In the recent Tax Court Memorandum decision, Pierce v. Commissioner, T.C. Memo. 2025-29, filed April 7, 2025, the court addressed a dispute concerning the fair market value of interests in Mothers Lounge, LLC, a baby products company, for federal gift tax purposes. This case provides valuable insights for tax practitioners, particularly CPAs specializing in tax, into the court’s rigorous analysis of business valuation methodologies, the scrutiny of expert witness testimony, and the application of relevant legal principles in the context of closely held business transfers.

Factual Background

Kaleb J. Pierce (petitioner) and his then ex-wife, Ms. Bosco, jointly owned Mothers Lounge, LLC, an S corporation. On June 4, 2014, the valuation date, they engaged in estate planning transactions involving their interests in the company. Specifically, each spouse gifted a 29.4% interest to an irrevocable trust and sold a 20.6% interest to Giving Stream, LLC, an entity owned by the same irrevocable trusts, in exchange for a promissory note of $3,419,600 each.

On their respective Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Return, the spouses reported the 29.4% gifted interests as having a value of $4,880,400 each, based on a valuation report dated September 23, 2014. They did not report the sales of the 20.6% interests, contending that the notes received were equal to the value of the interests. Both spouses elected to treat each gift as a split gift under IRC § 2513(a).

The Commissioner of Internal Revenue (respondent) subsequently audited the gift tax returns and determined a federal gift tax deficiency for the 2014 tax year against the petitioner. This determination was based on the respondent’s assertion that the fair market values of the transferred interests were higher than reported.

Taxpayer’s Request for Relief

In the Tax Court, the petitioner challenged the Commissioner’s determination of a gift tax deficiency. While the respondent partially conceded that the correct fair market values were less than the amounts determined in the notice of deficiency, the petitioner argued that the fair market values were not only lower than asserted by the respondent but also lower than the values initially reported on his gift tax return. To support this position, the petitioner presented expert testimony and a new valuation report. The ultimate goal of the petitioner was to demonstrate that the values of the gifted interests were lower, thereby reducing the alleged gift tax liability, and that the sold interests were exchanged for adequate consideration, thus not constituting taxable gifts to the extent of any excess value.

Court’s Analysis of the Law

The court began by outlining the fundamental principles of federal gift tax. IRC § 2501 imposes a tax on the transfer of property by gift. The tax is based on taxable gifts, which are the total gifts made during the year less certain deductions (not relevant in this case). IRC § 2512(b) states that where property is transferred for less than adequate and full consideration, the excess value of the property over the consideration received is deemed a gift. The fair market value of the gift property is determined as of the date of the gift, as defined in Treasury Regulation § 25.2512-1 and elucidated in United States v. Cartwright, 411 U.S. 546, 551 (1973), as the price at which the property would change hands between a willing buyer and a willing seller, neither being under compulsion and both having reasonable knowledge of relevant facts. This valuation is based on market conditions and facts available on the valuation date, without the benefit of hindsight, as established in Estate of Gilford v. Commissioner, 88 T.C. 38, 52 (1987).

In valuing stock of a closely held corporation, the court noted that in the absence of arm’s-length sales of the stock around the valuation date, courts typically consider the market, income, and asset-based approaches. The parties agreed, and the court concurred, that the income approach, specifically the discounted cash flow (DCF) method, was the most appropriate method to value Mothers Lounge. The DCF method determines value by adding the present value of projected cash flows for a discrete period, the present value of the terminal value, and the value of nonoperating assets, as cited in Estate of True v. Commissioner, T.C. Memo. 2001-167.

The court then delved into each component of the DCF analysis:

Projected Future Cash Flows: The court emphasized that these forecasts should consider the expected revenue and expenses of the company. Notably, the court addressed the concept of "tax affecting" the earnings of an S corporation. While an S corporation is not liable for entity-level tax, the court acknowledged the argument that tax affecting might be necessary when valuation data is based on C corporations, which do pay such taxes, citing Dallas v. Commissioner, T.C. Memo. 2006-212. The court referenced Estate of Cecil v. Commissioner, T.C. Memo. 2023-24, and Estate of Jones v. Commissioner, T.C. Memo. 2019-101, regarding the limited circumstances under which tax affecting may be allowed. The court adopted the Delaware Chancery method for tax affecting, as outlined in Del. Open MRI Radiology Assocs., P.A. v. Kessler, 898 A.2d 290, 330 (Del. Ch. 2006), which applies a reduced fictitious tax rate at the entity level to account for the lower overall tax burden of a pass-through entity.
Discount Rate: The court noted the parties’ agreement to use the weighted average cost of capital (WACC) formula, although it acknowledged its prior hesitations regarding WACC for small, closely held corporations, citing Estate of Hendrickson v. Commissioner, T.C. Memo. 1999-278. Focusing on the build-up method for calculating the cost of equity, the court discussed components such as the risk-free rate, market premium, size premium, and company-specific premium, referencing Estate of Jackson v. Commissioner, T.C. Memo. 2021-48. The court emphasized that company-specific risk adjustments must not include factors already accounted for in other components of the discount rate, citing Rakow v. Commissioner, T.C. Memo. 1999-177.
Terminal Value: This component estimates the value of an indefinite income stream after the discrete projection period. It is typically calculated by capitalizing a "normalized" cash flow figure with a growth rate and the discount rate, as mentioned in BTR Dunlop Holdings, Inc. & Subs. v. Commissioner, T.C. Memo. 1999-377.
Nonoperating Assets: The court explained that nonoperating assets, such as excess cash, are added to the value derived from the discounted future cash flows and terminal value, citing Estate of Maggos v. Commissioner, T.C. Memo. 2000-129 and Estate of Renier v. Commissioner, T.C. Memo. 2000-298. Excess cash is defined as the amount by which cash and short-term investments exceed a business’s working capital needs.

Finally, the court addressed the application of discounts for lack of control and lack of marketability, which are often applied to the value of minority interests in closely held businesses, citing Estate of Newhouse v. Commissioner, 94 T.C. 193, 249 (1990) and Mandelbaum v. Commissioner, T.C. Memo. 1995-255. The control discount reflects the minority shareholder’s inability to control the company’s management and liquidation. The marketability discount accounts for the absence of a ready market for closely held shares. The court referenced a non-exhaustive list of factors considered in determining the marketability discount, as outlined in Mandelbaum.

Application of the Law to the Facts

The court meticulously reviewed the expert reports and testimony presented by both the petitioner and the respondent.

Projected Future Cash Flows: The court rejected the respondent’s expert, Mr. Mitchell’s, projections as they were merely "knockoffs" of the petitioner’s 2017 Lone Peak report without independent analysis or corroboration of the underlying assumptions, citing TK–7 Corp. v. Estate of Barbouti, 993 F.2d 722, 732 (10th Cir. 1993). The court found Mr. Mitchell failed to adequately address concerns regarding the soundness of the assumptions in the 2017 report, including the impact of the petitioner’s infidelity and reliance on post-valuation date data. Conversely, the court found Mr. Pickett’s projections in the 2024 Lone Peak report credible, based on industry data from the online baby product industry and accounting for known and knowable market trends as of the valuation date.
Tax Affecting Rate: The court found it proper to apply tax affecting using the Delaware Chancery method, as both experts agreed this was the appropriate approach. However, the court accepted Mr. Pickett’s fictitious entity-level tax rate of 26.2%, finding Mr. Mitchell’s calculation of the individual tax rate unsupported.
Discount Rate: The court accepted Mr. Mitchell’s base cost of equity of 18%, finding his data set and analysis more persuasive. However, the court rejected Mr. Pickett’s 5% company-specific risk adjustment due to a lack of sufficient explanation and quantification of the underlying risks, citing Estate of Davis v. Commissioner, 110 T.C. 530, 538 (1998). The resulting weighted average cost of capital was determined to be 18%, as Mothers Lounge had no debt.
Terminal Value: The court adopted Mr. Pickett’s long-term growth rate of 3%, based on long-term GDP growth, finding Mr. Mitchell’s reliance on inflation without adequate explanation unpersuasive.
Nonoperating Assets: The court accepted Mr. Pickett’s analysis of excess cash of $1,351,978, determining that his method of calculating working capital as a percentage of sales was more reasonable for Mothers Lounge’s business model than Mr. Mitchell’s calculation based on a percentage of assets.
Control Discount: The court rejected Mr. Mitchell’s 10% control discount applied only to nonoperating assets due to lack of support and improper restriction of its application. The court found Mr. Pickett’s 5% discount for lack of control reasonable, based on the operating agreement and analysis of control premiums in similar industries.
Marketability Discount: The court adopted Mr. Pickett’s 25% marketability discount, finding his methodology of basing the estimate on companies similar to Mothers Lounge slightly more persuasive than Mr. Mitchell’s approach, which did not make such adjustments and relied on rejected cash flow forecasts.

Court’s Conclusions

Based on its analysis, the court accepted portions of both experts’ reports to arrive at its valuation of Mothers Lounge. The court accepted Mr. Pickett’s forecasts, tax affecting analysis, long-term growth rate, and excess cash calculation. It accepted Mr. Mitchell’s base discount rate. Finally, it accepted Mr. Pickett’s discounts for lack of control and marketability.

The court did not provide a specific final valuation number in the memorandum findings of fact and opinion but indicated that an appropriate order would be issued, and a decision would be entered under Rule 155, requiring the parties to perform the final calculations consistent with the court’s findings.

Implications for Tax Practitioners

Pierce v. Commissioner underscores several critical considerations for CPAs in tax practice when advising clients on gift tax valuations of closely held businesses:

Rigorous Expert Analysis: The court’s detailed scrutiny of the expert reports highlights the importance of a well-supported and thoroughly documented valuation analysis. Experts must independently corroborate data and assumptions, particularly when relying on prior reports.
Justification of Assumptions: All assumptions underlying the valuation, including projected cash flows, discount rates (especially company-specific risk premiums), growth rates, and working capital needs, must be clearly articulated and supported by relevant data and sound reasoning.
Consideration of All Relevant Facts: The valuation should consider all known and knowable facts as of the valuation date, including industry trends, company-specific risks (both internal and external), and the impact of management decisions.
Appropriate Valuation Methodology: Selecting and correctly applying the most appropriate valuation method, in this case the DCF method, is crucial. Each component of the chosen method must be carefully considered and justified.
Tax Affecting Analysis: When valuing S corporations using data derived from C corporations, a tax affecting analysis may be considered. However, practitioners must ensure a sound methodology, such as the Delaware Chancery method, is applied and that the analysis accounts for both the benefits and burdens of S corporation status.
Support for Discounts: Discounts for lack of control and marketability must be supported by relevant studies and an analysis of the specific characteristics of the subject company and the transferred interests. The methodology for determining the discount rates should be clearly explained.

By adhering to these principles and carefully documenting the valuation process, tax practitioners can better advise their clients and navigate potential challenges from the IRS in gift tax audits of closely held business interests. The Pierce case serves as a reminder of the Tax Court’s commitment to a thorough and evidence-based review of valuation disputes.

Prepared with assistance from NotebookLM.

The text of the case can be read via the following link:

Pierce v. Commissioner, T.C. Memo. 2025-29, April 7, 2025