INSIGHT: The Value of Stock Must Take Into Consideration a Pending Merger

The valuation of publicly traded corporate stock contributed to a trust prior to a pending merger—by a donor who knew of the merger—must take into consideration the pending merger, because a willing buyer and seller of the stock would consider the merger, the IRS Office of Chief Counsel advised.

Chief Counsel Advice Memorandum CCA 201939002 was issued regarding a gift tax audit. The donor was a co-founder and chairman of the board of directors of Corporation A, a publicly traded corporation. On Date 1, the donor transferred Corporation A shares to a newly-formed grantor retained annuity trust with an “X” term and a remainder to his children. On Date 2, after the market closed, Corporation A announced a merger with Corporation B. The merger was the culmination of negotiations with multiple parties, and then, before the Date 1 transfer, exclusive negotiations with Corporation B. On the “X” day of trading after the merger was announced, the value of the Corporation A stock, not surprisingly increased substantially, though less than the agreed merger price.

The issue was whether the hypothetical willing buyer and seller of shares in a publicly-traded corporation would consider a pending merger when valuing stock for gift tax purposes. The answer was an unqualified yes.

Subsequent Events Are Properly Considered

Tax code Section 2512(a) provides that if a gift is made in property, the value thereof at the date of the gift shall be considered the amount of the gift. The value of property is “the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts.” See Treasury Regulation Section 25.2512-1.

Treas. Reg. Section 25.2512-2(b)(1) provides that if there is a market for stocks or bonds, on a stock exchange, in an over-the-counter market or otherwise, the mean between the highest and lowest quoted selling prices on the date of the gift is the fair market value per share or bond. Treas. Reg. Section 25.2512-2(e) provides that in cases in which “it is established that the value per bond or share...determined on the basis of the selling...prices as provided under [Treas. Reg. Section 25.2512-2(b)] does not represent the fair market value thereof, then some reasonable modification of the value determined on that basis...shall be considered in determining fair market value.”

The willing buyer and seller, the Internal Revenue Service pointed out, are hypothetical persons, rather than specific individuals or entities, and their characteristics are not necessarily the same as those of the donor and the donee. The hypothetical willing buyer and willing seller are presumed to be dedicated to achieving the maximum economic advantage. Both parties are presumed to have made a reasonable investigation of the relevant facts. Thus, in addition to facts that are publicly available, reasonable knowledge includes those facts that a reasonable buyer or seller would uncover during the course of negotiations over the purchase price of the property. Moreover, a hypothetical willing buyer is presumed to be “reasonably informed” and “prudent” and to have asked the hypothetical willing seller for information that is not publicly available.

Generally, a valuation of property is made as of the valuation date, without regard to events happening after that date. See Ithaca Trust Co. v. United States. Subsequent events may be considered, however, if they are relevant to the question of value. A post-valuation date event may be considered if the event was reasonably foreseeable as of the valuation date. Furthermore, a post-valuation date event, even if unforeseeable as of the valuation date, also may be probative of the earlier valuation to the extent it is relevant to establishing the amount that a hypothetical willing buyer would have paid a hypothetical willing seller for the subject property as of the valuation date.

In Ferguson v. Commissioner taxpayers owned 18% of AHC and served as officers and on the board of directors. AHC entered into a merger agreement with DCI. The AHC board of directors unanimously approved the merger agreement. On Aug. 3, 1988, the tender offer was started. On Aug. 15, 1988, taxpayers, with the help of their broker, executed a donation-in-kind record with respect to their intention to donate stock to a charity and two foundations. On Sept. 9, 1988, the charity and the foundations tendered their stock. On Sept. 12, 1988, the final shares were tendered, and on Oct. 14, 1988, the “clean-up” merger was completed.

The court in Ferguson concluded that the transfers to charity and the foundations “occurred after the shares in AHC had ripened from an interest in a viable corporation into a fixed right to receive cash and the merger was practically certain to go through.” Consequently, the court concluded, the “assignment of income” doctrine applied, and the taxpayers realized gain when the shares were disposed of by the charity and the foundations.

The current case, the IRS noted, “shares many factual similarities with Ferguson.” While the Ferguson opinion deals exclusively with the assignment of income doctrine, it also relies on the proposition that the facts and circumstances surrounding a transaction are relevant to the determination that a merger is likely to go through. The current case presents an analogous issue, that is, whether the fair market value of the stock should take into consideration the likelihood of the merger as of the Date 1 transfer of Corporation A shares to the trust.

The Ferguson opinion and the opinion in Silverman v. Commissioner support the conclusion that the value of stock in Corporation A must take into consideration the pending merger. Accordingly, a value determined on the basis of the selling price, as provided in Treas. Reg. Section 25.2512-2(b), does not represent the fair market value of the shares as of the valuation date; pursuant to Treas. Reg. Section 25.2512-2(e), other relevant facts and elements of value must be considered in determining fair market value.

Under the fair market value standard as articulated in Treas. Reg. Section 25.2512-1, the hypothetical willing buyer and willing seller, as of Date 1, would be reasonably informed during the course of negotiations over the purchase and sale of the shares and would have knowledge of all relevant facts, including the pending merger. Indeed, the IRS observed, “to ignore the facts and circumstances of the pending merger would undermine the basic tenets of fair market value and yield a baseless valuation.” Therefore, unequivocally, a pending merger must be considered when valuing stock for gift tax (and presumably for other) purposes. See CCA 201939002, dated May 28, 2019, and released Sept. 27, 2019.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Robert Willens is president of the tax and consulting firm Robert Willens LLC in New York and an adjunct professor of finance at Columbia University Graduate School of Business.