                          T.C. Memo. 2002-145



                        UNITED STATES TAX COURT



                     LEO J. POLACK, Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 12739-98.          Filed June 10, 2002.


        Barry A. O’Neil and Glenn R. Kessel, for petitioner.

     Blaine C. Holiday and David Zoss, for respondent.



                MEMORANDUM FINDINGS OF FACT AND OPINION


     MARVEL, Judge:     Respondent determined a deficiency of

$442,200 in petitioner’s Federal gift tax for the taxable year

1992.     After concessions, the sole issue for decision is the

valuation of petitioner’s gifts of shares of stock in Zip Sort,

Inc., that he made to his children on December 31, 1992.
                               - 2 -

                         FINDINGS OF FACT

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

The stipulations of fact are incorporated herein by this

reference.   Leo J. Polack (petitioner) was a resident of

Minnesota when he filed the petition in this case.

Background

     Zip Sort, Inc. (ZSI), was incorporated on July 24, 1987, and

petitioner purchased ZSI in August 1987.    During 1987, ZSI

employed approximately 10 people and had 30 to 40 regular

customers.   ZSI engaged in the trade or business of printing and

preparing pieces of bulk mail for clients and, to that end,

operated lettershop and presorting divisions.

     The lettershop division processed mailings for ZSI’s

clients, providing services ranging from printing and folding

materials to stuffing and addressing envelopes.    In 1991,

petitioner purchased Stedman Enterprises, an unprofitable

printing company, to bolster ZSI’s lettershop division and as a

backup in the event of an imminent strike.

     The presorting division sorted the pieces of bulk mail

according to U.S. Postal Service (Postal Service) criteria in

order to take advantage of Postal Service refund programs.

Initially, ZSI employees manually sorted the pieces of bulk mail,

and the Postal Service discounted the postage for each piece of

mail in each of ZSI’s presorted mailings by 4 cents (presorting
                                 - 3 -

discount).    ZSI typically shared the presorting discount with its

customers such that ZSI would refund, or reduce, fees paid to ZSI

by 2 cents.   Despite receiving this presorting discount, the

presorting division historically maintained a very low profit

margin; high volume was essential to the success of the

presorting division.   Through 1990, ZSI’s overall performance was

stagnant, and petitioner attempted to sell ZSI’s unprofitable

presorting division but was unsuccessful.

     In 1990, the Postal Service instituted an additional refund

program wherein the Postal Service began refunding to

participants 0.9 cent for each piece of presorted bulk mail that

met certain Postal Service criteria (the value-added refund, or

VAR, program).   One criterion of the VAR program was that the

participant place bar codes on each piece of mail so that the

Postal Service could use optical scanners to economize its

operations.   In June 1990, ZSI entered into a lease1 for a

multiline optical character reader (MLOCR) which automated its

presorting division, printed bar codes on pieces of mail, and

sorted the pieces by ZIP Code.

     Although ZSI began leasing the MLOCR in 1990, ZSI did not

yet qualify for participation in the VAR program; in 1990, ZSI



     1
      ZSI leased the multiline optical character reader (MLOCR)
either because MLOCRs were too expensive to purchase (between
$400,000 and $1,000,000) or because, for security reasons, the
manufacturer would not sell a MLOCR to ZSI.
                                - 4 -

had difficulty developing customers to support the continued

lease of the MLOCR.    In the latter part of 1990, petitioner

entered into discussions with a majority shareholder of Postal

Automation, one of ZSI’s competitors, regarding the divestiture

of their respective presorting divisions.    Both parties were

anxious to sell their respective presorting divisions.

Petitioner eventually agreed to purchase Postal Automation’s

presorting division for approximately $200,000 to $250,000 and a

share of ZSI’s profits for the following 2 years.    Petitioner’s

bank financed the purchase and additional operating costs for ZSI

in exchange for security interests in petitioner’s home or farm

and in a printing company petitioner owned.

     In 1991, ZSI first qualified to participate in the VAR

program.   ZSI continued to receive the 4 cents presorting

discount and began receiving the 0.9 cent value-added refund (VAR

income or VARI).   During 1991, ZSI continued to split the

presorting discount with its customers but was able to retain all

of the VARI it received, and the presorting division had its

first profitable year.    By 1992, however, some of ZSI’s customers

had learned of the VAR program, and they demanded a share of the

VARI ZSI received.    ZSI complied, for fear of losing those

customers,2 and shared the VARI either by directly paying a


     2
      As of the valuation date, ZSI had at least five primary
competitors of relatively equivalent size, and there were few
                                                   (continued...)
                               - 5 -

portion of the VARI to the customer or by reducing that

customer’s service fees.   In 1992, ZSI transferred to its

customers, by direct payment or reduction in fees, $117,426, or

10.24 percent, of the $1,147,100 in gross VARI it received; ZSI

retained the other $1,029,674, or 89.76 percent, of the gross

VARI received.

     Although ZSI was profitable in 1991 and 1992, petitioner

expected ZSI would have to share with its customers substantially

more of the VARI in future years.   Petitioner feared that the

presorting division’s low profit margin and tough competition,

combined with a further reduction in retained VARI, would strain

ZSI’s finances.

Gifts of ZSI Stock

     Immediately prior to the gifts at issue herein, ZSI’s stock

was held as follows:




     2
      (...continued)
barriers to entry into ZSI’s industry. In 1992, ZSI purchased a
competing company with small profits for $100,000 to $125,000 and
procured a covenant not to compete from the seller. By the end
of 1992, ZSI owned at least three current covenants not to
compete.
                                 - 6 -

                            Voting       Nonvoting
     Owner of shares        shares        shares3

     Leo J. Polack           6,522       1,193,479
     Dana Rhoads               869         159,130
     Lora Oberle               870         159,131
     Gregory Polack            870         159,131
     Sherry Tollefson          869         159,130
     Patricia Kostuch          869         159,130

          Total             10,869       1,989,131

Dana Rhoads was the president of ZSI, and Lora Oberle, Gregory

Polack, Sherry Tollefson, and Patricia Kostuch are petitioner’s

four children.

     On December 31, 1992, petitioner gifted 260,000 of his

nonvoting shares of stock in ZSI to each of his four children,

and immediately thereafter, ZSI’s stock was held as follows:

                            Voting       Nonvoting
     Owner of shares        shares        shares

     Leo J. Polack           6,522         153,479
     Dana Rhoads               869         159,130
     Lora Oberle               870         419,131
     Gregory Polack            870         419,131
     Sherry Tollefson          869         419,130
     Patricia Kostuch          869         419,130

          Total             10,869       1,989,131

     Petitioner retained an appraisal company to appraise the

value of the gifted shares of stock in ZSI as of the date of the

gifts, December 31, 1992.    Gerald Gray, an appraiser with that

company, prepared an appraisal report and concluded that, on the


     3
      On Dec. 30, 1992, petitioner recapitalized ZSI and thereby
created the two classes of stock. The only difference between
the classes of stock was the presence of voting rights.
                                - 7 -

valuation date, ZSI was worth $2 million, and the 1,040,000

gifted nonvoting common shares of stock in ZSI were worth 50

cents each.   Petitioner timely filed his Form 709, United States

Gift (and Generation-Skipping Transfer) Tax Return, and therein

reported cumulative annual gifts of $520,000 in accordance with

the appraisal report.

     Following an examination, respondent determined that, on the

valuation date, the 1,040,000 gifted nonvoting common shares of

stock in ZSI were worth $1.65 each and issued a notice of

deficiency to that effect.    Just prior to trial, however,

respondent retained an appraisal company to appraise the value of

the gifted shares of stock in ZSI as of the valuation date.       Brad

Cashion, an appraiser with that company, toured ZSI’s facilities

and interviewed Mr. Rhoads.    Mr. Rhoads was primarily responsible

for ZSI’s daily operations and for coordination of those

operations with the Postal Service.     Mr. Cashion prepared an

appraisal report that concluded that, as of the valuation date,

ZSI was worth $3,800,000--comprising $3,630,000 as an operating

company and $170,0004 in nonoperating assets--and that the

1,040,000 gifted nonvoting common shares of stock in ZSI were




     4
      This nonoperating asset was stock listed on ZSI’s balance
sheet at $170,316.
                               - 8 -

worth 90 cents each.   At trial, however, respondent conceded that

the shares at issue were worth 88 cents each.5

                              OPINION

     The only issue for decision is the value of the 1,040,000

gifted shares of stock in ZSI on December 31, 1992.    In deciding

the value of gifted shares of stock, we look to “the price at

which such property would change hands between a willing buyer

and a willing seller, neither being under any compulsion to buy

or to sell, and both having reasonable knowledge of relevant

facts.”   Sec. 25.2512-1, Gift Tax Regs.6

     Although we consider all the relevant facts and

circumstances in valuing gifted property, the value of a closely

held business is best ascertained by relying on actual arm’s-

length sales or transfers, if any, of the stock within a

reasonable period of the valuation date.    Estate of Fitts v.

Commissioner, 237 F.2d 729, 731 (8th Cir. 1956), affg. T.C. Memo.

1955-269;   Estate of Andrews v. Commissioner, 79 T.C. 938, 940

(1982).   The record contains no evidence of a sale or transfer of




     5
      This concession was mathematical in nature and not in
substance different from Mr. Cashion’s reported conclusion that
the shares were worth 90 cents each.
     6
      Unless otherwise noted, all section references are to the
Internal Revenue Code in effect for the taxable year at issue,
and all Rule references are to the Tax Court Rules of Practice
and Procedure.
                                - 9 -

stock in ZSI other than that at issue; this highly probative

factor therefore is unavailable for our analysis.

     Another factor highly probative of a company’s value is the

value placed on an arm’s-length sale or transfer of shares of

stock in a company similar to the company at issue, such sale or

transfer taking place within a reasonable period of the valuation

date.   Sec. 2031(b); Rev. Rul. 59-60, 1959-1 C.B. 237, 242.    Both

parties identified other companies operating in this industry,

but the parties either distinguished ZSI from those companies or

did not provide us with data regarding any arm’s-length sale or

transfer.    Although petitioner and/or ZSI purchased certain

assets and divisions of competing companies, we do not have

sufficient data to consider whether those “sales” or “transfers”

are probative of ZSI’s value.    This factor is unavailable for our

analysis.

     In the absence of arm’s-length sales or transfers of stock

in the subject company or in comparable companies, we have

generally considered a number of other factors affecting the fair

market value of the company and the gifted shares of stock,

including:    The nature of the business and the history of the

enterprise from its inception; the economic outlook in general

and the condition and outlook of the specific industry in

particular; the book value of the stock and the financial

condition of the business; the earning capacity of the company;
                              - 10 -

the dividend-paying capacity; whether or not the enterprise has

goodwill or other intangible value; and the size of the block of

stock to be valued.   Rev. Rul. 59-60, 1959-1 C.B. at 238-239.

     Both experts considered these and other factors in examining

ZSI and in constructing their respective appraised value.7

Nevertheless, petitioner’s analysis of the factors and of ZSI’s

worth yielded a value nearly half that which respondent’s

appraisal yielded.8   The parties identified, and the Court



     7
      The Internal Revenue Service Restructuring & Reform Act of
1998, Pub. L. 105-206, sec. 3001, 112 Stat. 726, added sec.
7491(a), which is applicable to court proceedings arising in
connection with examinations commencing after July 22, 1998.
Under sec. 7491, Congress requires the burden of proof to be
placed on the Commissioner, subject to certain limitations, where
a taxpayer introduces credible evidence with respect to factual
issues relevant to ascertaining the taxpayer’s liability for tax.
In the instant case, petitioners have not raised the application
of this provision or otherwise argued that respondent bears the
burden of proof in this case. Further, the record indicates that
the Commissioner’s examination commenced before July 22, 1998.
In any event, both parties adduced testimony and offered exhibits
in support of their respective positions, and the evidence so
introduced, though sparse, was not equally compelling.
Accordingly, we have based our conclusion upon the preponderance
of the evidence and not upon any allocation of the burden of
proof. See Estate of Harper v. Commissioner, T.C. Memo. 2002-
121.
     8
      Petitioner contends we should accept his expert’s testimony
because his expert is significantly more experienced than
respondent’s expert. As our discussion indicates, our conclusion
turns on factual disputes and reflects our finding that
petitioner’s conclusions regarding disputed factual issues are
not grounded on credible evidence. An expert, no matter how
skilled, can only work with the factual record he is given by his
client or obtains through his own efforts. In this case,
petitioner’s expert relied primarily on petitioner’s unsupported
opinion regarding the disputed factual matters.
                               - 11 -

discovered, a number of differences in the parties’ analyses

contributing to the difference in value.    On brief, petitioner

addressed only the differences in the parties’ treatments of (1)

projected VARI, (2) projected annual capital expenditures, and

(3) a nonoperating asset.

I.   VARI

     Of the three items the treatment of which the parties

dispute, the one likely to have the most impact on ZSI’s value is

the extent to which ZSI will retain the VARI it receives.

     Respondent projected gross VARI to equal 18 percent of gross

sales for each projected year,9 or $1,620,000 for 1993.

Respondent’s projection was based on ZSI’s historical amounts of

gross VARI earned, petitioner’s projected gross sales, and the

parties’ consensus that gross VARI varies directly with gross

sales.    Respondent then projected, based on Mr. Rhoads’s

statements, that ZSI would retain 50 percent of the gross VARI

for each projected year.

     On the other hand, petitioner projected that ZSI would

retain only $350,000 of gross VARI for 1993,10 without projecting

what gross VARI would be, and that ZSI would retain amounts

proportionate to gross sales thereafter.    Petitioner argues that

     9
      Roughly 70 to 75 percent of all sales qualified for the VAR
program.
     10
      Petitioner’s projection equates to 21.60 percent of
respondent’s projected gross VARI. By contrast, respondent
projected ZSI would retain $810,000, or 50 percent, of
respondent’s projected gross VARI.
                              - 12 -

he was the most knowledgeable person regarding VARI and that

respondent’s projection, based on an interview with Mr. Rhoads,

is therefore erroneous.   We disagree for several reasons.

     First, respondent’s reliance on Mr. Rhoads’s statements was

not improper.   Mr. Rhoads had daily contact with ZSI and was

intimately involved with the presorting division’s operations; we

do not think it improbable that Mr. Rhoads was aware of those

factors impacting the presorting division’s profitability, not

the least of which was the amount of retained VARI.

     Second, respondent’s projection coincides with the most

objective and reliable evidence in the record--the presorting

discount.   ZSI saved 4 cents per piece of mail under the

presorting discount program and consistently has been able to

retain the benefits from 50 percent of that discount.      We have

seen no evidence to suggest the apportionment of the presorting

discount is distinguishable from the apportionment of the VARI.

     Third, and most importantly, petitioner’s projection is

unreliable and lacks probative value.11   Petitioner’s bald

projection of $350,000 does not appear to be based on any

evidence or knowledge personal to petitioner.   Although

petitioner generally dealt with ZSI’s creditors and financial


     11
      At trial, petitioner testified that he had estimated ZSI
would retain anywhere from 25 percent to 35 percent of VARI but
offered the Court no facts on which to evaluate the
reasonableness of his estimates.
                                - 13 -

arrangements personally, petitioner failed to show how his

involvement with ZSI’s finances imbued him with the ability to

set a dollar value on retained VARI without first considering any

financial records or evaluating ZSI’s customer base.     If

petitioner did consider any information in making his projections

or if petitioner’s expert examined that information in

petitioner’s stead, they have not so asserted, nor have they

identified the information.

      Respondent’s projections of gross and retained VARI are

reliable and probative of ZSI’s value, and petitioner has not

introduced evidence, other than his unsupported guess, to show

otherwise.   We therefore accept respondent’s projections

regarding VARI.

II.   Capital Expenditures

      The second item we consider is ZSI’s projected capital

expenditures.     Respondent projected ZSI would make capital

expenditures of $100,000, $125,000, $100,000, $100,000, and

$100,000 for the years 1993 through 1997, respectively, and that

those outlays would be sufficient to replace existing equipment

and to purchase new equipment as necessary.     Petitioner contends

that respondent’s projections fail to account for expenses of the

presorting division and that respondent’s projections are

inconsistent with ZSI’s history of expenses, projected level of

growth, and projected depreciation.      Petitioner instead projected
                              - 14 -

ZSI would make capital expenditures of $200,000 in years 1993

through 1995 and of $150,000 for each year thereafter.    As

discussed below, petitioner’s arguments and projections do not

rest on credible evidence, and we are persuaded that respondent’s

projections are more reliable.   We therefore accept respondent’s

projections regarding capital expenditures.

     As near as we can tell, petitioner’s argument that

respondent failed to account for the “expenditures necessary for

the multi-line optical readers or any expenses related to the

bar-coding function of Zip Sort’s business”; i.e., the presorting

division, stems from a misunderstanding between respondent’s

expert and Mr. Rhoads.   Mr. Rhoads told Mr. Cashion that $100,000

would be more than enough for expenses in 1993; Mr. Rhoads

intended that remark to relate only to the lettershop division,

but Mr. Cashion interpreted that remark as relating to the

lettershop division and the presorting division.   Nevertheless,

because there is no evidence (1) that the presorting division

owned, or was likely to purchase for use in its business, any

capital asset of substantial value12 or (2) that expenses related


     12
      In holding that petitioner’s argument fails, we note that
the MLOCR, the only asset we know to be used in the presorting
division, was leased rather than owned, and both parties
separately accounted for costs associated with equipment leases
in their projections. Without any evidence that the presorting
division included other assets, we can only assume that
respondent’s projections did, in fact, account for the presorting
division.
                               - 15 -

to the MLOCR or any expenses related to any other portion of the

presorting division would be capital in nature, this

misunderstanding does not persuade us that ZSI would incur

capital expenditures with regard to the presorting division.

     Likewise, petitioner’s arguments that respondent’s

projections of capital expenditures are inconsistent with ZSI’s

history of expenses, projected level of growth, and projected

depreciation are not supported by evidence.   Specifically,

petitioner alleged that respondent’s projections (1) improperly

reduce ZSI’s assets’ book values during a period of corporate

growth; (2) improperly depreciate assets not yet acquired; and

(3) fail to recognize that proper appraisal methodology would

project a growing company’s capital expenditures to be relatively

equal to its depreciation, in order to maintain the asset base.

As discussed below, we disagree with petitioner.

     Petitioner has not directed us to any authority that a

decline in a corporation’s assets’ book values is irreconcilable

with that corporation’s growth.   ZSI’s growth is tied more

closely to the service fees, the presorting discounts, and the

value-added refunds it generates than to its assets’ book

values.13   We therefore are not persuaded by petitioner’s


     13
      For 1993 and 1994, it appears that respondent projected
ZSI’s assets’ cumulative book value to increase, as ZSI’s capital
expenditures are projected to exceed its depreciation allowances.
                              - 16 -

argument that respondent improperly reduced ZSI’s assets’ book

values.   We also are unpersuaded by petitioner’s assertion that

respondent improperly depreciated assets not yet acquired.    The

record does not support petitioner’s assertion.   At no point do

respondent’s projections anticipate ZSI’s accumulated

depreciation exceeding the cumulative costs of ZSI’s capital

assets.   We note that although respondent projected annual

depreciation to exceed annual capital expenditures in 1995, 1996,

and 1997, ZSI’s assets’ book values were sufficient to

accommodate that depreciation.   Petitioner has not supplied us

with any historical cost or depreciation information regarding

assets that ZSI held on the valuation date, or that it could be

expected to hold thereafter, and, because of this dearth of

information, petitioner’s argument and projections on this point

lack any evidentiary foundation.

     Finally, in arguing that proper appraisal methodology

“usually” calls for ZSI’s capital expenditures to be relatively

equal to ZSI’s depreciation, petitioner ignored the reality of

ZSI’s situation.   Mr. Rhoads was a frugal manager and president,

and he ran ZSI’s operations so as to keep costs at a minimum.

Most of ZSI’s repair work was done in-house, and the machines

were observed and maintained around the clock to ensure their

continued operation.   Mr. Rhoads cannibalized machines to keep

other machines operational for as long as possible, and he
                              - 17 -

testified that he would be hard pressed to spend $50,000 each

year on capital expenditures--that $100,000 would replace all of

the lettershop division’s assets.

     Respondent’s projections were based on Mr. Rhoads’s

statements and the above operational history, and we find

respondent’s projections reliable and probative of ZSI’s value.

On the other hand, the record does not support petitioner’s

arguments or projections, and petitioner has failed to persuade

us that ZSI’s future capital expenditures will be tailored to

match ZSI’s book depreciation.   We therefore accept respondent’s

projections regarding capital expenditures.

III. Nonoperating Asset

     The last item we consider is the nonoperating asset held by

ZSI and listed on ZSI’s 1992 balance sheet at a value of

$170,316.   Respondent included the nonoperating asset’s value

(rounded to $170,000) in his final valuation of ZSI.     We surmise

from the single paragraph petitioner devoted to this issue that

although petitioner initially omitted the nonoperating asset’s

value from his valuation analysis, he now concedes that the value

should have been included but argues that the value of the

nonoperating asset must be offset by a $150,000 debt owed by ZSI

to a stockholder.   Petitioner’s argument is rooted in

petitioner’s testimony that the $150,000 debt was payable by ZSI

to petitioner and that during 1992 ZSI purchased the nonoperating
                               - 18 -

asset for petitioner in satisfaction of the debt.    Petitioner

testified that although both items appeared on ZSI’s 1992

financial records, neither item should have so appeared.

     Petitioner’s testimony is not supported by the record.

Petitioner did not introduce any evidence, other than his own

testimony, to show that he was the stockholder to whom ZSI’s debt

was payable or that ZSI purchased the nonoperating asset in

satisfaction of the debt.    We do not accept petitioner’s

completely uncorroborated testimony as persuasive proof that

respondent improperly included the nonoperating asset in

calculating ZSI’s value, in the face of the evidence that the

asset was listed on ZSI’s balance sheet at a value approximating

$170,000.    Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).

Conclusion

     Petitioner disputed a number of respondent’s assumptions in

valuing ZSI for purposes of Federal gift tax, but we are

persuaded that respondent’s valuation is supported by the

evidence.    We therefore conclude that ZSI’s value on the

valuation date was 88 cents per share, as respondent’s expert

calculated.

     We have considered all of petitioner’s arguments for a

different result, and, to the extent not discussed herein, we

find them moot, irrelevant, or without merit.
                        - 19 -

To reflect the foregoing,


                                 Decision will be entered

                            under Rule 155.
