In Estate of Simplot v. Commissioner, No. 00-70013 (9th Cir. May 14, 2001), the federal appellate court reversed the ruling of the U.S. Tax Court, and held that the value of a company’s minority interest voting shares was equal to the value of its non-voting shares. The Simplot case highlights the differences in how voting and non-voting shares in closely held companies should be valued.

Problems with the Tax Court Decision
In its 1999 decision valuing 18 shares of Class A minority voting stock, the Tax Court attributed a substantial taxable premium "because of the [shares’] inherent potential for influence and control." Critics noted, however, that the court failed to discount the minority interest for lack of marketability and lack of control. Further, its valuation could not be supported with simple arithmetic — under the court’s valuation, the overall worth of the company far exceeded its fair market value. Because the company at issue comprised a large block of non-voting shares (99.95 percent of outstanding shares) and a small block of voting shares, a buyer of the voting shares at issue, paying the Tax Court’s price, would likely lose most of his investment if the company were subsequently sold or merged. No willing buyer, the critics asserted, would pay such a price.

Ninth Circuit Reversal
The Ninth Circuit agreed with the critics and found that the Tax Court used improper assumptions to arrive at its value, rather than the appropriate objective standard. The correct approach uses a "purely hypothetical willing buyer and seller," as opposed to "specific individuals or entities." The Tax Court, however, considered "imaginary scenarios," such as combinations the potential purchaser might effect with other shareholders. Under the objective standard, the Ninth Circuit found that the minority interest voting shares were worth no more than non-voting shares.

The appellate court’s decision reaffirms that a discount is still appropriate for both minority interest voting shares and non-voting shares in a closely held business. Indeed, some empirical studies indicate that additional discounting should apply to non-voting shares.

Voting Versus Non-Voting
The Ninth Circuit’s ruling reversed what many thought to be significant errors by the Tax Court, and heightened awareness of the different treatments of voting and non-voting shares. Although the Ninth Circuit attributed the same value to the minority voting shares as to the non-voting shares, it neither affirmed nor overruled the Tax Court’s conclusion that a premium should apply to an entire class of voting shares. The appellate court acknowledged that a premium may be appropriate for a controlling block of shares.

The Simplot case also demonstrates that the Tax Court will consider non-economic factors in its valuations. Many appraisers believe these factors are irrelevant — that only economic factors should be considered — and that their job is to present purely economic valuation calculations to the courts for resolution, regardless of precedent. Nonetheless, lawyers involved in tax-related valuation cases should be sensitive to factors such as Congressional intent, case law, and IRS positions.