                        T.C. Memo. 2005-235



                       UNITED STATES TAX COURT



    ESTATE OF WEBSTER E. KELLEY, DECEASED, JOHN R. LOUDEN AND
   PATRICIA L. LOUDEN, PERSONAL REPRESENTATIVES, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 16894-03.              Filed October 11, 2005.


     Larry W. Gibbs, for petitioner.

     Kathryn F. Patterson, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     VASQUEZ, Judge:    Respondent determined a $136,679 deficiency

in the Federal estate tax of the Estate of Webster E. Kelley (the

estate).   The sole issue for decision is the fair market value of

Webster E. Kelley’s (decedent) 94.83-percent interest in a family

limited partnership and one-third interest in a limited liability

company.
                                - 2 -

                           FINDINGS OF FACT

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

John R. Louden and Patricia L. Louden (the Loudens), personal

representatives of the estate, resided in Plano, Texas, at the

time the petition was filed.    Decedent resided in Plano, Texas,

at the time of his death.

     Decedent and his predeceased wife had one child, Patricia L.

Louden.   Patricia L. Louden is married to John R. Louden, and

they have four children.

     On April 6, 1999, decedent, Patricia L. Louden, and John R.

Louden organized Kelley-Louden Business Properties, LLC (KLBP

LLC), and Kelley-Louden, Ltd., a Texas limited partnership

(KLLP).   Between June 6 and September 11, 1999, decedent

contributed $1,101,475 cash and certificates of deposit to KLLP.

On September 13, 1999, the Loudens contributed $50,000 cash to

KLLP.

     At the time of decedent’s death, December 8, 1999, decedent

owned the following interests, the values of which are at issue

in this case:

           KLBP LLC                     33.33 percent
           KLLP                         94.83 percent

The Loudens owned the remaining two-thirds interest in KLBP LLC.

The Loudens also owned a 4.17-percent interest in KLLP.      KLBP LLC

owned the remaining 1-percent interest of KLLP which is the only

asset of KLBP LLC.    Therefore, we are valuing decedent’s
                                - 3 -

interests of 94.83 percent in KLLP and of 33.33 percent in KLBP

LLC.

       On decedent’s date of death, KLLP held assets totaling

$1,226,421, which consisted of $807,271 cash and $419,150 in

certificates of deposit, and had no liabilities.

       In December 1999, the estate employed Appraisal

Technologies, Inc. (ATI), to prepare a valuation of decedent’s

interests in these closely held entities.    ATI concluded that a

53.5-percent valuation discount was applicable.1

       On September 1, 2000, the estate filed a Form 706, United

States Estate (and Generation-Skipping Transfer) Tax Return,

reporting decedent’s 94.83-percent interest in KLLP at a value of

$521,565 and his interest in KLBP LLC at a value of $1,833.33.

       Respondent issued a notice of deficiency determining that

the discounts claimed by the estate were too high and lower

discounts were appropriate.2   Respondent contends that the estate

is entitled to a 25.2-percent discount.




       1
        The estate states several times on brief that ATI used a
55.15-percent discount; however, in calculating the discounts
applied by the estate, we find that ATI used a 53.5-percent
discount.
       2
        The   statutory notice of deficiency sets forth numerous
alternative   arguments including arguments based on secs. 2035,
2036, 2038,   and 2703. At trial, respondent conceded all the
alternative   arguments.
                               - 4 -

                              OPINION

I.   Burden of Proof

      As a general rule, the notice of deficiency is entitled to a

presumption of correctness, and the taxpayer bears the burden of

proving the Commissioner’s deficiency determinations incorrect.

Rule 142(a);3 Welch v. Helvering, 290 U.S. 111, 115 (1933).4

Section 7491(a), however, provides that if a taxpayer introduces

credible evidence and meets certain other prerequisites, the

Commissioner shall bear the burden of proof with respect to

factual issues relating to the liability of the taxpayer for a

tax imposed under subtitle A or B of the Internal Revenue Code

(Code).   For the burden to shift, however, the taxpayer must

comply with the substantiation and record-keeping requirements as

provided in the Code and have cooperated with the Commissioner.

See sec. 7491(a)(2).

     The estate did not claim that section 7491(a) applies.

Accordingly, the burden remains on the estate.


      3
        Unless otherwise indicated, all Rule references are to
the Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code as in effect at the
time of decedent’s death.
      4
        The presumption of correctness does not apply when the
Government’s determination is a “‘naked’ assessment without any
foundation whatsoever”. United States v. Janis, 428 U.S. 433,
441 (1976). The estate argues that the notice of deficiency may
not be entitled to a presumption of correctness if we conclude
that the report of its expert, ATI, had no probative value. As
we give some probative value to the ATI report, we conclude that
this is not an issue.
                                     - 5 -

II.    Fair Market Value of Decedent’s Interests

       A.     Introduction

               1.    General Principles

       Property includable in a decedent’s gross estate generally

is to be valued as of the date of the decedent’s death.            Sec.

2031.       For purposes of the estate tax, property value is

determined by finding the price at which the property would

change hands between a willing buyer and a willing seller,

neither being under any compulsion to buy or to sell, and both

having reasonable knowledge of relevant facts.          Sec. 20.2031-

1(b), Estate Tax Regs.         The willing buyer and willing seller are

hypothetical persons. Estate of Newhouse v. Commissioner, 94 T.C.

193, 218 (1990) (citing Estate of Bright v. United States, 658

F.2d 999, 1006 (5th Cir. 1981)).          The hypothetical buyer and

seller are presumed to be dedicated to achieving the maximum

economic advantage.          Id.

       Valuation is a factual determination, and the trier of fact

must weigh all relevant evidence of value and draw appropriate

inferences.         Estate of Deputy v. Commissioner, T.C. Memo. 2003-

176.

       There are three common approaches to measure the interest in

a closely held entity--the income approach, the net asset value

(NAV) approach, and the market approach.          Id.   Value is

determined under the income approach by computing a company’s
                                            - 6 -

income stream.             Estate of Jelke v. Commissioner, T.C. Memo. 2005-

131.    Value is determined under the NAV approach by computing the

aggregate value of the underlying assets as of a fixed point in

time.    Id.     Value is computed under the market approach by

comparison with arm’s-length transactions involving similar

companies.          Id.     The NAV approach is often given the greatest

weight in valuing interests in an investment company.              See Estate

of Ford v. Commissioner, T.C. Memo. 1993-580, affd. 53 F.3d 924,

927-928 (8th Cir. 1995) (citing Rev. Rul. 59-60, sec. 5, 1959-1

C.B. 237, 242).

       After determining the NAV of KLLP and KLBP LLC, it is

appropriate to discount decedent’s interest in each entity to

reflect lack of control and/or lack of marketability.              See

Peracchio v. Commissioner, T.C. Memo. 2003-280.

               2.     Expert Opinions

                          a.   In General

       In deciding valuation cases, courts often look to the

opinions of expert witnesses.               Each party in this case relies on

an expert opinion to determine the values of the properties at

issue.    We evaluate expert opinions in light of all the evidence

in the record, and we are not bound by the opinion of any expert

witness.       Helvering v. Natl. Grocery Co., 304 U.S. 282, 295

(1938); Shepherd v. Commissioner, 115 T.C. 376 (2000), affd. 283

F.3d 1258 (11th Cir. 2002).             We may reject, in whole or in part,
                                  - 7 -

any expert opinion.      Estate of Davis v. Commissioner, 110 T.C.

530, 538 (1998).      Because valuation necessarily involves an

approximation, the figure at which we arrive need not be directly

traceable to specific testimony or a specific expert opinion if

it is within the range of values that may be properly derived

from consideration of all the evidence.        Estate of True v.

Commissioner, T.C. Memo. 2001-167 (citing Silverman v.

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

1974-285).

                 b.    The Estate’s Expert

       The estate employed ATI in December of 1999 to prepare a

valuation report for transfers decedent made at yearend.

Decedent’s death, however, converted the Federal gift tax

valuation study into a Federal estate tax valuation study.         The

estate’s communications regarding the valuation were solely with

Ron Lint (Mr. Lint), the founder and president of ATI.       Mr. Lint

has the designation of accredited senior appraiser from the

American Society of Appraisers (ASA).        Mr. Lint testified that he

assigned the valuation project to Jeff Mills (Mr. Mills), a

subordinate at ATI, who also has the designation of accredited

senior appraiser from the ASA.      The valuation report was prepared

and signed by Mr. Mills, but Mr. Lint adopted the report as his

own.
                                - 8 -

     ATI used the NAV approach and the income approach in

determining the proper valuation of decedent’s interests.   ATI

gave 80-percent weight to the NAV approach and 20-percent weight

to the income approach.5

     ATI appraised decedent’s 94.83-percent limited partnership

interest in KLLP at a fair market value of $521,565, applying a

53.5-percent valuation discount to the adjusted NAV of KLLP, and

appraised decedent’s one-third interest in KLBP LLC at $1,833.33,

also applying a 53.5-percent valuation discount.

                c.   Respondent’s Expert

     Respondent submitted an expert report prepared by Raymond F.

Widmer (Dr. Widmer).    Dr. Widmer has a bachelor of arts degree in

economics, a master of business administration degree with a

concentration in economics and quantitative methods, and a Ph.D.

in economics.

     Dr. Widmer used the NAV approach and valued the interests

using a 25.2-percent valuation discount.   Applying this discount,

Dr. Widmer determined a value of $869,970 for the 94.83-percent

limited partner interest in KLLP and $3,055 for the one-third

interest in KLBP LLC.




     5
        At trial, the estate’s expert, Mr. Lint, admitted that
the income approach calculation in the ATI report was incorrect
because, among other problems, it did not compound the earnings
each year.
                                - 9 -

     B.   Fair Market Value Before Discounts

     As determined supra, the NAV method is generally an

appropriate method to apply when computing the value of a

nonoperating entity.   See Estate of Ford v. Commissioner, supra.

While more than one method may be used, giving appropriate weight

as necessary, we find that in this case, where the interest to be

valued is an interest in a family limited partnership whose

assets consist solely of cash and certificates of deposit, the

income approach should not be afforded more than minor weight.

     The parties agree that the value of KLLP’s assets on the

valuation date, decedent’s date of death, was $1,226,421,

consisting of $807,271 cash and $419,150 in certificates of

deposit and no liabilities.    Therefore, we use this as the NAV.

     C.   Minority Interest (Lack of Control) Discount

           1.   Introduction

     Pursuant to the partnership agreement, a buyer of all or any

portion of the transferred interests would have limited control

of his investment.   A hypothetical willing buyer would account

for this lack of control by demanding a reduced price; i.e., a

price that is below the NAV of the pro rata share of the interest

purchased in KLLP.   A minority discount will therefore apply in

this case where a partner lacks control.   See Estate of Bischoff

v. Commissioner, 69 T.C. 32, 49 (1977).
                              - 10 -

          2.   Determination of the Minority Interest Discount

     Each expert witness determined a minority interest discount

or discount for lack of control by reference to general equity

closed-end funds.   In a closed-end fund, the assets are brought

together for professional management, and the shareholders have

no control over the underlying assets.    The owner of an interest

does not have the ability to sell the underlying assets.     The

closed-end funds typically trade at a discount relative to their

share of the NAV, and as the shares enjoy a high degree of

marketability, the discounts must be attributable to some extent

to a minority shareholder’s lack of control over the investment

fund.   Peracchio v. Commissioner, T.C. Memo. 2003-280.

Therefore, it is appropriate to compare the ownership of a

partnership interest in KLLP to the ownership of a closed-end

fund and apply an appropriate discount for lack of control.

     Both experts divided the comparable closed-end funds into

quartiles by price to NAV ratios.   The first quartile represents

the funds that are in high demand and therefore trade at premiums

or low discounts.   The fourth quartile represents the funds that

are in low demand and trade at higher discounts.

               a.   The Estate’s Expert

     In computing the minority discount, ATI determined that KLLP

would be most comparable to the closed-end funds in the fourth

quartile with price to NAV discounts of 21.8 percent to 25.5
                              - 11 -

percent.   ATI considered several factors in making this

determination, including:   KLLP is smaller in size than a

publicly traded fund; closed-end funds generally have a staff of

analysts and professional managers devoted to the full-time

management of the fund investments which reduces risk whereas

KLLP is not managed in the same manner; closed-end funds offer

diversification of the portfolio of investments while KLLP is not

diversified; and KLLP does not have a performance history whereas

most closed-end funds have a performance history of 5 to 10

years.

     Once ATI determined an appropriate discount range of 21.8

percent to 25.5 percent, ATI then further adjusted the discount

based on several factors and restrictions inherent in KLLP and

using other partnership studies.    One such study, published by

Partnership Profiles, Inc. (PPI), found that the average discount

for 18 publicly registered but nontraded miscellaneous

partnerships, when the NAV of such partnerships was compared to

the prices at which investors acquired units in them in the

secondary market, was 29 percent.    ATI also discussed another

study published by PPI which compared the NAV of approximately

100 publicly registered but nontraded real estate partnerships

with the prices at which investors acquired units in these

partnerships in the secondary market.    The average discount to

NAV was 27 percent for the transactions studied.    Therefore, ATI
                                 - 12 -

used a 25-percent minority discount for valuing the interests in

KLLP.

                  b.   Respondent’s Expert

        Dr. Widmer calculated a minority discount of 12 percent by

calculating an arithmetic mean of the entire data set for closed-

end funds, not only the fourth quartile.     Dr. Widmer determined

that it is essential to use the whole array of closed-end funds

as this calculation will remove the marketability element in the

discounts or premiums.

             3.   Conclusion

        We are not persuaded that ATI’s exclusive use of the fourth

quartile of closed-end funds is proper.      “While we have utilized

small samples in other valuation contexts, we have also

recognized the basic premise that ‘[a]s similarity to the company

to be valued decreases, the number of required comparables

increases’.”      McCord v. Commissioner, 120 T.C. 358, 384 (2003)

(quoting Estate of Heck v. Commissioner, T.C. Memo. 2002-34); see

also Lappo v. Commissioner, T.C. Memo. 2003-258.      We are also not

persuaded by ATI’s analyses of PPI’s studies regarding minority

discounts as ATI admits that these discounts contain some element

of discount for lack of marketability, and therefore these

studies result in an overstatement of the minority discount.

        In determining the minority discount for KLLP, we believe a

correct analysis would be to take the arithmetic mean of all of
                                - 13 -

the closed-end funds, as shareholders in all closed-end funds

lack control.   In using only the fourth quartile, ATI combined

elements of the lack of marketability discount with the minority

discount because the funds in the fourth quartile had the lowest

demand and therefore the highest marketability discount.   As the

lack of marketability will be dealt with in the discount for lack

of marketability, see infra, we agree with respondent that ATI’s

discount for lack of control is too high and that it was

incorrect to use solely the fourth quartile funds.

     Although we find neither expert particularly persuasive on

this issue, we will apply a 12-percent discount on the grounds

that (1) respondent has effectively conceded that a discount

factor of up to 12 percent would be appropriate, and (2)

petitioner has failed to prove that a figure greater than 12

percent would be appropriate.    See Peracchio v. Commissioner,

supra (using a 2-percent minority discount factor for the “cash

and money market funds” asset category of a family limited

partnership).

     D.   Marketability Discount

           1.   Introduction

     A discount for lack of marketability is appropriate in

valuing the interests in KLLP as there is not a ready market for

partnership interests in a closely held partnership.    Estate of

Newhouse v. Commissioner, 94 T.C. at 249.   Although both experts
                                - 14 -

agree that a lack of marketability discount should be applied to

the partnership’s NAV (after applying the minority interest

discount), they disagree on the magnitude of that discount.      See

Peracchio v. Commissioner, T.C. Memo. 2003-280; see also Estate

of Bailey v. Commissioner, T.C. Memo. 2002-152 (indicating that

the application of a minority discount and a discount for lack of

marketability is multiplicative rather than additive).

            2.   Determination of the Marketability Discount

     There are several ways to determine a marketability

discount.    Two of the most common include the initial public

offering (IPO) approach and the restricted stock approach.

McCord v. Commissioner, supra at 387.     IPO studies compare the

private-market price of shares sold before a company goes public

with the public-market prices obtained in the IPO of the shares

or shortly thereafter.    See id.   Restricted stock studies compare

private-market prices of unregistered (restricted) shares in

public companies with the public-market prices of unrestricted

but otherwise identical shares in the same corporations.       See id.

A variant of the restricted stock approach, the private placement

approach, attempts to isolate the effect that impaired

marketability has on the discount determined under the restricted

stock approach.    See id. at 388, 392.

     This Court has concluded that the private placement approach

is appropriate where the interest to be valued was part of an
                               - 15 -

investment company as the assessment and monitoring costs would

be relatively low in the case of a sale of an interest in that

company.   Id. at 394; Lappo v. Commissioner, supra.   KLLP is an

investment company as 100 percent of its assets consist of cash

and certificates of deposit.   See McCord v. Commissioner, supra.

                a.   The Estate’s Expert

     In determining the marketability discount, ATI used the

restricted stock approach by drawing an analogy between

partnership interests in KLLP and the common stock of a private,

closely held corporation.   In doing so, ATI considered several

restricted stock studies and their findings.

     ATI also listed as barriers to marketability of a limited

partnership interest in KLLP the following:    (1) Once admitted as

a limited partner, one must continue as a limited partner until

all partners unanimously consent to the admission of a substitute

limited partner and to the withdrawal of the transferring

partner, and the limited partner must execute legal documents as

required by the general partner, who must receive and approve the

documents in writing; (2) a limited partner can assign, transfer,

encumber, or pledge all or part of his partnership interest only

if such assignment is fully executed by assignor and assignee,

such assignment is received by the partnership and recorded on

the books, and the transfer is approved by unanimous vote of all

the partners; (3) no partner has a property right in any of the
                             - 16 -

partnership property, regardless of whether specific property was

contributed to the partnership by a given partner; (4) limited

partnership interests are fully paid and nonassessable, and

limited partners do not have the right to withdraw or reduce

their capital contributions to the partnership; (5) limited

partners could be asked to lend additional money to the

partnership or increase their capital contributions and may have

their partnership interests diluted if they do not increase their

contribution and other partners do make additional contributions;

(6) general partners are not liable personally for the return of

capital contributions to the partnership, and limited partners

have no recourse against general partners should their claims to

assets remaining after liquidation and discharge of debts and

obligations not be satisfied; (7) the general partner has sole

discretion to determine whether to make distributions of any

type; and (8) upon the dissolution of the partnership, the

general partner acts as liquidator and has a reasonable amount of

time to wind up the partnership assets, and therefore the limited

partner may not obtain the final proceeds from an investment for

6 months or longer.

     After considering all of these factors and the results of

the restricted stock studies, ATI determined that a 38-percent

marketability discount is appropriate for an interest in KLLP.
                                - 17 -

               b.   Respondent’s Expert

     Using the private placement approach, Dr. Widmer determined

a 15-percent discount for lack of marketability on the basis of a

study by Dr. Mukesh Bajaj, Bajaj, et al., “Firm Value and

Marketability Discounts”, 27 J. Corp. L. 89 (2001), which found

that the private placement of unregistered shares has an average

discount of about 14.09 percent higher than the average discount

on registered placements.    Dr. Widmer also based this discount on

the low risk of the partnership’s portfolio.

          3.   Conclusion

     We are not persuaded by ATI’s recommendation of a 38-percent

marketability discount as the restricted stock studies referred

to in ATI’s expert report examine mostly operating companies, and

there are fundamental differences between an investment company

holding easily valued and liquid assets (cash and certificates of

deposit), such as KLLP, and operating companies.     See Peracchio

v. Commissioner, supra.     Moreover, ATI did not analyze the data

from these studies as they related to the transferred interests

herein, and therefore we cannot accept the premise that this

average discount is appropriate.    See id.

     We are also not persuaded by Dr. Widmer’s recommendation of

a 15-percent marketability discount.     While we agree that the

Bajaj study is an appropriate tool in determining the lack of

marketability discount, Dr. Widmer’s conclusion based on the
                                 - 18 -

study is not entirely accurate.     The Bajaj study states that the

14.09-percent discount, which Dr. Widmer focused on, is not

solely a reflection of marketability discount but is also

influenced by additional factors which have to be accounted for.

Bajaj et al., supra at 107.     These factors depend on the fraction

of total shares offered in the placement, business risk,

financial distress of the firm, and total proceeds from the

placement.   Id. at 107-109.

     As we find the parties’ assumptions and analyses concerning

the marketability discount only minimally helpful, we use our own

analysis and judgment, relying on the parties’ experts’

assistance where appropriate.      Helvering v. Natl. Grocery Co.,

304 U.S. at 295.

     In McCord v. Commissioner, 120 T.C. at 394-395, we focused

on the Bajaj study and found that a 20-percent marketability

discount was appropriate for interests in a family limited

partnership classified as an investment company.     Dr. Bajaj

divided the private placements into three groups according to the

level of discounts--the 29 lowest discounts, the middle 29

discounts, and the 30 highest discounts.      Id. at 394.   The low

discount group, with a discount of 2.21 percent, is dominated by

registered private placements which did not suffer from impaired

marketability.     Id.   The high discount group, with a discount of

43.33 percent, is dominated by unregistered private placements
                              - 19 -

which, unlike the sale of an interest in an investment company,

have relatively high assessment and monitoring costs.     Id.     As

these characteristics do not reflect the characteristics of an

investment company, we concluded in McCord, as we do here, that

the partnership is in the middle discount group, and a discount

of 20 percent (rounded from 20.36 percent) is applicable.       Id.

In McCord, we did not refine the 20-percent discount any further

to incorporate specific characteristics of the partnership at

issue as we were not persuaded that we could refine the figure.

Id. at 395.

     In Lappo v. Commissioner, T.C. Memo. 2003-258, we found that

a 21-percent initial discount was appropriate for an interest in

a family limited partnership consisting of marketable securities

and real estate subject to a long-term lease.   We then made a

further upward adjustment of 3 percent to the marketability

discount accounting for characteristics specific to the

partnership, including:   The partnership was closely held with no

real prospect of becoming publicly held; the partnership was

relatively small and not well known; there did not exist a

present market for the partnership interests; and the partnership

had a right of first refusal to purchase the interests.     Id.     As

these characteristics are similar to the characteristics in KLLP,

we find that a 3-percent upward adjustment is applicable.
                                - 20 -

     Therefore, we hold that a 20-percent initial marketability

discount is appropriate.     We further find that an upward

adjustment of 3 percent is proper to incorporate characteristics

specific to the partnership.

     E.   Conclusion

     On the basis of all the evidence and using our best

judgment, we conclude that a 12-percent minority discount and a

23-percent marketability discount are appropriate in valuing the

interests in KLLP.     The fair market value of the 94.83-percent

limited partnership interest is $788,059 computed as follows:

Total NAV as of 12/8/99                             $1,226,421
94.83 percent of NAV                                 1,163,015
Less: 12-percent minority interest discount           (139,562)
                                                     1,023,453
Less: 23-percent marketability discount               (235,394)
FMV of 94.83-percent interest                          788,059

We conclude that the fair market value of the 33.33-percent

interest in KLBP LLC, the sole asset of KLBP LLC being a 1-

percent general partnership interest in KLLP, is $2,770 computed

as follows:

Total NAV as of 12/8/99                             $1,226,421
33.33 percent of 1 percent of NAV                        4,088
Less: 12-percent minority interest discount               (491)
                                                         3,597
Less: 23-percent marketability discount                   (827)
FMV of 33.33 percent of 1-percent interest               2,770

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
