25,000         $25,000        -0-
     Investments              492,000         492,000        -0-
     Building and
       equipment              196,000         196,000        -0-
     Timber Property        5,239,000         329,000    $4,910,000
       and Harris Cnty.
       Real Estate
     Other                     19,000          19,000        -0-

     Subtotal               5,971,000        1,061,000    4,910,000

     Liabilities              (14,000)          ---           ---

     Net asset value        5,957,000           ---           ---

     Capital gains         (1,414,000)          ---           ---

     Selling costs           (350,000)          ---           ---

     Liquidation value      4,193,000           ---           ---


     C.    Unified Credit Bequest

     In December 1993, acting in its capacity as successor

independent administrator of John's Estate, Northern Trust funded

the unified credit bequest in John’s will.        After taking into

account all taxable gifts made to him by John during his lifetime

and all other amounts passing to him which were includable in

John's taxable estate, Northern Trust concluded that Andrew was

entitled to receive a bequest of property equal in value to

$111,617.49 as his share of the unified credit bequest, including

a life insurance policy on Andrew’s life valued at $5,366.            Thus,

Northern Trust computed that $106,251 worth of Johnco stock was

required to fund the balance of Andrew’s share of the bequest

(after taking into account the life insurance interest).            Using
                              - 12 -


the John Appraisal value of the Johnco stock on John’s date of

death of $44.65 per share, Northern Trust distributed 2,380

Johnco shares to Andrew to satisfy the $106,251 balance of his

share of the unified credit bequest.   In contrast, the Estate had

reported on decedent's Form 706 her interest in Johnco stock

under the assumption that $140,150 worth of Johnco stock, or

3,135 shares, would be necessary to fund Andrew's share of the

unified credit bequest.

      In funding the remaining $106,251 of the bequest with Johnco

stock, Northern Trust disregarded the $86.80 per-share valuation

that had been reported on the Form 706 filed by John’s estate and

instead used a valuation of $44.65 per share, resulting in the

distribution of 2,380 Johnco shares to Andrew.   If Northern Trust

had funded Andrew's share of the unified credit bequest using the

$86.80 per-share value, only 1,224 shares of Johnco stock would

have been required to fund the $106,251 balance of the bequest,

leaving 81,641 shares as part of the Estate.

IV.   Decedent's Bequests of Johnco Stock

      A.   Testamentary Provisions

      Under her Last Will and Testament (the Will), decedent made

a bequest to Andrew and Dinah in equal shares of one-half each of

such property "as necessary to use the maximum unified estate tax

credit as allowed under * * * 26 USCA 2010".   The terms of this

bequest further provided that the bequest to Andrew "shall be

first satisfied out of the shares of JOHNCO, INC. common stock
                              - 13 -


which I own, as such shares exist and are valued by independent

appraisal as of my date of death.”

     A similar provision in the Will bequeathed the residuary of

the Estate to Andrew and Dinah in equal shares of one-half each,

with Andrew's share to be satisfied first out of the shares of

Johnco, as valued by independent appraisal as of the date of

decedent’s death.   Consequently, the amount passing to both

Andrew and Dinah under the Will was dependent on the valuation of

the Johnco stock held by decedent on her date of death.

     B.   Family Settlement

     On December 23, 1993, before respondent had raised any

question regarding the valuation of decedent's Johnco stock,

Andrew and Dinah entered into a family settlement and release

agreement6 (family settlement agreement) whereby Andrew was

allocated the remaining 80,485 shares7 of decedent's Johnco stock

at an agreed-upon date of death value of $4,025,000.8   Dinah was


     6
       The Texas family settlement doctrine provides that parties
to a will are free to decide among themselves how property should
be distributed, and such settlements are given substantial
deference under Texas law. See Shepherd v. Ledford, 926 S.W.2d
405 (Tex. App. 1996); In re Estate of Hodges, 725 S.W.2d 265
(Tex. App. 1986).
     7
       Under the valuation assumptions employed by Northern
Trust, 80,485 shares remained in the Estate after transferring
2,380 shares of Johnco stock to Andrew to fund his share of the
unified credit bequest.
     8
       As noted supra, in December 1992, approximately 1 year
prior to the settlement, Northern Trust had hired RPR to value
the Johnco shares for purposes of decedent's Form 706. In the
Decedent Appraisal, RPR had appraised the liquidation value of
Johnco at $4,200,000 as of decedent’s date of death. The 80,485
                                                   (continued...)
                              - 14 -


allocated other assets of the estate, primarily marketable

securities and cash, with a date of death value of $4,025,000.

Under the terms of the agreement, Andrew and Dinah were each

entitled to the income earned on the properties they would

receive from the date of the settlement until the date of

distribution.   Although siblings, Andrew and Dinah were

represented by separate counsel in the settlement.   Inasmuch as

Andrew and Dinah were motivated to ensure that they received

everything they were entitled to under the Will, their interests

were adverse, and they were acting at arm's length in entering

into the family settlement agreement.


                     ULTIMATE FINDINGS OF FACT

     Under the terms of the unified credit bequest, 1,224 shares

of Johnco stock were bequeathed to Andrew.   Accordingly, 81,641

shares of Johnco stock are includable in decedent's gross estate.

     On September 22, 1991, the fair market value of 81,641

issued and outstanding shares of Johnco (a 98-percent interest)

was $5,784,477.




     8
      (...continued)
shares of Johnco remaining in the Estate after the funding of the
unified credit bequest to Andrew represented approximately 97
percent of the outstanding shares of Johnco stock. Presumably
RPR’s December 1992 appraisal had an impact on the ultimate
settlement amount of $4,025,000.
                              - 15 -


                               OPINION

I.   Number of Shares

     The number of shares of Johnco stock includable in

decedent's estate depends upon the number of such shares

bequeathed to Andrew in the unified credit bequest of John's

will, because as the beneficiary of the residuary of John’s

estate, decedent inherited whatever Johnco shares held by John at

death were not specifically bequeathed to Andrew.   Petitioner

took the position on the estate tax return that 79,730 shares

were includable in decedent's estate.    Respondent determined in

the notice of deficiency that the correct number is 80,485.    In

the petition, petitioner did not assign error to this aspect of

respondent's determination and now contends that 80,485 is the

correct number.   Respondent, however, in his answer avers that

the correct number is in dispute and contended at trial and on

brief that the correct number is 81,251.9


     9
       The parties address only obliquely what the consequences
are for the allocation of the burden of proof occasioned by these
modifications in position. The only clue to petitioner's
position is the following stipulation entered by the parties:

     Petitioner asserts * * * that respondent is bound by
     the following statement, at page 2, in the notice of
     deficiency, "Finally it is determined that the decedent
     owned 80,485 shares of Johnco, Inc. common stock.

For his part, respondent on brief expressly disavows a claim to
any increase in the amount of the deficiency initially determined
and seeks to minimize the significance of his change in position
regarding the number of Johnco shares in decedent’s estate.
According to respondent, the determination in the notice that
there were 80,485 shares in decedent’s estate “constitutes
nothing more than a position, subject to a shift based on more
                                                   (continued...)
                              - 16 -


     The parties' disagreement turns upon the appropriate

valuation of the Johnco shares for purposes of determining the

amount of Johnco stock bequeathed to Andrew pursuant to the

unified credit bequest in John's will.   Respondent contends that

the Johnco share value reported on the estate tax return for

John's estate as John's date-of-death value--namely, $86.80 per

share--must be used.   Respondent thus calculates that 1,614

shares of Johnco stock were required to fund a unified credit

bequest of $140,15010 (1,614 shares x $86.80 = $140,095.20),

leaving 81,251 in John's residuary estate inherited by decedent.

In respondent's view, since decedent served as executor of John's

estate and filed the return on which the $86.80 per-share value

as of John's date of death was reported, and this return has not

been amended, the $86.80 per-share value is an admission which

should be used as evidence of such value.



     9
      (...continued)
current information.”
     We believe that respondent's change from the position taken
in the notice, after petitioner acceded to it in the petition,
raises a "new matter" as that term is used in Rule 142, because
the ascertainment of the number of Johnco shares in decedent's
estate potentially requires different evidence, namely, of the
value of the Johnco shares at John's date of death, as opposed to
decedent's date of death. Accordingly, the burden of proof
shifts to respondent to establish that the number of Johnco
shares in decedent's estate exceeded 80,485. (Since respondent
first signaled this change of position in his answer by averring
that the number of Johnco shares in decedent's estate was
"disputed", respondent was not required to seek leave to amend
his answer in order to put the issue of the number of shares
before us.)
     10
       This figure was the amount reported on the estate tax
return for John's estate as Andrew's unified credit bequest.
                              - 17 -


     Petitioner contends that the Johnco share value on John's

date of death as postulated in the John Appraisal performed by

RPR in December 1992--namely, $44.65 per share--must be used for

purposes of determining the number of shares received by Andrew

pursuant to the unified credit bequest.   Petitioner thus

calculates that 2,380 shares of Johnco stock were required to

fund a unified credit bequest of $106,25111 (2,380 shares x

$44.65 = $106,26712), leaving 80,485 shares in John's residuary

estate inherited by decedent.13   In petitioner's view, the

$86.80 per-share value reported on John's estate's return as the

value of the Johnco shares on John's date of death should not be

used for purposes of determining the number of shares passing to

Andrew pursuant to the unified credit bequest because the terms

of John's will required that the bequest be funded with Johnco

shares "as such shares * * * are valued by independent appraisal



     11
       Although the returns for both John's and decedent's
estates used the assumption that Andrew's unified credit bequest
was equal to $140,150, petitioner contends that this amount was
subsequently recomputed to be $106,251. Since the lower figure
is adverse to petitioner's interests (because it has the effect
of increasing the number of shares that passed to decedent's
estate pursuant to the residuary clause of John's will), we
accept it as established.
     12
       There is a $16 discrepancy in petitioner's computations,
but we consider it immaterial.
     13
       The position taken by petitioner on the return for
decedent's estate--that there were 79,730 (rather than 80,485)
Johnco shares includable in the estate--was also premised on the
$44.65 per-share appraised value of the Johnco shares. The
difference results from the downward revision in the calculation
of Andrew's unified credit bequest as equal to $106,251 rather
than the original $140,150 assumed when the return was filed.
                               - 18 -


as of my date of death.”    In filing the return for John's estate

in her capacity as executrix thereof, decedent did not obtain an

independent appraisal of the Johnco stock passing through the

estate.   According to petitioner, since the $86.80 per-share

value reported on the return was not the product of an

independent appraisal, the terms of John's will preclude its use

in determining the number of shares required to satisfy the

unified credit bequest to Andrew.    Instead, petitioner contends,

the number of shares passing to Andrew must be determined on the

basis of the December 1992 appraisal performed by RPR of the

value of the Johnco shares as of John's date of death; namely,

$44.65 per share.    This appraisal was independent, having been

commissioned by Northern Trust in its capacity as successor

independent administrator of John's estate in order to comply

with the terms of John's will in funding the unified credit

bequest to Andrew.

     The upshot of petitioner's position is that John's estate

may report one value for the Johnco stock on the estate tax

return while another, lower value for the stock may be used for

purposes of funding a unified credit bequest made in John’s will.

For the reasons outlined below, we disagree and instead conclude

that the valuation used on John's estate's return must also be

used for purposes of funding the unified credit bequest.

     Although the determination of the number of Johnco shares

that passed to Andrew pursuant to the unified credit bequest and

to decedent under the residuary clause of John's will turns upon
                              - 19 -


the value of the shares on John's date of death, the evidence in

the record of such value is scant.     The John Appraisal, which

postulated the $44.65 per-share value on John's date of death

contended for by petitioner, is not in the record.     Its

conclusions are in the record only because they are stated in the

Decedent Appraisal.   Moreover, the John Appraisal was performed

by RPR, whose valuation methodologies are considered in some

detail elsewhere in this opinion.    Because we conclude infra that

there are substantial flaws in the methodology employed by RPR to

value the Johnco stock on decedent's date of death, which

produced a significantly understated estimate of value, we

likewise do not believe that RPR's valuation of the stock as of

John's date of death is reliable.    Accordingly, the evidence in

the record strongly supports the conclusion that the $44.65 per-

share value contended for by petitioner is too low.

     More significantly, we do not believe that John, as

testator, contemplated that the requirement in his will that the

unified credit bequest be funded with Johnco shares "as * * *

valued by independent appraisal" as of his date of death would

result in the use of different date-of-death values for the

Johnco stock--one for purposes of the estate tax return for

John's estate and the other for purposes of funding the unified

credit bequest.   Such a construction of the will would put John's

estate's marital deduction in jeopardy, because shares eligible

for the section 2056 marital deduction on the basis of the

valuation used on the return would--if a different, lower
                                - 20 -


valuation were used for funding the unified credit bequest--be

shifted from the surviving spouse to the unified credit bequest

beneficiary.   For example, at the $86.80 per-share value reported

on John's estate's return, it would take 1,224 Johnco shares to

fund a $106,251 unified credit bequest, leaving 81,641 shares to

the surviving spouse, eligible for the marital deduction.    But if

the unified credit bequest were later funded using a $44.65 per-

share value, it would take 2,379 shares to do so, thereby

shifting 1,155 shares (2,379 - 1,224 = 1,155) that were eligible

for the marital deduction on the return as filed to the unified

credit bequest beneficiary.   Given that John's will clearly is

drafted to maximize the benefit of the unified credit bequest and

the marital deduction, we shall not ascribe to John an intent

that would place the marital deduction in jeopardy.   Accordingly,

we interpret John's will as requiring that the same Johnco share

value reported on the estate tax return for John's estate be used

for purposes of funding the unified credit bequest.   Based on

that value ($86.80 per share) and a unified credit bequest equal

to $106,251, the number of shares passing to Andrew pursuant to

the unified credit bequest was 1,224 (1,224 shares x $86.80 =

$106,243).   As a result, the number of Johnco shares passing to

decedent pursuant to the residuary clause of John's will, and

includable in her estate, was 81,641, or 98 percent of the

outstanding shares of Johnco.
                              - 21 -


II.   Fair Market Value

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

weigh all relevant evidence to draw the appropriate inferences.

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

(1944); Helvering v. National Grocery Co., 304 U.S. 282, 294-295

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

1957), affg. in part and remanding in part T.C. Memo. 1956-178;

Estate of Newhouse v. Commissioner, 94 T.C. 193, 217 (1990);

Skripak v. Commissioner, 84 T.C. 285, 320 (1985).

      Fair market value is defined for Federal estate and gift tax

purposes as the price that a willing buyer would pay a willing

seller, both having reasonable knowledge of all the relevant

facts and neither being under compulsion to buy or to sell.

United States v. Cartwright, 411 U.S. 546, 551 (1973) (citing

sec. 20.2031-1(b), Estate Tax Regs.); see also Snyder v.

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

Commissioner, 92 T.C. 312, 335 (1989).   The willing buyer and the

willing seller are hypothetical persons, rather than specific

individuals or entities, and the individual characteristics of

these hypothetical persons are not necessarily the same as the

individual characteristics of the actual seller or the actual

buyer.   Estate of Curry v. United States, 706 F.2d 1424, 1428-

1429, 1431 (7th Cir. 1983); Estate of Bright v. United States,

658 F.2d 999, 1005-1006 (5th Cir. 1981); Estate of Newhouse v.

Commissioner, supra at 218; see also Estate of Watts v.

Commissioner, 823 F.2d 483, 486 (11th Cir. 1987), affg. T.C.
                              - 22 -


Memo. 1985-595.   The hypothetical willing buyer and willing

seller are presumed to be dedicated to achieving the maximum

economic advantage.   Estate of Curry v. United States, supra at

1428; Estate of Newhouse v. Commissioner, supra at 218.       This

advantage must be achieved in the context of market and economic

conditions at the valuation date.     Estate of Newhouse v.

Commissioner, supra at 218.

     For Federal estate tax purposes, the fair market value of

the subject property is generally determined as of the date of

death of the decedent; ordinarily, no consideration is given to

any unforeseeable future event that may have affected the value

of the subject property on some later date.    Sec. 20.2031-1(b),

Estate Tax Regs.; see also Estate of Newhouse v. Commissioner,

supra at 218; Estate of Gilford v. Commissioner, 88 T.C. 38, 52

(1987).

     Although the parties have stipulated the fair market value

of Johnco's assets, they are not in agreement as to the value of

decedent's Johnco stock.   Petitioner contends that insofar as

Johnco has a relatively low basis in highly appreciated assets

(built-in capital gains), a share of stock in Johnco is worth

less than a proportionate share of Johnco's assets, because such

assets cannot be disposed of without the corporate level

recognition of capital gains taxes.    Moreover, petitioner

contends that decedent's Johnco stock is less valuable because of

the existence of a minority shareholder and because the shares

lack marketability.   Finally, petitioner asserts that the family
                                - 23 -


settlement agreement, as an arm's-length transaction, is the best

indicator of fair market value.

     A.     Expert Opinions

     As is customary in valuation cases, the parties rely

primarily on expert opinion evidence to support their contrary

valuation positions.    We evaluate the opinions of experts in

light of the demonstrated qualifications of each expert and all

other evidence in the record.     Anderson v. Commissioner, supra;

Parker v. Commissioner, 86 T.C. 547, 561 (1986).    We have broad

discretion to evaluate "`the overall cogency of each expert's

analysis.’"    Sammons v. Commissioner, 838 F.2d 330, 334 (9th Cir.

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

1986), affg. in part and revg. in part T.C. Memo. 1983-200),

affg. in part and revg. in part on another ground T.C. Memo.

1986-318.    Expert testimony sometimes aids the Court in

determining values, and sometimes it does not.    See, e.g., Estate

of Halas v. Commissioner, 94 T.C. 570, 577 (1990); Laureys v.

Commissioner, 92 T.C. 101, 129 (1989) (expert testimony is not

useful when the expert is merely an advocate for the position

argued by one of the parties).    We are not bound by the formulas

and opinions proffered by an expert witness and will accept or

reject expert testimony in the exercise of sound judgment.

Helvering v. National Grocery Co., supra at 295; Anderson v.

Commissioner, supra at 249; Estate of Newhouse v. Commissioner,

supra at 217; Estate of Hall v. Commissioner, supra at 338.

Where necessary, we may reach a determination of value based on
                              - 24 -


our own examination of the evidence in the record.    Lukens v.

Commissioner, 945 F.2d 92, 96 (5th Cir. 1991) (citing Silverman

v. Commissioner, 538 F.2d 927, 933 (2d Cir. 1976), affg. T.C.

Memo. 1974-285); Ames v. Commissioner, T.C. Memo. 1990-87.      Where

experts offer divergent estimates of fair market value, we decide

what weight to give these estimates by examining the factors they

used in arriving at their conclusions.    Casey v. Commissioner, 38

T.C. 357, 381 (1962).   We have broad discretion in selecting

valuation methods, Estate of O'Connell v. Commissioner, 640 F.2d

249, 251 (9th Cir. 1981), affg. on this issue and revg. in part

T.C. Memo. 1978-191, and the weight to be given the facts in

reaching our conclusion because “finding market value is, after

all, something for judgment, experience, and reason”, Colonial

Fabrics, Inc. v. Commissioner, 202 F.2d 105, 107 (2d Cir. 1953),

affg. a Memorandum Opinion of this Court dated January 22, 1951.

Moreover, while we may accept the opinion of an expert in its

entirety, Buffalo Tool & Die Manufacturing Co. v. Commissioner,

74 T.C. 441, 452 (1980), we may be selective in the use of any

part of such opinion, or reject the opinion in its entirety,

Parker v. Commissioner, supra at 561.    Finally, because valuation

necessarily results in an approximation, the figure at which this

Court arrives need not be one as to which there is specific

testimony if it is within the range of values that may properly

be arrived at from consideration of all the evidence.    Silverman

v. Commissioner, supra at 933; Alvary v. United States, 302 F.2d

790, 795 (2d Cir. 1962).
                              - 25 -


     1.    Petitioner's Experts

     At trial, petitioner relied on the reports of two experts,

John H. Lax and Mr. Buck.   Mr. Lax, a principal in the Valuation

Services Group of Arthur Andersen LLP (Andersen), has more than

25 years of experience in business valuation and holds the

designations of certified management accountant and accredited

senior appraiser from the Institute of Management Accounting and

the American Society of Appraisers, respectively.   Mr. Buck is a

managing director of RPR, holds an M.B.A. from Harvard Business

School, and has more than 30 years of experience in corporate

finance.

     For purposes of their estimates, both of petitioner’s

experts assumed that they were valuing 80,485 shares, or 97

percent, of the outstanding stock of Johnco.

     a.    John H. Lax

     Mr. Lax used income and market approaches in valuing

decedent's Johnco stock to show that Johnco was not viable as a

going concern.   Starting with a hypothetical purchase price of

$7 million,14 he assumed that a prospective purchaser would

leverage Johnco by financing 75 percent of the purchase price

with a 10-percent, 10-year term loan.   Next, Mr. Lax forecasted

income for the 10-year period in which the term loan would be

outstanding if the timberland were managed for sustainable yield.

He assumed that timber growth and inflation would be 4 percent


     14
       Mr. Lax's report provides no basis or explanation for the
choice of the $7 million purchase price.
                              - 26 -


annually.   Based on his assumptions, Mr. Lax determined that

Johnco's pretax income would be negative for all 10 years.    Thus,

he concluded that Johnco could not produce sufficient cash-flow

to finance $5 million15 of an assumed $7 million purchase price.

     Next, Mr. Lax valued Johnco using a market approach in which

he multiplied Johnco's earnings before interest and taxes (EBIT)

by a multiple derived from a comparison to public companies (the

EBIT method).   For purposes of comparison, Mr. Lax selected two

large, publicly traded, limited partnerships (the partnerships),

which controlled 1,153,000 and 5,904,000 acres of timberland,

respectively, of which approximately 70 percent was located in

Georgia, Florida, and other parts of the South.   Mr. Lax

determined that the price/EBIT ratio of the partnerships was

between 7.1 and 8.4, meaning that a partnership unit traded at

7.1 to 8.4 times its EBIT.   When applied to Johnco's EBIT, these

multiples suggested a range in value between $1 million and

$1,150,000 before adjustment for lack of marketability.     However,

we are not persuaded that the two partnerships constitute useful

comparables for Johnco, as they controlled timberland that was

respectively 213 and 1,092 times larger than the Timber Property.

     Mr. Lax also identified certain characteristics of Johnco

that he thought detracted from its marketability:   (1) History of

low earnings and cash-flow; (2) concentration of asset value in


     15
       We note that a $7 million purchase financed using 75
percent debt and 25 percent equity would imply $5.25 million in
debt and $1.75 million in equity, not $5 million in debt as used
by Mr. Lax in his report.
                              - 27 -


one category; (3) size of the company; (4) lack of professional

management; and (5) C corporation status.   A 10-percent discount

for lack of marketability to reflect these factors was apparently

incorporated by Mr. Lax into his final determination of fair

market value.

     Mr. Lax determined that Johnco was a "negative cash flow

producing C corporation holding company" whose assets could not

support a $7 million purchase price.   He concluded that it was

obvious that a willing buyer would buy decedent's Johnco stock

only if Johnco's assets could quickly be sold for a fair return.

     After analyzing publicly traded timber companies, Mr. Lax

determined that those companies realized a return on equity (ROE)

between 9 percent and 12 percent.   But unlike Johnco, Mr. Lax

observed, those companies had professional management,

geographically diverse assets, and the ability to borrow to cover

short-term downturns.   By comparison, Johnco, Mr. Lax concluded,

was "on the small end of being a viable timber company" and had

very limited professional management and no geographical

diversity.

     Using the Capital Asset Pricing Model (CAPM) and the

Arbitrage Pricing Theory (APT), Mr. Lax determined a cost of

equity (COE) for the large publicly traded timber companies of

12.67 percent.   Due to the limiting characteristics of Johnco,

Mr. Lax concluded that a buyer of decedent's Johnco stock would

demand a premium of a 5-percent to 10-percent greater return, so

that an annual pretax ROE of 17 percent to 22 percent would be
                                - 28 -


required.    Concluding that Johnco could not provide such a

return, Mr. Lax assumed that a willing buyer would liquidate

Johnco over 1 year for the following amounts:

                                                   1
     Amount realized                                $6,000,000
                                                   2
     Less 34% tax on built-in capital gains         (1,870,000)

     Net liquidation value                             4,130,000
     1
      Mr. Lax's report provides no basis or explanation for this
     figure. Insofar as the report details Johnco's assets, it
     does not provide a value for the Timber Property and omits
     the Harris County Real Estate.
     2
       This equation apparently ignores Johnco's basis in its
     assets of $1,060,590, which if taken into account, would
     lower estimated capital gains taxes, resulting in a higher
     valuation.

Based upon the foregoing, Mr. Lax determined the fair market

value of decedent's 97-percent share of the outstanding Johnco

stock to be $4 million.16

     b.     G. Clyde Buck

     Under the assumption that prospective buyers would seek to

maximize their economic return, Mr. Buck first identified three

possible strategies for realizing income from Johnco's assets:

(A) Sell all of the timber, then sell the residual land, over a

period of 24 months; (B) sell the timberland intact; or (C)

operate the timberland as a going concern, cutting on a

sustainable yield basis.    Using present value concepts, Mr. Buck

valued each of the three possible strategies on an after-tax




     16
          97 percent of $4,130,000 = $4,006,100.
                                  - 29 -


basis,17 determining their present values to be as follows

(millions):

     Discount Rate         20%               25%            30%

          Case A           $3.9             $3.8           $3.6
          Case B            4.6              4.6            4.6
          Case C            0.9              0.7            0.6

     Like Mr. Lax, Mr. Buck determined that the highest present

value would be realized through a liquidation, insofar as the

prospective buyer would receive a large cash inflow within a

relatively short time.    Although a quick sale of the Timber

Property might result in a lower sale price, Mr. Buck concluded

that because of the high discount rates that would be demanded by

an investor, the present value of that strategy would be the

highest.    Mr. Buck dismissed the option of operating Johnco as a

going concern, because "the economic benefits are not worth the

delay in getting cash".

     Mr. Buck testified that a hypothetical willing purchaser of

a controlling interest in a small company like Johnco would

expect a return on investment of at least 20 to 25 percent, and

perhaps as much as 30 to 35 percent.       According to Mr. Buck, an

investor in a private company expects a higher rate of return

than an investor in a public company18 because of a lack of

investment liquidity, the uncertainty of the underlying asset


     17
        Mr. Buck's approach incorporated the effect of built-in
capital gains into the determination of fair market value by
calculating present value on an after-tax basis.
     18
       Mr. Buck assumed that historical returns of publicly
traded securities were in the range of 10 to 15 percent.
                             - 30 -


values, and the uncertainty of the timing of future cash-flows.

In analyzing expected return, Mr. Buck testified that a

hypothetical buyer would consider Johnco's historical earnings

and cash-flows, income taxes, and liquidity.

     Mr. Buck also considered Johnco's liquidation value based

upon the stipulated net asset values, taking into account the

effect of the built-in capital gains.    Assuming a 31-percent

capital gains rate, Mr. Buck calculated the net liquidation of

Johnco as follows:

     Net asset value                               $6,958,000
     Less: Estimated capital gains taxes           (1,698,000)
     Less: Estimated selling costs                   (420,000)

     Net liquidation value                          4,840,000

While acknowledging that a hypothetical buyer would consider the

liquidation value of Johnco's assets to be the primary factor,

Mr. Buck testified that such a buyer would also consider Johnco's

operating results as an indicator of its going concern value.

Based upon past operating results, Mr. Buck concluded that going

concern value would not be of interest to a prospective buyer

because a greater amount could be realized through liquidation,

unless it could be determined that past operations had been

"intentionally depressed" to produce below-normal profits.      Mr.

Buck noted that a buyer of decedent's Johnco stock would in

theory have the ability to replace Johnco's existing management

and alter Johnco's operating strategy.    According to Mr. Buck,

the potential need to make such changes would create concerns and
                               - 31 -


additional considerations for a hypothetical buyer, however,

including:

     (i) the potential need to buy out the 3% minority
     shareholder, (ii) the need to terminate existing Johnco
     management, (iii) the need to identify and retain outside
     assistance to manage and, if appropriate, liquidate Johnco's
     assets and (iv) the risk of costly litigation with Johnco's
     minority shareholder.

Mr. Buck determined that the foregoing considerations and risks

could result in a 10-percent discount from the price a willing

buyer would pay if there were no minority shareholder

considerations.19   (We shall hereinafter refer to this discount

to reflect the presence of a 3- to 4-percent minority shareholder

as a nuisance discount.)    Accordingly, Mr. Buck determined that

the fair market value of decedent's Johnco stock was $4.2

million.20




     19
       Because Mr. Buck assumed that decedent held 80,485
shares, or 97 percent, of the outstanding stock of Johnco on her
date of death, the remaining shares held by Andrew made him a 3-
percent shareholder under this assumption.
     20
       This figure reflects an average of the values calculated
by Mr. Buck under case B with a 10-percent discount, under Case B
without a discount, and under case A without a discount,
calculated as follows:

     Case B with discount
          0.97(0.90 x $4,600,000) = $4,000,000

     Case B without discount
          0.97($4,600,000) = $4,462,000

     Case A without discount
          0.97($3,800,000) = $3,700,000

     Average = $4,200,000
                                - 32 -


     2.     Respondent's Expert:   Francis X. Burns

     Respondent relies on the expert report of Francis X. Burns,

a principal of IPC Group, LLC (IPC), a Chicago-based consulting

firm.     Mr. Burns, who holds a master of management degree in

finance and economics from Northwestern University's Kellogg

School of Management, valued Johnco based on the fair market

value of its assets.     Mr. Burns’ use of an asset approach is

supported by Rev. Rul. 59-60,21 1959-1 C.B. 237, 243, which

states:

          The value of the stock of a closely held
     investment or real estate holding company * * * is
       closely related to the value of the assets
     underlying the stock. For companies of this type
     the appraiser should determine the fair market
     values of the assets of the company. * * *

In support of his choice, Mr. Burns noted that Johnco:     (1) Was

classified as a personal holding company on its 1990 and 1991

returns; (2) had only one employee; and (3) produced no goods or

services other than the contracted sale of a percentage of timber

growth each year.     He also found it significant that petitioner

and respondent had stipulated the fair market value of Johnco's

assets.     Because the fair market value of the assets was

stipulated, Mr. Burns' report focused on evaluating the merits of

petitioner's position regarding the valuation discounts it

sought.


     21
       Rev. Rul. 59-60, 1959-1 C.B. 237, outlines factors to be
considered in valuing the stock of closely held corporations and
“has been widely accepted as setting forth the appropriate
criteria to consider in determining fair market value”. Estate
of Newhouse v. Commissioner, 94 T.C. 193, 217 (1990).
                               - 33 -




          a.     Nuisance Discount

     Mr. Burns was critical of the nuisance discount sought by

petitioner.    Traditionally, he noted, the potential actions of a

4-percent minority shareholder22 do not warrant any discount from

fair market value, but in practice, controlling interests are

often given a control premium for the power that they wield over

minority shareholders.    According to Mr. Burns, the buyer of a

96-percent interest in Johnco would possess ultimate control over

the company's operations, while the possibility of the minority

shareholder’s causing problems for the new owner of the majority

interest was mere speculation.

          b.     Marketability Discount

     Mr. Burns also disagreed with the views of petitioner's

experts concerning a discount for lack of marketability.

According to Mr. Burns, lack of marketability is a relative

concept; there is not one standard of marketability to which all

assets can be compared.    Instead, assets must be compared to

their relevant market.    While petitioner and its experts focused

on the marketability of Johnco stock in the market for the stock

of closely held corporations, Mr. Burns determined the timber

market to be the relevant market for assessing marketability,




     22
       Mr. Burns assumed Andrew was a 4-percent shareholder on
the valuation date based upon the number of Johnco shares
reported as owned by decedent on her Form 706; namely, 79,730
shares, or 96 percent, of the outstanding shares of Johnco.
                               - 34 -


because a 96-percent interest in Johnco represented control over

substantial timber assets.

     In evaluating the marketability of Johnco's timber assets,

Mr. Burns determined that both the quality of the Timber Property

and conditions in the timber market were important.    The primary

source of information for Mr. Burns' analysis was the Engineering

and Valuation report of Robert Baker, who also testified at

trial.    Mr. Baker is an experienced forester employed as an

engineering revenue agent for respondent in his Shreveport,

Louisiana, office.   His expertise and familiarity with timber in

central Louisiana were apparent in his report and testimony.    In

his report, Mr. Baker concluded that the Timber Property was an

above-average property for several reasons:    (1) It was a unique,

highly desirable tract due to its size, contiguous nature, and

past prudent management; (2) it was located within a very

competitive timber products market; and (3) it was being valued

at a time when the market for timber properties was viable and

active.   Mr. Burns noted that the stipulated value of the Timber

Property was based on the market prices paid for similar

properties and concluded that because petitioner had not

presented any evidence that the Timber Property would be more

difficult to sell than comparable tracts, the appraised fair

market value of the Timber Property was a realistic and

realizable amount.   While concluding that at least 94 percent of

Johnco's assets were marketable, Mr. Burns acknowledged the

possibility that a willing buyer interested primarily in the
                                - 35 -


Timber Property might seek a discount for the less certain

marketability of Johnco's miscellaneous assets, which included a

building, equipment, and a vacant lot and constituted the

remaining 6 percent of Johnco's total net asset value.

Accordingly, Mr. Burns determined that 6 percent should be the

ceiling on any discount for lack of marketability.

             c.   Built-In Capital Gains Discount

     Mr. Burns opposed the application of a built-in capital

gains discount, as such a discount emphasized net proceeds,

rather than fair market value, to a willing buyer.     Such an

emphasis, he thought, "is founded on a counter-intuitive premise;

that is, a hypothetical and instantaneous sale of the same assets

which the willing buyer has just purchased."     Accordingly, he

considered both the prospect of liquidation and the recognition

of built-in capital gains to be speculative.     Mr. Burns noted

that respondent's forester, Mr. Baker, Johnco's former forester,

Mr. Elliott, and even a forester hired by petitioner, Mr.

Screpetis,23 had all concluded that the best use of the Timber

Property was as commercial timberland and that a timber products

company or a pension fund was the most likely purchaser.     In

testimony, petitioner's expert Mr. Lax also conceded that the

most likely purchaser was a timber products company or a pension

fund.     Thus, Mr. Burns concluded, insofar as a timber products



     23
       Mr. Screpetis was a consultant forester employed by
George Doyle, Inc., which had been hired by Mr. Buck to appraise
the Timber Property in connection with his valuation of Johnco.
                                - 36 -


company that acquired Johnco would be likely to continue

harvesting timber, a sale of the assets might never take place,

and taxation of the built-in capital gains could be postponed

indefinitely.

     Even if Johnco were to be liquidated, Mr. Burns thought it

would be possible to avoid recognition of the built-in capital

gains using a number of "tax strategies", such as:   (1) Accepting

debt obligations payable over future years and electing the

installment method; (2) exchanging the property in a like-kind

exchange; and (3) electing S corporation treatment and holding

the assets for at least 10 years.

          d.    Selling Costs

     Mr. Burns also rejected applying a discount to reflect

future selling costs.   He noted that selling costs are part of

any transaction and would be reflected in the selling prices of

comparable properties used to value the Timber Property.

Moreover, Mr. Burns thought it inappropriate to discount the fair

market value of decedent's Johnco stock for selling costs that

were only hypothetical, insofar as they would not be incurred

unless and until the new purchaser sold the Timber Property.

B.   Fair Market Value of Johnco

     1.   Built-In Capital Gains

     On several occasions, we have held that, in valuing stock in

a closely held corporation using the net asset value method, a

discount to reflect potential capital gains tax liabilities at

the corporate level was unwarranted where there was no evidence
                              - 37 -


that a liquidation was planned or that it could not have been

accomplished without incurring a capital gains tax at the

corporate level.   Ward v. Commissioner, 87 T.C. 78, 103-104

(1986); Estate of Andrews v. Commissioner, 79 T.C. 938 (1982);

Estate of Piper v. Commissioner, 72 T.C. 1062 (1979); Estate of

Cruikshank v. Commissioner, 9 T.C. 162 (1947).   Our denial in the

past of a built-in capital gains discount was based in part on

the notion that valuation discounts for estate and gift tax

purposes are not appropriate where based on an event that may not

transpire.   See, e.g., Ward v. Commissioner, supra at 103-104

(selling costs and taxes recognized not taken into account when

liquidation only speculative); Estate of Piper v. Commissioner,

supra at 1087 (no discount for built-in capital gains where no

evidence liquidation was planned, or could not have been

accomplished without corporate level recognition of capital

gains); Estate of Cruikshank v. Commissioner, supra at 165 (tax

on appreciation only hypothetical where no demonstrated intent to

liquidate, and liquidation could occur without corporate level

tax).

     Prior to the repeal of the doctrine established in General

Utils. & Operating Co. v. Helvering, 296 U.S. 200 (1935) (the

General Utilities doctrine), the recognition of corporate level

capital gains taxes could also be speculative because the General

Utilities doctrine, as codified in former sections 336 and 337,

allowed the tax-free liquidation of a corporation and thus the

complete avoidance of corporate level capital gains.   Thus, even
                                - 38 -


where it could be established that a liquidation was planned, the

General Utilities doctrine still made it possible to avoid

corporate level taxes, causing any projected tax liability from

built-in capital gains to be purely speculative and not

warranting consideration in determining fair market value.      See,

e.g., Estate of Piper v. Commissioner, supra at 1087; Gallun v.

Commissioner, T.C. Memo. 1974-284.

     Recently, in Estate of Davis v. Commissioner, 110 T.C. 530

(1998), we held that in determining the fair market value of

stock in a closely held corporation after the repeal of the

General Utilities doctrine, consideration of the effect of built-

in capital gains is not precluded as a matter of law and is

appropriate in some circumstances.       In Estate of Davis, we were

convinced on the record that even though no liquidation or asset

sale was planned, a hypothetical willing buyer and seller would

not have disregarded the existence of built-in capital gains in

agreeing on a purchase price.    In that case, both the taxpayer’s

and the Commissioner’s experts had recommended taking into

account built-in capital gains in determining fair market value.

Even before the repeal of the General Utilities doctrine, courts

had on occasion considered built-in capital gains.      See, e.g.,

Obermer v. United States, 238 F. Supp. 29, 34-36 (D. Haw. 1964)

(finding expert testimony showed built-in capital gains tax would

necessarily adversely affect value of stock at issue to willing

buyer); Clark v. United States, 36 AFTR 2d 75-6417, 75-1 USTC

par. 13,076 (E.D. N.C. 1975) (well-informed willing buyer of
                                - 39 -


stock in corporation would consider that underlying assets of

corporation included inactive investment portfolio that, upon

liquidation, would incur substantial capital gains tax

liability).

     Petitioner's position is that a prospective buyer of

decedent's Johnco stock would value the stock with the intention

of liquidating Johnco.    Thus, in petitioner's view, a prospective

liability for built-in capital gains is not speculative, and a

built-in capital gains discount is warranted.    Petitioner's

experts have attempted to support this conclusion by comparing

the net present value of Johnco as a going concern to its net

present value if liquidated.    We think it is clear that

petitioner's experts were able to reach this result only because

they incorrectly valued decedent's Johnco stock on the basis of

Johnco's income, rather than its assets.    We agree with Mr. Burns

that decedent's Johnco stock is properly valued under Rev. Rul.

59-60, 1959-1 C.B. 237, by looking to the fair market value of

Johnco's assets.   That method is most reasonable in a case like

this one, where the corporation functions as a holding, rather

than an operating, company and earnings are relatively low in

comparison to the fair market value of the underlying assets.

See Estate of Davis v. Commissioner, supra; Estate of Piper v.

Commissioner, supra at 1069-1070; Estate of Cruikshank v.

Commissioner, supra.     Contrary to petitioner's position, we agree

with respondent that in light of the many desirable

characteristics of the Timber Property the most likely buyer of
                              - 40 -


decedent's Johnco stock would be a large timber products company

or pension fund.

     While it may still be possible after the repeal of the

General Utilities doctrine to avoid recognition of built-in

capital gains, respondent has failed to convince us that any

viable options for avoidance would exist for a hypothetical buyer

of decedent's Johnco stock.   The tax strategies suggested by Mr.

Burns, who is not an expert in taxation, can at best defer the

recognition of built-in capital gains, but only by deferring

income and ultimately cash-flow, and suggest the work of an

advocate rather than a disinterested expert witness.24    Perhaps

anticipating that the avoidance strategies offered by his expert

do not withstand scrutiny, respondent argues on brief that

petitioner could "hire some creative and resourceful tax

practitioner" and since "someone might think of a way to avoid

the tax effect of an immediate liquidation", the tax on built-in

capital gains is only speculative.     Contrary to respondent, we do

not think Mr. Burns has demonstrated any real possibilities for

avoidance of the built-in capital gains tax by Johnco, let alone


     24
       We note also that in suggesting the availability of an S
corporation election as a means of avoiding the tax on built-in
capital gains, respondent and his expert overlook clear obstacles
to that approach. Electing S corporation status would require
the consent of all shareholders; thus Andrew could thwart that
approach. Also, the shareholders of an S corporation must
generally be individuals, whereas experts of both parties
conclude that the likely buyer of decedent's Johnco stock would
be a large timber products company or a pension fund. Finally,
respondent and his expert fail to consider the impact that sec.
1374 might have on any decision to convert Johnco from C to S
corporation status.
                              - 41 -


done so in a manner sufficient to prevent petitioner from being

able to carry its burden of final persuasion, as respondent

asserts.

     We may allow the application of a built-in capital gains

discount if we believe that a hypothetical buyer would have taken

into account the tax consequences of built-in capital gains when

arriving at the amount he would be willing to pay for decedent's

Johnco stock.   Because Johnco's timber assets are the principal

source of the built-in capital gains and, as discussed infra, are

subject to special tax rules that make certain the recognition of

the built-in capital gains over time, we think it is clear that a

hypothetical buyer would take into account some measure of

Johnco's built-in capital gains in valuing decedent's Johnco

stock.

     On the valuation date, Johnco had a valid election under

section 631(a) that could not be revoked absent a showing of

undue hardship.   Section 631(a) treats the cutting of timber as

though it were a hypothetical sale or exchange of the timber.

This fictitious sale is deemed to have been consummated at the

time when the cutting occurs, and the timber must be cut for sale

or use in the taxpayer's trade or business.   The sale price in

this hypothetical sale is the fair market value of the timber on

the first day of the taxable year in which it is cut.   Gain or

loss under section 631(a) is measured by the difference between

the fair market value of the cut timber and its adjusted basis
                                - 42 -


for depletion,25 and is characterized as a sale or exchange under

section 1231.    The fair market value of the cut timber then

becomes the new basis of the timber (new basis) for all purposes

in the hands of the taxpayer.    If the cut timber is then sold,

ordinary gain or loss is calculated as the difference between the

amount realized and the new basis.

     As a result of its section 631(a) election, Johnco will

recognize its built-in capital gains under section 1231 as it

cuts timber.    This recognition will occur independently of any

liquidation.    Consequently, we conclude that a hypothetical

willing buyer of decedent's Johnco stock would take into account

Johnco's built-in capital gains, even if his plans were to hold

the assets and cut the timber on a sustainable yield basis.     For

this reason, we hold that a valuation of decedent's Johnco stock

should take into account Johnco's built-in capital gains, but

only in an amount reflecting the rate at which they will be

recognized, measured as the net present value of the built-in

capital gains tax liability that will be incurred over time as

timber is cut.

     We calculate the net present value of the built-in capital

gains tax liability by estimating Johnco's capital gains


     25
       Where only a portion of the timber is cut, basis is
allocated to cut and standing timber in proportion to timber
units. See sec. 612; sec. 1.612-1, Income Tax Regs. Units of
timber are ordinarily expressed in terms such as thousands of
board feet, log scale or cords, as appropriate. Timber quantity
is generally estimated upon acquisition and subsequently
increased as timber is acquired and decreased as units of timber
are cut and sold.
                              - 43 -


recognition for future years, calculating capital gains taxes

that will then be owed, and discounting those future tax

liabilities to their present value.    The results of our

calculations are dependent on four independent variables:    (1)

The rate at which Johnco's timber grows; (2) the effects of

inflation; (3) capital gains tax rates; and (4) the discount rate

employed.   Each of the variables chosen for our calculations was

within the range of figures offered by the parties' experts.

Based on the testimony we received from Messrs. Elliott and

Baker, we think that a prospective purchaser of Johnco would

manage the Timber Property for sustainable yield by cutting an

amount of timber each year equivalent to that year's timber

growth.   Mr. Elliot, who has had many years of involvement with

the Timber Property, testified that historically, the Timber

Property had produced annual growth of 8 to 10 percent.

Accordingly, for purposes of our calculations, we assume annual

timber growth to be 10 percent.   In our calculations, we also

assume a 4-percent rate of inflation, based upon the 3- to-5-

percent, and 4-percent, estimates of Messrs. Buck and Lax,

respectively.   As in effect on the valuation date, we assume a

34-percent capital gains tax rate under section 1201.    Finally,

in selecting a discount rate for our equations, we assume a rate

of 20 percent and note that this in between the 17 to 22 percent

suggested by Mr. Lax and the 20 to 25 percent suggested by Mr.

Buck.
                              - 44 -


     Based on the foregoing, we have calculated Johnco's

estimated future built-in capital gains recognition necessary to

fully recognize the built-in capital gains present on the

valuation date.   Using the above assumptions in our calculations,

as indicated in the appendix, approximately 9 years of timber

sales on a sustainable yield basis would be required to recognize

fully the built-in capital gains present on the valuation date.

To simplify our calculations, for each year's cutting, we have

assumed that timber prices on the cutting date equaled the fair

market value on the first day of the taxable year, so that no

ordinary gains or losses result.   As shown in the appendix, we

have calculated the expected cash outflows for each of those 9

years attributable to tax liability from the built-in capital

gains in existence on the valuation date.   Discounting those

expected cash outflows back to the present using a 20-percent

rate, we find the net present value of the future built-in

capital gains tax liability to be ($872,920) and allow a

reduction of $855,46226 in determining the fair market value of

decedent's Johnco stock.27




     26
       Decedent’s Johnco shares constituted 98 percent of the
company’s outstanding stock, and 98 percent of $872,920 is
$855,462.
     27
       The parties have not addressed the applicability of a
built-in capital gains discount with respect to the Harris County
Real Estate, which had a fair market value and basis of $240,000
and $111,740, respectively, on the valuation date. We
accordingly decline to do so.
                               - 45 -




     2.     Marketability Discount

     Where appropriate, this Court has on numerous occasions

applied a discount for lack of marketability in valuing shares of

stock in a closely held company.     See, e.g., Estate of Jung v.

Commissioner, 101 T.C. 412 (1993); Estate of Furman v.

Commissioner, T.C. Memo. 1998-157; Mandelbaum v. Commissioner,

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

(3d Cir. 1996); Estate of Lauder v. Commissioner, T.C. Memo.

1992-736.    On brief, petitioner argues that it is entitled to a

10-percent discount for lack of marketability.    Neither report of

petitioner's two experts addresses a marketability discount

directly.    Mr. Buck's report does contend that the existence of a

3-percent minority shareholder would cause a 10-percent discount

from the price that a willing buyer would otherwise pay for a 97-

percent interest in Johnco.    Mr. Buck does not characterize such

a discount as one for marketability, and we agree.    We

characterize such a discount as a nuisance discount and address

it separately, infra.

     Only respondent's expert report addresses marketability

directly.    Although often closely related, "marketability" and

"liquidity" are not interchangeable terms.    As respondent’s

expert argued, liquidity is a measure of the time required to

convert an asset into cash and may be influenced by

marketability.    Marketability, on the other hand, is not a

temporal measure--it is a measure of the probability of selling
                              - 46 -


goods at a specific price, time, and terms, based upon two

variables: Desirability of the asset (reflected in demand) and

the existence and depth of an established market for buyers and

sellers of the asset type.   By these standards, a minority

interest in Johnco stock would lack marketability.    A minority

shareholder would have limited means of realizing economic gain,

inasmuch as he could not compel distributions or liquidations and

could not readily sell his interest to realize appreciation in

the corporation's market value, because no established market

exists for the sale of stock in closely held corporations.

     In evaluating the marketability of a 98-percent stock

interest in Johnco, it is not the desirability of the Johnco

stock, or the existence of a market for such stock, that is the

focus of our analysis.   Because a 98-percent stock interest

confers control, including the ability to liquidate the

corporation, it is the desirability of Johnco's assets

(principally the Timber Property) and the existence of a market

for such assets that is most relevant in our analysis of

marketability.   Under Texas corporate law, a 98-percent

controlling shareholder would have the authority to liquidate

Johnco.   As discussed supra, the Timber Property, which

constituted 86 percent of Johnco's assets, was a highly desirable

parcel of timberland located within a highly competitive timber

market.   During the early 1990's, the local market for timberland

was considered to be very active, and properties of the size and

quality of the Timber Property were in high demand.    According to
                              - 47 -


Mr. Baker, there were a number of potential buyers for the Timber

Property, including both timber products companies and pension

funds, and he expected that it would sell within a few weeks

after being placed on the market.   A 98-percent shareholder in

Johnco could also partially liquidate Johnco by selling timber or

cutting rights, while retaining a fee in the land, inasmuch as a

great portion of Johnco's fair market value was attributable to

the value of the timber itself.   Thus, Johnco, at least to the

extent of its timberland, was marketable.

     Not all of Johnco's nontimber assets were marketable,

however.   While cash and marketable securities certainly were

marketable, Johnco's building and equipment were not, inasmuch as

they were specialized assets that were not easily transported,

and for which no established market existed.   Finally, we think

that the Harris County Real Estate owned by Johnco was

marketable.   That property's location within Tanglewood, a

desirable residential area in suburban Houston, suggests that it

could have been sold at its fair market value within a reasonable

time, as one of petitioner's experts, Mr. Buck, confirmed.

     Petitioner offers no expert opinion in support of a 10-

percent discount for lack of marketability.    Respondent's expert

calculated that approximately 6 percent of Johnco's assets lacked

marketability and therefore concluded that the ceiling on any

discount for lack of marketability should be 6 percent.   In

reaching that figure, however, respondent's expert treated the

Harris County Real Estate as lacking marketability, a conclusion
                              - 48 -


with which we disagree.   Removing the Harris County Real Estate

from the assets lacking marketability reduces their percentage of

the total assets to approximately 3 percent.     Relying on

respondent's expert's analysis, as adjusted, we conclude that

petitioner is entitled to a 3-percent discount for lack of

marketability.

     3.   Nuisance Discount

     This Court has never recognized the application of a

nuisance discount as such in determining the fair market value of

stock in a closely held corporation.   Petitioner seeks a discount

to reflect the nuisance that a 3-percent28 shareholder would pose

to a potential buyer of decedent's Johnco stock, contending that

Andrew could use his position as president of Johnco to sabotage

or impede a sale of decedent's Johnco stock.29    We do not think

Andrew was in such a position.   Andrew may have been president,

but Northern Trust, as executor of the Estate, controlled Johnco

and could have fired Andrew if he interfered unreasonably with

the sale of decedent's Johnco stock.   We also think the risk of

minority shareholder litigation on the valuation date is remote,



     28
       In accordance with its position that shares constituting
a 97-percent interest in Johnco were includable in decedent’s
estate, petitioner assumes that Andrew’s unified credit bequest
made him a 3-percent shareholder of Johnco. We elsewhere
conclude that the correct percentages are 98 and 2, respectively.
     29
       Petitioner also argues in this regard that Andrew could
interfere with a potential buyer's due diligence. However, a
hypothetical willing buyer is deemed to have reasonable knowledge
of all relevant facts for purposes of defining the market value,
and thus petitioner's contention is irrelevant.
                                  - 49 -


insofar as a 97-percent, or 98-percent,30 shareholder would have

considerable discretion in its control of Johnco under Texas

corporate law.    We acknowledge that the existence of a minority

shareholder may pose an annoyance in comparison to ownership of a

100-percent stock interest but think that a hypothetical buyer

would be willing to overlook this factor in light of the

desirability of the Timber Property.       Accordingly, we agree with

respondent that no nuisance discount is warranted.

     4.    Selling Costs

     We have rejected the conclusions of petitioner's experts

that a hypothetical purchaser of decedent's Johnco stock would

liquidate Johnco.    We agree with respondent that the application

of any discount to reflect selling costs that a hypothetical

purchaser might incur is unwarranted

     5.    Effect of Settlement

     We now turn to the question of what effect, if any, the

settlement agreement between Andrew and Dinah should have in our

determination of the fair market value of decedent's Johnco

stock.    For Federal estate tax purposes, the fair market value of

the subject property is determined as of the date of death of the

decedent, or alternatively, on the alternate valuation date under

section 2032; ordinarily, no consideration is given to any

unforeseeable future event that may have affected the value of

the subject property on some later date.      Sec. 2031; sec.



     30
          See supra note 28.
                               - 50 -


20.2031-1(b), Estate Tax Regs.; see also First Natl. Bank v.

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

Newhouse v. Commissioner, 94 T.C. at 218; Estate of Gilford v.

Commissioner, 88 T.C. at 52.

     In this case, petitioner asks us to look at the price

negotiated in a settlement consummated more than 2 years after

the death of decedent as being determinative of the fair market

value of decedent's Johnco stock on the valuation date.     While we

normally do not look to future events in determining fair market

value, the amount set by a freely negotiated agreement made

reasonably close to the valuation date may be relevant, but is

not conclusive, as to fair market value.     United States v.

Simmons, 346 F.2d 213 (5th Cir. 1965); First Natl. Bank v. United

States, supra; Estate of Spruill v. Commissioner, 88 T.C. 1197

(1987).   Although the product of a freely negotiated and arm's-

length agreement, in which both parties were represented by

counsel, we are not persuaded that the $4,025,000 settlement

amount accurately reflected the fair market value of decedent's

Johnco stock on the valuation date.     The settlement amount

closely resembles the $4,200,000 amount recommended by Mr. Buck.

We have found serious fault in his assumptions regarding the need

to liquidate Johnco and have accordingly rejected his

determination of fair market value.     In arriving at a settlement

amount of $4,025,000, we think it is likely that Andrew and Dinah

also acted upon the erroneous assumption that Johnco was properly

valued by assuming it would be liquidated.     Thus, while we
                                   - 51 -


believe the settlement was arm's length, we doubt its reliability

as an accurate measure of the fair market value of decedent's

Johnco stock on the valuation date.           Thus, we accord little

weight to the settlement amount in determining the fair market

value of decedent's Johnco stock.

C.   Valuation Conclusions

     On the basis of the foregoing, we find that for purposes of

computing the taxable estate of decedent, the fair market value

of decedent's 81,641 shares of Johnco stock was $5,784,477

(approximately $71 per share) on the date of decedent's death,

calculated as follows:

                                                     Fair market value
                                                     of stock interest
                                              100%                    98%

     Johnco                             $6,958,000                 $6,818,840

     Reduction for built-in
     capital gains                          (872,920)                (855,462)

     Difference                             6,085,080               5,963,378

     Less marketability discount            (182,552)                (178,901)

     Fair market value                      5,902,528               5,784,477


           Fair market value per share: $71

III. Constitutional Challenge

     We now address petitioner's contention that a portion of the

estate tax as applied is unconstitutional.              The Federal estate

tax is imposed on the transfer of the taxable estate of every

decedent who is a citizen or resident of the United States.                 Sec.

2001; United States Trust Co. v. Helvering, 307 U.S. 57, 60

(1939).   The taxable estate is defined as the decedent's gross
                               - 52 -


estate, less specified deductions.      Sec. 2051.   Federal estate

taxes are not a permissible deduction from the gross estate.       The

value of the gross estate generally includes the value of all

property to the extent of the interest therein of the decedent at

the time of his death.   Secs. 2031, 2033.

     Petitioner "acknowledges the power of the federal government

to impose an estate tax", but "challenges the application of the

current estate tax to property which is not transferred, but

which is instead required to be paid to the federal government in

the form of estate taxes".    According to petitioner's argument,

the constitutionality of the estate tax depends upon its status

as an excise tax imposed upon the transfer of property at death.

Because the estate tax is calculated using the taxable estate as

a base (i.e., with no deduction for estate tax paid), a portion

of the tax collected by the Government is imposed on property

that is not susceptible of transfer by the decedent but instead

is required to be paid to the Government in the form of the

estate tax.   This portion is thus, in petitioner's terms, "a tax

on tax payment", and such treatment makes the computation of the

estate tax “tax inclusive”.   As a result, petitioner contends,

the portion of the estate tax attributable to property that is

paid to the Government in satisfaction of the estate tax is not a

mere excise tax on the transfer of property at death but a direct

tax on the value of the property itself, which is

unconstitutional because it is not apportioned in accordance with

Article I, Section 9, Clause 4 of the Constitution.
                              - 53 -


     There are a number of problems with petitioner's theory.

First, we believe petitioner overlooks both the long history of

treating taxes occasioned by death as excise rather than direct

taxes31 and the fact that the Supreme Court's touchstone for

determining a direct tax has been historical treatment, rather

than logical analogy.   In New York Trust Co. v. Eisner, 256 U.S.

345 (1921), the Supreme Court brushed aside the taxpayer's effort

to distinguish the estate tax there at issue from the inheritance

tax sustained against a "direct tax" challenge in Knowlton v.

Moore, 178 U.S. 41, 81 (1900).   The taxpayer in New York Trust

Co. had sought to make a distinction, for "direct tax" purposes,

between an inheritance tax and an estate tax, based upon the

former's imposition on the privilege of receipt.   The Supreme

Court, relying heavily on its earlier opinion in Knowlton v.

Moore, supra, dismissed the effort, not because of "some

scientific distinction", but based

     on the practical and historical ground that this
     kind of tax always has been regarded as the
     antithesis of a direct tax; “has ever been treated
     as a duty or excise, because of the particular
     occasion which gives rise to its levy.” [Knowlton v.
     Moore] 178 U.S. 81-83 * * * Upon this point a page
     of history is worth a volume of logic. [New York
     Trust Co. v. Eisner, supra at 349.]




     31
        Knowlton v. Moore, 178 U.S. 41, 81 (1900); see, e.g.,
Bromley v. McCaughn, 280 U.S. 124, 137 (1929) ("[excise] taxes of
this type were not understood to be direct taxes when the
Constitution was adopted"); New York Trust Co. v. Eisner, 256
U.S. 345 (1921).
                                - 54 -


The estate tax regime at issue in New York Trust Co.32 was "tax

inclusive" in the same manner now faulted by petitioner in the

current estate tax structure provided in sections 2001-2209.

We think petitioner's effort to dissect the estate tax at

issue herein into a constitutionally permissible portion

(i.e., the tax imposed with respect to property transferred to

heirs) and a constitutionally impermissible portion (i.e., the

tax imposed with respect to property paid to the Government as

tax, or the "tax on a tax payment") is the kind of "scientific

distinction" long ago rejected in New York Trust Co., Knowlton

v. Moore, supra, and Nicol v. Ames, 173 U.S. 509 (1899).     Just

as the differences in estate and inheritance taxes were deemed

inconsequential for purposes of determining what constitutes a

direct tax in New York Trust Co., we believe petitioner's

distinctions likewise lack constitutional significance.

     Second, both the inheritance tax upheld in Knowlton v.

Moore, supra, and the estate tax upheld in New York Trust Co.,

against "direct tax" challenges were "tax inclusive" in the

same manner as that with which petitioner finds fault in the

current estate tax.    Concededly, the "direct tax" attack in

the prior cases was not framed in terms of the taxes' "tax

inclusive" structure.    We have found only one case where the

"tax inclusive" feature of the estate tax was attacked on

constitutional grounds.    In Old Colony Trust Co. v. Malley, 19



     32
          Revenue Act of 1916, ch. 463, sec. 201, 39 Stat. 777.
                              - 55 -


F.2d 346 (1st Cir. 1927), an estate challenged an estate tax

regulation that expressly disallowed the deduction of estate

taxes from the determination of the net estate for purposes of

computing estate tax liability, as unconstitutional and as

inconsistent with the statute (Revenue Act of 1916, ch. 463,

sec. 203, 39 Stat. 778, as amended).   The estate contended

that the amount of estate tax imposed by the statute should

not be included in the base used as a measure of the tax.     The

Court of Appeals rejected the challenge, finding the

regulation consistent with the meaning of the statute and the

constitutional challenge “a claim so obviously unsound as to

call for no discussion.”   Old Colony Trust Co. v. Malley,

supra at 347.

     Third, petitioner's fundamental claim, and the fatal flaw

in its argument, concerns the nature of the transfer required

to insulate the estate tax from attack based on the "direct

tax" strictures of the Constitution.   Petitioner sums up its

argument as follows:

     Petitioner views the estate tax as a tax on the transfer
     of property at death, consistent with Knowlton v. Moore,
     178 U.S. 41 (1900), and is concerned solely with the
     amount of property that a decedent can transfer at death.

          The problem with the estate tax as it is currently
     assessed is that a large portion of the tax is imposed on
     the decedent's property not because of its transfer at
     death but, rather, merely because of its ownership by the
     decedent, in clear violation of Pollock v. Farmers' Loan
     & Trust Co., 157 U.S. 429, reh'g granted, 158 U.S. 601
     (1895). Specifically, the amount of a decedent's estate
     that must be paid as estate tax is not "transferred" at
     death to anyone. Therefore, it cannot itself be taxed
                              - 56 -


      under what is supposed to be an excise tax on the
      transfer of property at death.

In petitioner's view, then, the estate tax may

constitutionally be imposed only with respect to property that

is transferred to a person.   We think petitioner confines the

permissible scope of the tax far too narrowly in light of

long-established Supreme Court interpretations.   With

reference to a predecessor estate tax (Revenue Act of 1918,

ch. 18, sec. 401, 40 Stat. 1096), which provided for a

computation of the taxable estate in the same "tax inclusive"

fashion as the current tax, the Supreme Court observed:    “What

this law taxes is not the interest to which the legatees and

devisees succeeded on death, but the interest which ceased by

reason of death.”   Young Men's Christian Association v. Davis,

264 U.S. 47, 50 (1924).   See also Ithaca Trust Co. v. United

States, 279 U.S. 151, 155 (1929); Knowlton v. Moore, supra at

49.   Instead, the estate tax extends more broadly as an excise

upon the shifting at death of the incidents of property.    As

the Supreme Court clarified more than 50 years ago in

Fernandez v. Wiener, 326 U.S. 340, 352 (1945):

      It is true that the estate tax as originally devised and
      constitutionally supported was a tax upon transfers. But
      the power of Congress to impose death taxes is not
      limited to the taxation of transfers at death. It
      extends to the creation, exercise, acquisition, or
      relinquishment of any power or legal privilege which is
      incident to the ownership of property, and when any of
      these is occasioned by death, it may as readily be the
      subject of the federal tax as the transfer of property at
      death. [Citations omitted.]
                                - 57 -


     The taxpayer in Fernandez had challenged the imposition

of the estate tax in that case on "direct tax" grounds not

dissimilar to those advanced by petitioner.      Fernandez

involved a since-repealed provision (Revenue Act of 1942, ch.

619, sec. 402, 56 Stat. 941-42) that required the inclusion of

the entire amount of community property (both the decedent's

and the surviving spouse's shares, except for any portion

traceable to the surviving spouse’s personal earnings or

separate property) in the taxable estate of the first-dying

spouse.    The taxpayer argued that insofar as the estate tax

was imposed on the value of the surviving wife's share of

community property, it was an unconstitutional (unapportioned)

direct tax because there was no "transfer" of the wife's

community share to her; she merely retained the share she

owned prior to her husband's death.      The Court, although

conceding that the wife owned her share before and after her

husband's death, concluded that the husband's death terminated

a right to manage the wife's share accorded him under State

law and made her control exclusive.      This "redistribution of

powers and restrictions on powers", even though ownership

never changed "[furnishes] appropriate [occasion] for the

imposition of an excise tax."    Fernandez v. Wiener, supra at

355-356.    "It is enough that death brings about changes in the

legal and economic relationships to the property taxed".       Id.

at 356.
                              - 58 -


     Under the very broad test of Fernandez, we think the

estate tax imposed in the instant case is free of

constitutional defect.   There was a cessation of decedent's

interests in the assets of her gross estate that was

occasioned by death, both with respect to any property

transferred to Andrew and Dinah and any property remitted to

the Government in payment of the estate tax.       Accordingly, the

imposition of the estate tax in this case falls well within

the taxing power previously sanctioned by the Supreme Court.

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
Inflation Rate          4%
Timber Growth          10%

Rate
Capital Gains          34%

Tax Rate
Discount Rate          20%




                                                         TIMBER GROWTH            YEAR-END TIMBER CUTTING
       Beginning   Fair Market      Adjusted Purchased Annual Year-End   Units   Basis Basis     Built-in     Capital

                      Value                                                                         Gains      Gains
Year    Timber     Total    Per      Basis   Built-in Growth   Timber     Cut     Per    Allocat Recognized     Tax

         Units               Unit             Gain             Units             Unit      ed

 1        100,000 $6,000,0 $60.00 $217,85 $5,782,15 10,000     110,000 10,000    $1.98 $19,805     $580,195   $197,266

                        00               0         0
 2        100,000 6,240,00   62.40 198,045 5,201,955 10,000    110,000 10,000     1.80    18,004    605,996    206,039

                         0
 3        100,000 6,489,60   64.90 180,041 4,595,959 10,000    110,000 10,000     1.64    16,367    632,593    215,081

                         0
 4        100,000 6,749,18   67.49 163,674 3,963,366 10,000    110,000 10,000     1.49    14,879    660,039    224,413

                         4
 5        100,000 7,019,15   70.19 148,794 3,303,327 10,000    110,000 10,000     1.35    13,527    688,388    234,052

                         1
 6        100,000 7,299,91   73.00 135,268 2,614,939 10,000    110,000 10,000     1.23    12,297    717,695    244,016

                         7
 7        100,000 7,591,91   75.92 122,971 1,897,244 10,000    110,000 10,000     1.12    11,179    748,012    254,324

                         4
                                         - 60 -


 8         100,000 7,895,59   78.96 111,791 1,149,232 10,000   110,000 10,000    1.02    10,163     779,396     264,995

                          1
 9         100,000 8,211,41   82.11 101,629   369,836 10,000   110,000   4,555   0.92     4,209     369,835     125,744

                          4
                                                                                                  $5,782,150 $1,965,93

                                                                                                                      1

Note: numbers may reflect                                                               Net Present Value     ($872,920

rounding                                                                                (NPV) =                       )
