Publications banner
Taxnotes

Firehouse Subs Founders and IRS Dispute Share Valuation

By: Erin McManus

 

Robin and Chris Sorensen, the brothers who founded the restaurant chain Firehouse Subs, are fighting the IRS over the value of shares they contributed and sold to their living and family trusts.

 

At issue in Sorensen v. Commissioner is whether the value of nonvoting Firehouse Restaurant Group Inc. shares that were given and sold by the brothers to their trusts as part of an estate plan is governed by a defined-value formula and the value of the company at the time of the transfers . Tax Court Judge David Gustafson ordered the case continued July 7.

 

Both brothers are challenging deficiencies totaling $13.6 million and penalties totaling $5.43 million.

 

The Sorensens each reported on their 2014 Forms 709, “United States Gift (and Generation-Skipping Transfer) Tax Return,” that a number of shares with a fair market value of $5 million were contributed to their trusts on December 31, 2014. The Sorensens also sold shares to their trusts on March 31, 2015, claiming they had an FMV of $12 million, according to their June 25 first amended pretrial memorandum.

 

In its June 24 pretrial memorandum, the IRS says, based on a valuation report performed by Jeff Anderson of CONSOR IP Experts, that the FMV of one share of Firehouse was $2,076 on the date of the trust contribution and $2,228 on the date of the sale of shares to the trusts. The Sorensens’ expert, Alexander Rey of Dixon Hughes Goodman LLP (now of Forvis), estimated the FMV at $532 for both transactions.

 

Both valuation experts used the income and market approach, but differed over the discount to be applied to the value of comparable public companies. Rey applied a 60 percent discount while Anderson applied none. Rey also applied a capital equity discount rate of 26 percent, and Anderson applied a 13.14 percent rate.

 

Carsten Hoffman of Stout Risius Ross LLC said it isn’t unusual that the valuations are far apart, or even that “valuation penalties are coming into play.”

 

Courts tend to lean toward the better appraisal, Hoffman said. “Having said that, there are still instances where the better appraisal does not exist, and the court is stuck coming up with its own opinion. In that case, sometimes a result that splits the values can still occur," he told Tax Notes.

 

The IRS noted in its memorandum that the Sorensens sold Firehouse to Restaurant Brands International Inc. on December 15, 2021, for $1 billion. It said Chris’s Form 709 included the Dixon Hughes Goodman valuation and the trust agreement, but that Robin’s Form 709 did not.

 

The IRS argues that the FMV of the gifted shares was $5,000,234 rather than the $5 million reported on the brothers’ Forms 709. It says the Sorensens’ estate planning attorney advised their accountants to use a fractional number of shares — 9,384.56, rather than 9,385.

 

Defined Value

The Sorensens structured the gift of shares to their family trusts to ensure “that they limited the value of the gifts for the benefit of their children and so that they knew exactly how much of their exemptions they were using, without exceeding the amount that would incur gift tax liability,” according to the brothers’ pretrial memorandum.

 

The IRS objected to the defined-value formula used by the Sorensens in determining how many shares they were transferring to the trusts, which was similar to the formula in Wandry v. Commissioner, T.C. Memo 2012-88, appeal dismissed (10th Cir. 2012).

 

The Sorensens argue that Wandry “held that language in taxpayers’ gift transfer documents was effective to limit the taxpayers’ gifts of LLC membership units to dollar amounts equal to their federal gift tax exclusions.”

 

“In Wandry, the gift transfer documents provided (1) the dollar amount of LLC membership units intended to be transferred (equal to the taxpayers’ federal gift tax exclusions); (2) a statement that the taxpayers intended to rely on a third-party appraiser’s valuation to determine the number of membership units equivalent to the dollar amount intended to be transferred; and (3) a statement providing for the correction of the number of membership units equivalent to the chosen dollar amount if the [IRS] challenged “such valuation and a final determination of a different value is made by the IRS or a court of law,” the brothers’ pretrial memorandum states.

 

In response, the IRS notes that it issued an action on decision (AOD 2012-04, 2012-46 IRB 1) disagreeing with Wandry “because the application of the gift tax is based on the objective facts and circumstances of when the donor relinquishes dominion and control over the gifted property.”

 

The IRS deemed the “irrevocable stock power” language an attempt to adjust the number of shares transferred as “a condition subsequent” in violation of public policy.

 

Instead, the IRS points to Nelson v. Commissioner, 17 F. 4th 556 (5th Cir. 2021) , which said a gift is considered complete, and thus subject to the gift tax, when “the donor has so parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or the benefit of another.”

 

Wandry is not the only case to use a formula clause. Many cases have successfully done so. The recent Nelson case only failed because the language of the formula clause was not stated correctly,” Hoffman said.

 

The petitioners in Sorensen v. Commissioner, Dkt. Nos. 24797-18, 24798-18, 20284-19, 20285-19 (T.C. 2022), are represented by Stephanie Loomis-Price, Briana Loughlin, and Abigail Rosen Earthman of Winstead PC.

Company Tax Notes
Category FREE CONTENT;ARTICLE / WHITEPAPER
Intended Audience CPA - small firm
CPA - medium firm
CPA - large firm
Published Date 07/29/2022

User-added image

 


Taxnotes

Tax Notes
(703) 533-4432
www.taxnotes.com

Tax Notes is the first source of essential daily news, analysis, and commentary for tax professionals whose success depends on being trusted for their expertise.

Tax Notes is a portfolio of publications offered by Tax Analysts, a nonprofit tax publisher. It provides comprehensive and impartial coverage of tax news, while its commentary contributes important voices to the discussion and understanding of tax policy.

Founded in 1970, Tax Analysts was created to foster free, open, and informed discussion about taxation. In 1972 Tax Analysts published Tax Notes Federal, its first weekly journal, featuring news, commentary, and analysis on federal taxation. In 1989 Tax Analysts added Tax Notes International, a weekly magazine focused on international taxation. Tax Notes State rounded out the weekly portfolio in 1991. Each magazine offers best-in-class tax commentary and analysis on the latest changes in tax law and policy, as well as on court opinions, legislative action, and revenue rulings.

Tax Notes has continued to innovate through the years, adding the online daily news services Tax Notes Today FederalTax Notes Today International, and Tax Notes Today State between 1987 and 1991. Tax Notes also provides several research and reference tools, as well as specialized services focusing on exempt organizations, state tax audit guidance, and international tax treaties.