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By Mary Maher Bova, Maher

The national office of the IRS raised the issue of swing vote premium values for minority business interests shortly after conceding defeat in the battle for minority interest discounts in family businesses (Rev. Rul. 93-12, I.R.B. 1993-7, February 16, 1993, revoking Rul. 81-253, 1981-1 C.B. 187). It looks like a new valuation battle is about to begin.

To its credit, the national office simply raised the issue of a swing-vote value in Technical Advice Memorandum 9436005, knowing that the facts of each case will determine if such a value exists. Any time the voting power of a minority interest can be combined with the voting power of other minority interests to create a controlling interest the potential for swing-vote value exists.

The potential for swing-vote value was raised in an early gift tax case involving shares of the Times-Mirror Company. The Chandler family controlled the Times-Mirror Company which published the Los Angeles Times. Marian Otis Chandler owned 1,634 shares, 28.37% of the 5,760 outstanding shares of the Times-Mirror Company. The remaining shares were held by members of the Chandler family, relatives, management of the Times-Mirror Company and its employees. The IRS claimed these shares should not be valued as a minority interest, because they could be combined with other family interests to form a controlling block of stock.

The Tax Court found no evidence that members of the family would act in concert with the purchaser of these 1,634 shares to change the management of the company. The Tax Court concluded that the 1,634 shares represented a minority interest in the company and must be valued on the basis that they did not represent a controlling interest. The facts of the case did not establish a swing-vote value for these shares at the time of the gift (Marian Otis Chandler, BTA Memo, March 27 1941).

The IRS was successful in presenting the issue of swing vote value to the Tax Court in a case involving a 10% voting stock interest in the Rock Island Refining Corporation, an Indianapolis based business that refined and distributed gasoline and other petroleum products.

For many years ownership of the Rock Island Refining Corporation was equally distributed between the Winkler and Simmons Families. On September 28, 1981 Clara Winkler died owning the following shares:

Percent Of

Number Class Class

8,000 Voting common 10.0%

7,600 Non-voting

common 10.6

Evidence on trial established that neither family sought to gain control of the company. The valuation report submitted by the expert for the IRS, Yale Kramer, however, mentioned vague rumors of a possible sale of the company. The Tax Court stated that there was no evidence of a possible sale. The Tax Court also pointed out that the standard for fair market value of a closely held business is the price that would be paid to a willing seller by a willing buyer.

The Tax Court then stated: "Looking at this even split between the two families, the 10% block of voting stock, in the hands of a third party, unrelated to either family, could indeed become critical. While it is difficult to put a value on this factor, we think it increases the value of the Class A voting stock by at least the 10% that Mr. Kramer found." The Tax Court concluded: "...that a 10% block of voting stock has swing vote characteristics and that a minority discount would be inappropriate here" [Estate Of Clara Winkler, TCM 1989-231 (1989)].

A technical advice memorandum is an answer the national office of the IRS gives to an inquiry made by an agent. The estate and gift tax agent raised the issue of whether swing vote potential increased the value of gifts to family members given these facts:

1. A father held 100% of the stock of a closely held company.

2. The father made the following gifts:


Donee Ownership

Child number one 30%

Child number two 30

Child number three 30

His spouse 5

3. The father (donor) claimed a 25% discount for each gift of stock.

The advice given by the national office of the IRS to the estate and gift tax agent was that the swing-vote attributes of each block of stock are factors to be taken into consideration in determining the value of each block of stock (Technical Advice Memorandum 9436005, May 26 1994).

Economic Realities

A minority block of stock can, at times, have greater value to shareholders. This can happen when:

* An opportunity exists that requires the creation of a controlling block of stock. For example, the by-laws of a corporation may require the vote of 75% of the shareholders to approve the sale of the business and--

* there is a written offer to buy the business.

* this offer has been considered and is being explored by the board of directors.

* no shareholder holds 75% of the voting shares.

In this case, the minority shares' market value increases because the shares can be combined into a controlling block of stock and used to take advantage of an opportunity.

* A problem exists that can be solved by forming a controlling block of stock. For example, the management of the business may be directly responsible for losses that could force a liquidation of the business. However, at the annual meeting shareholders can replace the board of directors with new directors who will make changes in management. For example, assume that--

* management is responsible for losses that could lead to the liquidation of the business.

* the by-laws permit the corporation's directors to be elected by a
majority of the outstanding voting shareholders.

* there are individuals who would serve as directors and have declared their intention to replace the existing management team.

* there is no shareholder who owns 51% of the outstanding voting

In this case, the minority blocks of stock become more valuable because they can be combined into a controlling block of stock and used to solve a problem.

It is important to consider the impact of the applicable state law on the power of a shareholder who has created a controlling block of stock before assigning a swing-vote value.

The Bottom Line

The facts of each case determine whether a swing-vote value exists. There has to be a need to create a controlling block of stock to take advantage of an opportunity or solve a problem. Speculation that opportunities or problems may exist sometime in the future do not create swing-vote value. Once the opportunity passes or the problem is solved, swing vote value evaporates. *

Established in 1980, Maher Economics has completed more than 1,000 business valuation studies that establish the fair market value of businesses of all types and sizes.


Michael Goldstein

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