What do these amounts have in common: $0, $4.3 million, $9.3 million, $26 million, and $92.2 million? Amazingly, they are all valuation estimates of the same company at the same point in time. And the cause of these wild swings in value? The estimate of personal goodwill, as a recent estate case in Tax Court illustrates. The Tax Court held that the $9.3 million value, which was substantially discounted for personal goodwill, was correct over the Commissioner’s $92.2 million value. Estate of Adell v. Comm’r (U.S.T.C., 2014).

Franklin Adell owned 100% of STN, a company that provided cable uplink services to a single customer: The Word, a 24-hour religious broadcast network. The Word was a 501(c)(3) organization formed by Adell and his son, Kevin, who was made president of STN. The driving force of the entire operation—the network and the uplink business—was Kevin’s personal relationships with churches and religious leaders. He had no employment contract with STN, and there was no noncompete agreement. The deal was that The Word would pay STN a “programming fee” equal to the lesser of: (a) actual cost; or (b) 95% of net programming revenue received by The Word.

When the elder Adell passed away, his estate reported on Form 706 that the 100% interest in STN was worth $9.3 million based on a valuation from an experienced financial analyst who used the discounted cash flow method. Almost four years after Adell’s death, the estate filed an amended return that claimed the STN stock was worth $0. The IRS issued a notice of deficiency and determined that the value of STN was $92.2 million. Next stop: Tax Court.

At trial, the estate’s expert submitted a revised valuation for STN of $4.3 million, based on liquidation value. The expert said his original valuation failed to account for the deal that put a limit on the programming fee, which prevents STN from being profitable. One problem with this approach, however, was that the deal seems never to have been enforced, as STN had healthy profits.

The IRS also revised its valuation, coming up with $26 million also using the DCF method. The IRS expert based his calculation on the assumption that a hypothetical buyer could retain the son by paying him $1.3 million a year.

The court noted the estate’s “substantially inconsistent positions” but adopted the estate’s original $9.3 million valuation. It discredited the estate’s revised valuation in light of the company’s historical profitability and expectations that it would make a profit in the future. At the same time, the IRS expert’s goodwill approach also was inappropriate. He greatly undervalued the pivotal role the son played in operating both companies and his personal relationship with customers. Plus, if he quit, he could compete directly with the company, the court pointed out. In 2010, the son actually did quit and took all of the business and employees with him to a new company he formed.  Estate of Adell v. Comm’r (U.S.T.C., 2014).

Dwight A. Ensley, JD, MBA, BBA, CVA