Two months after the Tax Court decided the Bross Trucking case, it addressed the significance of personal goodwill in valuing the stock of a closely held corporation, STN.Com Inc. in Estate of Franklin Z. Adell, TC Memo 2014-155. The decedent, Franklin Adell, owned all of the shares of STN stock. His son Kevin was the president of STN and was instrumental in the development of its business.
STN provided cable uplinking for its only customer, the Word, which was a 24-hour, urban, religious programming station. Kevin had prior experience with religious programming and used his connections to garner the support of various religious leaders in launching the Word.
In valuing the STN shares for Franklin’s estate tax return, the estate appraiser used the discounted cash flow method, projecting future revenue for the five years subsequent to death. In determining the projected cash flow during that period, the estate’s appraiser reduced the cash flow by an economic charge for Kevin’s personal goodwill because STN’s revenue was dependent upon Kevin’s relationships. Kevin had no employment agreement with STN and was not subject to a covenant not to compete. The appraiser quantified the economic charge at between 37 and 44 percent of sales. There is no explanation in the decision as to how this very sizable charge was derived.
The Tax Court accepted this valuation, concluding that because Kevin was free to leave STN and compete against it, the large economic charge taken was warranted. This economic charge had an enormous impact on the value of STN, reducing the value by more than 70 percent from what it would have been without the economic charge.
This adjustment for personal goodwill was enormously beneficial to the estate, resulting in a final valuation which was about one-third of the IRS appraiser’s value. The reduction attributable to Kevin’s personal goodwill is conceptually similar to a loss of key person discount. However, the decisions authorizing such a discount have generally quantified that discount at 5 to 15 percent. The economic charge applied in the Adellcase is tantamount to a loss of key person discount of more than 50 percent.
It remains to be seen whether this valuation approach to personal goodwill could supplant the much more modest loss of key person discount in the future. However, the taxpayer victories in Bross Truckingand Adell could also turn into a double-edged sword. The IRS asserted in Bross Trucking that the transfer of personal goodwill was a taxable gift. The court did not reject that possibility entirely, but found that the facts did not support that such a transfer was made. However, suppose Kevin Adell had used his personal relationships to help establish his children in a new cable uplinking venture. The rationale behind Bross Trucking and the quantification of personal goodwill endorsed in theAdell decision could result in the IRS asserting that Kevin Adell’s assistance to his children amounted to a multi-million-dollar taxable gift.