919 / How are stocks and bonds listed on an exchange or in an over-the-counter market valued for federal transfer tax purposes?

In general, their value is the fair market value per share or bond on the applicable valuation date (see Q 916). 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 valuation date is the fair market value per share or bond. (Listed securities and Treasury bonds must be reported and valued in dollar fractions smaller than eighths or 30-seconds, respectively, if the mean selling price on the applicable valuation date results in a smaller fraction.)¹

Restricted securities (sometimes referred to as “unregistered securities,” “investment letter stock,” “control stock,” or “private placement stock”) are securities that cannot lawfully be distributed to the general public until a registration statement relating to the corporation underlying the securities has been filed and made effective by the SEC. Information and guidance in the valuation of these securities is contained in Revenue Ruling 77-287.²

If there were no sales on the valuation date but there were sales on dates within a reasonable period both before and after the valuation date, the fair market value is determined by taking a weighted average of the means between the highest and lowest sales on the nearest date before and the nearest date after the valuation date. The average is to be weighted inversely by the respective numbers of trading days between the selling dates and the valuation date. If the stocks or bonds are listed on more than one exchange, the records of the exchange where the stocks or bonds are principally dealt in should be employed if such records are available in a generally available listing or publication of general circulation. In the event that such records are not so available and such stocks or bonds are listed on a composite listing of combined exchanges in a generally available listing or publication of general circulation, the records of such combined exchanges should be employed.³

If it is established with respect to bonds for which there is a market on a stock exchange, that the highest and lowest selling prices are not available for the valuation date in a generally available listing or publication of general circulation, but that closing selling prices are so available, the fair market value per bond is the mean between the quoted closing selling price on the valuation date and the quoted closing selling price on the trading day before the valuation date. If there were no sales on the trading day before the valuation date but there were sales on a date within a reasonable period before the valuation date, the fair market value is determined by taking a weighted average of the quoted closing selling price on the valuation date and the quoted closing selling price on the nearest date before the valuation date. The closing selling price for the valuation date is to be weighted by the number of trading days between the previous selling date and the valuation dates. If there were no sales within a reasonable period before the valuation date but there were sales on the valuation date, the fair market value is the closing selling price on such valuation date. If there were no sales on the valuation date but there were sales on dates within a reasonable period both before and after the valuation date, the fair market value is determined by taking a weighted average of the quoted closing selling prices on the nearest date before and the nearest date after the valuation date. The average is to be weighted inversely by the respective numbers of trading days between the selling dates and the valuation date. If the bonds are listed on more than one exchange, the records of the exchange where the bonds are principally dealt in should be employed.⁴

If the above measures are inapplicable because actual sales are not available during a reasonable period beginning before and ending after the valuation date, the fair market value may be determined by taking the mean between the bona fide bid and asked prices on the valuation date, or if none, by taking a weighted average of the means between the bona fide bid and asked prices on the nearest trading date before and the nearest trading date after the valuation date, if both such nearest dates are within a reasonable period. The average is to be determined in the manner described above.⁵

If the foregoing measures are inapplicable because no actual sale prices or bona fide bid and asked prices are available on a date within a reasonable period before the valuation date, but such prices are available on a date within a reasonable period after the valuation date, or vice versa, then the mean between the highest and lowest available sale prices or bid and asked prices may be taken as the value.⁶

If it is established that the value of any bond or share of stock determined on the basis of selling or bid and asked prices as provided above does not reflect the fair market value thereof, then some reasonable modification of that basis or other relevant facts and elements of value are considered in determining the fair market value.

To quote the Tax Court: “In general, property is valued as of the valuation date on the basis of market conditions and facts available on that date without regard to hindsight…The rule that has developed, and which we accept, is that subsequent events are not considered in fixing fair market value, except to the extent that they were reasonably foreseeable at the date of valuation.”⁷ Generally, post-valuation date events should be ignored when valuing property for gift tax or estate tax purposes.

Where sales at or near the date of death or gift are few or of a sporadic nature, such sales alone may not indicate fair market value. In certain exceptional cases, the size of the block of stock to be valued in relation to the number of shares changing hands in sales may be relevant in determining whether selling prices reflect the fair market value of the block of stock to be valued. If the executor or donor can show that the block of stock to be valued is so large in relation to the actual sales on the existing market that it could not be liquidated in a reasonable time without depressing the market, the price at which the block could be sold as such outside the usual market, as through an underwriter, may be a more accurate indication of value than market quotations.⁸ “[W]here a security is actively traded on the market and the block in question represents, let’s say, less than three months’ average market trading, any blockage claim should be given careful examination before a discount is approved.”⁹

The IRS has held that, in the estate tax setting, underwriting fees that are necessarily incurred in marketing a large block of stock are deductible as administration expenses under IRC Section 2053(a)(2), and are not considered in determining the blockage discount to be accorded in valuing the stock under IRC Section 2031 (see Q 847). Where a blockage discount is allowed, says the Service, the relevant valuation figure is the price that the public would pay to the underwriter for the stock, not the price the underwriter would pay to the estate.¹⁰ For a discussion of the blockage discount issue, see Est. of Sawade v. Comm.¹¹

If actual sale prices and bona fide bid and asked prices are lacking, then the fair market value is to be determined by taking the following factors into consideration:

(1)     In the case of corporate or other bonds, the soundness of the security, the interest yield, the date of maturity, and other relevant factors; and

(2)     In the case of shares of stock, the company’s net worth, prospective earning power and dividend-paying capacity, and other relevant factors.

Some of the “other relevant factors” referred to in (1) and (2) above are the following: the goodwill of the business, the economic outlook in the particular industry, the company’s position in the industry and its management, the degree of control of the business represented by the block of stock to be valued, and the values of securities of corporations engaged in the same or similar lines of business which are listed on a stock exchange. However, the weight to be accorded such comparisons or any other evidentiary factors considered in the determination of a value depends upon the facts of each case.¹² In addition to the relevant factors described above, consideration is also given to nonoperating assets, including the proceeds of life insurance policies payable to or for the benefit of the company, to the extent such nonoperating assets have not been taken into account in the determination of net worth, prospective earning power and dividend-earning capacity.¹³

Another person may hold an option or a contract to purchase securities owned by a decedent at the time of his death. The effect, if any, that is given to the option or contract price in determining the value of the securities for estate tax purposes depends upon the circumstances of the particular case. Little weight will be accorded a price contained in an option or contract under which the decedent is free to dispose of the underlying securities at any price he chooses during his lifetime. Such is the effect, for example, of an agreement on the part of a shareholder to purchase whatever shares of stock the decedent may own at the time of his death. Even if the decedent is not free to dispose of the underlying securities at other than the option or contract price, such price will be disregarded in determining the value of the securities unless it is determined under the circumstances of the particular case that the agreement represents a bona fide business arrangement and not a device to pass the decedent’s shares to the natural objects of his bounty for less than an adequate and full consideration in money or money’s worth.¹⁴ For a case applying this regulation, see Dorn v. the United States.¹⁵ In any event, an option or a contract to purchase securities which fails to meet the Chapter 14 valuation rules test for such options or agreements (see Q 943) will be disregarded.¹⁶

In any case where a dividend is declared on a share of stock before the decedent’s death but payable to stockholders of record on a date after his death and the stock is selling “ex-dividend” on the date of the decedent’s death, the amount of the dividend is added to the ex-dividend quotation in determining the fair market value of the stock as of the date of the decedent’s death.¹⁷