Revenue Ruling 79-59 for Valuing Blocks of Stock

Determining the value of stock in a closely held corporation is a frequent requirement for federal estate and gift tax purposes. The Internal Revenue Service (IRS) provides guidance for this process, with principles established in Revenue Ruling 59-60. This ruling sets a standard for arriving at fair market value for shares that are not publicly traded.

The Concept of a Control Premium

A control premium is the additional value that an investor would pay to acquire a block of stock that gives them a controlling interest in a company. This premium exists because control confers specific and valuable rights that are not available to minority shareholders. The value of control translates into tangible power over the company’s direction and financial decisions, allowing a controlling shareholder to effectively run the business.

The powers associated with a controlling interest directly influence the company’s value. These include the ability to elect the board of directors, appoint senior management, set executive compensation, and dictate corporate strategy. This level of influence means the holder can manage the company to maximize their investment return.

Furthermore, control grants the power to make financial decisions that affect all shareholders, such as determining the company’s dividend policy. A controlling party also holds the authority to pursue a sale, merger, or liquidation of the company. This collection of rights makes a controlling block of shares inherently more valuable per share than a non-controlling block.

The Concept of a Minority Discount

A minority discount is a reduction applied to the per-share value of a stock block that does not provide control over a company. This discount reflects the disadvantages and lack of power of a minority ownership position. A shareholder with a non-controlling interest cannot direct the company’s policies or strategic decisions, placing them in a passive role.

The justification for a minority discount stems from specific limitations. A minority shareholder cannot compel the company to pay dividends or appoint management. They also lack the power to set salaries or influence the strategic direction of the business, making their returns dependent on the actions of controlling owners.

Another factor is the limited marketability of a minority interest in a private company, as there is no ready public market for these shares. Finding a third-party buyer can be difficult because they would acquire a stake with no decision-making power. This illiquidity, combined with the lack of control, is why a minority block of stock is valued at a discount.

Factors That Determine Valuation Adjustments

The size of a control premium or minority discount is based on a detailed analysis of the company’s specific facts and circumstances, not a fixed formula. Appraisers must consider several factors, including:

• The nature and history of the business
• The economic and industry outlook
• The book value and financial condition of the company
• The company’s earning capacity and dividend-paying capacity
• Any goodwill or other intangible assets

The distribution of ownership is a significant consideration. A minority interest may be valued differently if the remaining shares are held by a single individual versus being fragmented among many other shareholders. If ownership is widely dispersed, a smaller block of stock might represent effective control, influencing the valuation.

Corporate documents and shareholder agreements also determine the value of a stock block. The company’s articles of incorporation and bylaws may contain provisions that grant special rights or impose restrictions on certain shares. A shareholders’ or buy-sell agreement can restrict the transferability of shares or set a price for future transactions, impacting any premium or discount.

Valuing Multiple Blocks of Stock

When valuing stock for estate tax purposes, a principle of aggregation applies if the decedent owned multiple blocks of shares in the same corporation. The blocks are not valued in isolation but are combined to assess whether they constitute a controlling or minority position.

For example, consider an individual who owns two separate 30% blocks of stock in a closely held company. For estate tax valuation, these are not treated as two separate minority interests subject to a discount. Instead, they are aggregated into a single 60% ownership block.

This combined block represents a controlling interest, and its valuation would include a control premium. This aggregation principle prevents an estate from artificially lowering its tax liability by claiming minority discounts on separate blocks of stock that, when combined, actually give the decedent control.