Cecil v. Commissioner (T.C. Memo 2023-24)

The case of the Estate of William A.V. Cecil, Sr., Donor, Deceased v. Commissioner[1] is one of the most important valuation cases certainly since Kress v. United States,[2] but possibly ever. Cecil touches a number of important topics of debate in business valuation. Its precedence and insight into the Tax Court’s thinking is essential to understand for any business owner and their advisors.

The Estate of William Cecil, Sr. challenged the valuation of a minority interest in the Biltmore Company (“TBC”), which owned the Biltmore House (the “House”). Built by George W. Vanderbilt in the 1880s, the House is still the largest private residence in the United States at 178,926 square feet. TBC operates in the hospitality industry with tours, restaurants, a variety of stores, etc.

Income Approach vs Asset Approach:

The Estate’s experts used the income and market approaches while rejecting the asset approach, but the Internal Revenue Service’s (“IRS”) expert included an asset approach with a drastically higher valuation. Although TBC was technically a “holding” company (in that it held the House) which are typically valued with an asset approach, the Tax Court properly understood the nuances of the issue. This reminds me of Jones v. Commissioner,[3] where the Tax Court ruled similarly on the issue stating that “when valuing an operating company that sells products or services to the public, the company’s income receives the most weight.” TBC generated operating cash flows from operations at the House. While a controlling position has the ability to achieve the highest and best use of an asset (i.e. its liquidation), a minority position does not have the same luxury. A minority interest holder has no power to dictate a sale and its only benefit is the associated cash flows. Therefore, an asset approach is not reasonable, which the Tax Court ruled, rejecting the asset approach outright.

Applicability of Tax Affecting:

The Tax Court also addressed the issue of tax affecting in the valuation. Tax affecting is the application of an effective tax rate to adjust the subject company’s prospective earnings as a willing buyer would do. A controversial topic stemming back to Gross v. Commissioner[4] where the Tax Court ruled that tax affecting was inappropriate for a corporation under Subchapter S (an “S-Corp”) which is not subject to an entity level tax. Following Gross was a string of cases similarly ruling against tax affecting. However, two more recent cases ruled in favor of tax affecting, Kress v. United States[5] and Jones. In Cecil, the Tax Court specified that tax affecting was not appropriate in all scenarios, but the facts of the case (which were not explicitly mentioned) merited it. Also of note, this marks the second high profile case (along with Kress) where both experts of the taxpayer and the IRS tax affected.

Applicability of Discounts for Lack of Voting Rights, Control, and Marketability:

Both experts applied discounts for lack of voting rights, control, and marketability. The Tax Court rejected the discount for lack of voting rights all together while accepting discounts for lack of control of 20% (taxpayer’s expert) and discounts for lack of marketability ranging from 19% to 27% (IRS’s expert). This implied all-in discounts ranging from approximately 35% to 42%.

Conclusion:

Cecil v. Commissioner is an important case that provides insight on a number of issues in the valuation industry. The case marks a win for taxpayers and market focused thinking that has been sorely missed since Gross. More importantly it highlights the importance of a qualified business valuation performed by a qualified appraiser with an understanding of the nuances. At DeJoy, our team of dedicated and credentialed valuation professionals has a proven track record of delivering comprehensive, reliable, and defensible valuations.

[1] T.C. Memo 2023-24.

[2] James F. Kress and Julie Ann Kress v. U.S., Case No. 16-C-795, U.S. District Court, E.D. Wisconsin, March 25, 2019.

[3] T.C. Memo 2019-101.

[4] T.C. Memo. 1999-254, affd. 272 F.3d 333 (6th Cir. 2001).

[5] James F. Kress and Julie Ann Kress v. U.S., Case No. 16-C-795, U.S. District Court, E.D. Wisconsin, March 25, 2019.

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