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HomeMy WebLinkAbout11-19-09IN THE COURT OF COMMON PLEAS OF CUMBERLAND COUNTY, PENNSYLVANIA In re: ) Orphans Court Division Estate of Robert M. Mumma, ) Number 21-86-398 Deceased ) PRAECIPE TO THE ORPHANS' COURT: Please file on the docket and make the attached Curriculum Vitae and Report of Daaiel P. Johnson, Esquire and the attached Curriculum Vitae and Report of Joseph D. C. Wilson III part of the record. Respectfully submitted, ~Q~~ m. rn Dated: November 13, 2009 Barbara M. Mumma 541 Bridgeview Drive Lemoyne, PA 17043 717-730-2188 ~ ~ i •,"-3 ~ r __ ;~ cn ;,,. r--~ C7 ~ ~+ r _ _. j ~ ~ -,-r 7 ~ --r J , ~ ~ , ;, N -1- TN WILLIr~MS ~~CC~LILSON ATTORNEYS AT LAW Daniel P. Johnson is one of the founding partners of Williams Coulson. Mr. Johnson's law practice is concentrated in the areas of estate, tax and business planning, estate and trust administration, and the representation of fiduciaries and beneficiaries of estates and trusts involved in probate litigation. Mr. Johnson has Iectured on estate and gift tax at Duquesne University School of Law and on estate, tax, and charitable planning topics to various professional and civic organizations. He has been recognized by his peers as one of the Best Lawyers in America® in the trusts and estate practice and has been selected for inclusion in Pennsylvania Super Lawyers. Mr. Johnson is a cum Zaude graduate of the University of Pittsburgh School of Law, where he was an editor of the Law Review and awarded membership to the Order of Barristers and the Order of the Coif. He received his undergraduate degree from the Pennsylvania State University. Mr. Johnson is a member of the Estate Planning Council of Pittsburgh, and is an officer in the _ Probate and Trust Law Section of the Allegheny County Bar Association. He is a member of the Real Property, Probate and Trust Law Section of the Pennsylvania Bar Association. Mr. Johnson is admitted to practice law in Pennsylvania. Williams Coulson is a Pittsburgh based firm which concentrates its practice in estate, business, tax, and retirement planning services. WILLIAMS ~ OLILSON ATTORNEYS AT LAW ONE GATEWAY CENTER 420 FORT DUQUESNE BOULEVARD • 16'" FLOOR PITTSBURGH, PA 15222 (412) 454-0200 • FAX: (412) 28I-6622 DANIEL P. JOHNSON {aizl asaozza djohnson®williamscoulsoa.com September 28, 2009 Ms. Bazbaza Mumma 541 Bridgeview Drive Lemoyne, PA 17043 Re: Funding of Mazital Trust Pursuant to Last Will and Testament of Robert M. Mumma Dear Ms. Mumma: I have been asked to express my opinion on the interpretation of the marital trust funding provision found in Article Seventh of the Last Will and Testament of Robert M.1Vlumma. In preparing this letter, I have reviewed the Will as well as the opinions of Jonathan M. Crist, Esquire, Joseph D. C. Wilson, III and David C. Cleaver, Esquire. I have not reviewed the accountings nor verified any of the numbers set forth in those opinion letters. My comments aze limited to the proper procedure to carry out the funding of the marital trust pursuant to the terms of the Will. Article Seventh of the Will sets forth the :funding provision for the marital trust. The relevant portion of Article Seventh provides as follows: "If my wife, BARBARA McK. MUMMA, survives me, I give and bequeath to the trustees hereinafter named, an amount equal to fifty (50%) percent of my total gross estate as finally determined for Federal Estate Tax purposes, taking into account and including therein, for computation purposes, my undivided interest in the value of all my interests in property which pass or have passed to my wife under other provisions of this Will or otherwise than under this Will, but only to the extent that such interests are, for the purpose of the Federal Estate Tax, included in determining my gross estate and allowed as a marital deduction. In funding this Trust, I authorize my Executors to use cash or other property or a combination thereof, and I direct that any such other property so used shall, for the purpose of funding the trust, be valued as of the date of its distribution. In computing the amount of this bequest, I direct that the values and amounts as finally determined for Federal Estate Tax purposes shall control." {WC387685.I F WILLIAMS COULSON JOHNSON LLOYD PARKER 8c TEDESCO, LLC IRS CIRCULAR 230 TAX ADVICE DISCLAIMER: Any federal tax advice contained in this communication (including attachments or enclosures) is not intended or written to be used, and it cannot be used, for the purpose of (1) avoiding any penalty that may be imposed by the Internal Revenue Service or (2) promoting, marketing or recommending any transaction or matter. Page 2 The above is a pecuniary formula provision which the trustees are to follow in determining the amount that should be transferred to the marital trust. The starting point for determining the proper funding of the marital trust is to determine "the amount equal to fifty (50%} percent of my total gross estate as finally determined for Federal Estate Tax purposes." The provision "as finally determined for Federal Estate Tax purposes" is a dvrection to the trustees that the value of the gross estate is to be made after any audit of the Federal Estate Tax return. Mr. Cleaver is correct in his statement that the amount is not determined by the values of the assets as reported on the Federal Estate Tax return filed by the Executors, but rather, the values of the estate assets as finally determined after an audit, if any, by the Internal Revenue Service. In this case the Executors underreported the value of the assets on the Federal Estate Tax return so that the final values were increased after audit. The value of the gross estate after audit is the proper value to be used in determining fifty (50%) percent of the gross estate. It is important to note that the calculation of fifty (50%) percent of the total gross estate is only the beginning point for purposes of determining the amount to be transferred to the marital trust. The Will then directs the trustees to make the determination "taking into account and including therein, for computation purposes, the testator's undivided interest in the value of all other interests in property which pass or have passed to his wife under other provisions of the Will or otherwise then under his Will ...". (emphasis added) This means that in computing the amount to set aside in the marital trust the trustees must take into account any other assets that pass to testator's wife either asnon-probate assets (joint property interests and beneficiary designation property) or pursuant to other provisions of the Will (automobiles and other articles of personal use per Article Sixth of the Will). Mr. Cleaver improperly applies the word "including" in his interpretation of the Will. Applying Mr. Cleaver's interpretation of Article Seventh would result in the marital trust being funded with an amount exactly equal to fifty (Sd%) percent of the testator's gross estate. Nowhere in his opinion does Mr. Cleaver explain why the testator would have included all of the words after fifty (50%) percent if the funding of the marital trust was not to be reduced by the value of the other assets the testator's wife received. In other words, there is no reason that the testator would not have simply put a period after the words "an amount equal to fifty {50%) percent of my total gross estate as finally determined for Federal Estate Tax purposes" if the funding was not somehow be affected by the balance of the paragraph. Mr. Cleaver is essentially stating that the following words set forth in Article Seventh have no purpose: "...taking into account and including therein, for computation purposes, my undivided interest in the value of alI my interests in property which pass or have passed to my wife under other provisions of this Will or otherwise than under this Will, but only to the extent that such interests are, for the purpose of the Federal Estate Tax, included in determining my gross estate and allowed as a marital deduction." Mr. Cleaver is wrong. The above provision does have a purpose, and that purpose is to provide that the marital trust is to be funded with sufficient assets so that the amount transferred to the marital trust after taking into account all other assets that the testator's widow received will equal fifty (50%) percent of the gross estate. In other words, the amount in the marital trust plus the JOSEPH D.C. WILSON III, CPA Joseph D.C. Wilson III established his independent professional practice in 1988. From 1996 through 2001, Mr. Wilson was also the founding and senior partner of Wilson Chemel & Company, LLC, a boutique tax firm. Mr. Wilson structures transactions and coordinates tax and financial strategy for families and for foreign investors. He also acts as a personal representative in the United States for foreign investors or as a member of a board of directors or an executive committee of a venture. Mr. Wilson has qualified and has testified in federal and state courts as an expert witness. He has particulaz expertise in dealing with flow-through entities, with investEnents and investment advisors, and with real estate matters. From 1991 until 1997, Mr. Wilson was a member of and then chairman of the executive committee of a 1400-acre residential golf course development. From 1991 through 1996, he was president of a 330-acre multi-use golf course development. PROFESSIONAL AND BUSINESS BACKGROUND: Mr. Wilson, a Certified Public Accountant since 1973, was a partner in Arthur Young from October I, 1982 until September 30, 1988, serving as the Pittsburgh Office Director of Tax from 1985 - 1988 and as the Atlanta Office Director of Services to Foreign Investors from 1981 - 1985. He served temporary assignments in Brussels, Belgium in 1979 and 1981. He was an Arthur Young national expert in the areas of Mergers and Acquisitions and of Foreign Investors, an instructor at more than 30 advanced Arthur Young national seminars, and co-author of the materials for and repeat instructor at the Arthur Young National Tax Instructor Seminar and the Arthur Young National Seminaz for New Tax Managers. Mr. Wilson has advised on the liquidation and restructuring of family business entities, passive activity and rental real estate issues, alternative minimum tax matters, the exercise of stock options, and compliance with the PA Uniform Principal and Income Act. He has acted as primary advisor on the establishment of and sale of family businesses and the creation of joint ventures. He has created fmancial and tax structures (using partnerships, LLCs, and corporations) for new ventures requiring different economic returns to different parties, such as founders, developers, contributors of property, outside investors, managers, new employees, and local partners, where, for example, amulti-state enterprise may have local partners participating in the economic results only from individual locations. He has been intimately involved in the research, creation, implementation, and funding of family trusts, private foundations, private annuities, charitable gifts, family partnerships, family loans, infra-family installment sales, like- kind exchanges, testamentary trusts, and GRATs, CRUTs, CLATs and sales of beneficial interests in such entities. Li addition to structuring individual transactions or interpreting allocation or distribution provisions of particular agreements, Mr. Wilson has envisioned, researched, and implemented tax-savings transactions which are replicable in similaz situations. Virtually all of Mr. Wilson's structures have been audited by the IItS ai one time or another. In no instance has the structure, itself, or any portion of the structure, been disallowed or re-characterized by the Service. As early as the late 1970's, for gift tax, estate tax, and restructurings, Mr. Wilson was reporting, and successfully supporting under examination, discounts. on minority interests in family-owned business and investment entities. JOSEPH D. C. WILSON III Ceartrtao Yuattc Accouxrwxr September 28, 2009 PRIVATE AND CONFIDENTIAL Ms. Barbara Mumma 541 Bridgeview Drive Lemoyne, PA 17043 RE: Estate of Robert M. Mumma Dear Ms. Mumma: 618 HBNRY W. OIdVHR BU1LDIIdG 535 SbII1'fiPlELD STRB81' Pft158URGF1, PSNDYSYLVAIVIA 15222 (412) 594-2701 phone (412) 471-2117 fax jwilsonlOJdcwilaon.com You asked me to review various records from the Estate of Robert M. Mumma, who died on April 12, 1986, and from the Marital Trust and Residuary Trust created by Mr. Mumma's will to determine if the Marital Trust had been overfunded and if the discretionary withdrawals of principal from that trust (so- called "5 and 5 distributions" or "5% withdrawals") had been excessive. In doing that review, I was also to note any other issues of concern. I have reached the conclusions contained in this report to a reasonable degree of professional certainty, based on my review of the information available to me. Because of extreme time pressures, inconsistencies in the material reviewed, and the unavailability of some materials, I was not able always to tie transfers out to the dollar, precisely to determine allocations, or fully to investigate inconsistencies. Accordingly, my calculations may contain minor inaccuracies; I may have used figures that are slightly incorrect; and I certainly did not investigate all inconsistencies nor follow up on all issues that caught my attention. Those factors in no way, however, affect my overall conclusions. CONCLUSION: My review of various documents relating to the Estate of Robert M. Mumma and the trusts formed under his will led me to conclude that the Marital Trust was grossly overfunded. Further, the 5% withdrawals were far in excess of the amounts provided for in the will, and the payments to the Marital Trust as statutory interest were excessive. The Marital Trust was overfunded for two reasons: first, the amount to be funded was overstated; and second, the assets transferred to fund the trust were significantly undervalued. The withdrawals were excessive because the Marital Trust had been overfunded and (thus the 5% amount was overstated) and because the assets withdrawn were significantly undervalued. The payment of statutory interest was excessive because the Marital Trust had been overfunded (thus the 5% per annum calculated interest was overstated) and because the assets used to make the payment were significantly undervalued. JOSEPH D. C. WILSON III CLtTIDIlD PUtLIC ACCOIINTANT Barbara Mumma September 28, 2009 Page 2 DOCUMENTS REVIEWED: In performing my work, I reviewed portions of the accountings for the Estate of Robert M. Mumma, the Marital Trust under his will, and the Residuary Trust under his will; the Estate Tax return (Form 706} and related filings; portions of the income tax returns (Forms 1041) for those entitids; the transcript of Mr. Hadley's testimony in this matter on August 8, 2009; various valuation reports, and various memoranda, letters, valuations and worksheets, particularly relating to the 5% withdrawals for the Marital Trust and the payment of statutory interest to the Marital Trust by the Estate. I also reviewed the reports of Jonathan M. Crist, David C. Cleaver, and Robert C. May. ISSUES RAISED: Two determinations must be made in order to evaluate the reasonableness of the transfers. First, the amount of each transfer, withdrawal, or payment must be determined. Secondly, if the transfer, withdrawal, or payment is not made in cash, then the assets used to satisfy the obligations must be valued. AMOUNTS: In each case, the amount of the transfer, withdrawal, or payment is determined by formula. The formulae for the valuation of the 5% withdrawal and the payment of statutory interest are relatively straightforward, the first being an annual right to request 5% of "the principal" in the Marital Trust; and the second being 5% of the unfunded amount of the Marital Trust from date of death to date of funding. The calculation of the funding of the Marital Trust is a little more complicated. Amount of the Marital Trust: The establishment of the Marital Trust is contained in Article Seventh of Mr. Mumma's will, which provides, in part: SEVENTH: If my wife, BARBARA McK. MOMMA, survives, me, I give and bequeath to the trustees hereinafter named, an amount squat to fifty (5096) peroent of my total gross estate as finally determined for Federal Estate Tax purposes, taking into account and including therein, for computation purposes, my undivided interest in the value of ail my interes#s in property which pass or have passed to my wife under other provisions of this Will or otherwise than under this Will... in computing the amount of this bequest, I direct that the values and amounts as finally determined for Federal Estate Tax purposes shall control. The application of this article results in the Marital Trust to be funded with $7,787,150, computed as follows: jOSSPH D. C. WILSON III CEETIIIED PUELIC ACCOUNTANT Barbara Mumma September 28, 2009 Page 3 Total Gross Estate as reported on the Federal Estate Tax Return, Form 706 16,645,786 Increase reflected on Estate Tax Closing Letter of 06/11/90 from the I.R.S. 650,551 Total gross estate as finally determined for Federal Estate Tax purposes 17,296,337 Fifty percent of the above to the wife 8,648,169 Including therein, for computational purposes: Schedule D, life insurance 516,765 Schedule E, joint property 596,907 But onty to the extent included in the gross estate 29( 8,453) 298,453 Schedule F, personal use property Mercedes Coupe 36,000 Personal properly, less clock and jewelry 8,800 1975 Formula Motorboat _ .1,000 45,800 (861,018) Amount to fund the Marital Trust 7,787,150 The Marital Trust was actually funded as follows: Cash -11/19/86 2,500 Stock and real estate - 12115 ~ 12/28/87 6,837,401 Liabilities assumed - 12/31!87 (550,092) 6,289,809 Cash • 11/16/01 1,358,360 - 12/06/01 800,000 Note 03/31/03 200,000 2,358,360 8,648,169 Amount by which the Marital Trust was over-funded 861,018 Mr. Crist and Mr. Cleaver disagreed on the interpretation of this provision. Mr. Crist's reading was correct, although his calculation was incorrect because he did not take into account the adjustment made to the gross estate resulting from the I.R.S. examination. VALUATIONS: jOSBPH D. C. WILSON III CEtiIlltD PUILIC ACCOUN7AN7 Barbara Mumma September 28, 2009 Page 4 Even greater errors were made in the valuation of the assets transferred, and therefore in the base on which the 5% withdrawals were made and on which the statutory interest was paid, and in the valuation of the assets transferred to make such withdrawals and payment. That is, because the Marital Trust was overfunded, the statutory interest paid was excessive and the 5% withdrawals were overstated. The overpayments were further increased because the assets used to fund the statutory interest and the 5% withdrawals were similarly undervalued, and thus too much property was distributed. Although the amount required to fund the Marital Trust under Article Seventh of Mr. Mumma's will was to be determined using estate tax values, the value of any property transferred to fund the trust was to be determined at date of distribution from the Estate to the Marital Trust. The non-cash assets used to fund the Marital Trust were transferred from the Estate in late December, 1987. Article Seventh states: In funding this Trust, I authorize my Executors to use cash or other property or a combination thereof, and I direct that any such other property so used shall, for the purpose of funding the trust, be valued as of the date of its distribution. Similarly, property used to make the 5% withdrawals and to pay the statutory interest should have been valued at the dates of those transfers. Rather than having the properties appraised for this purpose, the executrices used valuations from the estate tax return with slight adjustments. For the following several reasons, however, those valuations provide little or no basis for determining values to be used in funding the Marital Trust: The valuations on the estate tax return were specifically calculated for use on that return; the operating businesses were being actively marketed before the Marital Trust was funded; there is clear evidence that the fair market values of the assets transferred were significantly higher than the estate tax valuations; and there is clear evidence that the Executrices and their advisors knew or should have known that the estate tax valuations were irrelevant when the Marital Trust was initially funded. Please note that the entities transferred to the Marital Trust were not the entities owned directly by Mr. Mumma at his date of death because of the liquidations of Pennsylvania Supply Company and Kim Company on December 19, 1986, and the incorporation of Hummelstown Quarries as a separate entity prior to that liquidation. The values assigned to the stock in Hummelstown, Nine Ninety Nine, and Union Quarries, (a former subsidiary of Kim Company) were established from the estate tax value of Pennsylvania Supply Company. The following discussion will therefore treat Union Quarries, Hummelstown Quarries, and Nine Ninety Nine, as though they had been in the estate, and when reference is made to "estate tax value," the point of reference is really the values assigned to those entities when distributed from Kim Company or Pennsylvania Supply Company in the 1986 liquidations. jOSBPH D. C. WILSON III CBRTIlISD TURLIC ACCOUNTANT Barbara Mumma September 28, 2009 Page 5 Purpose of the valuations: A sepazate appraisal is strongly encouraged when a Marital Trust is funded with property, with updates made for subsequent withdrawals. A basic rule of valuation is that an appraiser is to consider the use of the valuation in doing the work and that an appraisal should not be used for any other purpose other than its original and stated purpose. The (current: 2008-2009 edition) Uniform Standards of Professional Appraisal Practice states: Standards Rule 9-2 In developing an appraisal of an interest in a business enterprise or intangible asset, an appraiser must: (b) identify the intended use of the appraiser's opinions and conclusions; THE ISSUE: An appraiser must identify and consider the intended users of the appraiser's reported opinions and conclusions in order to identify the problem to be solved and to understand his or her development and reporting responsibilities in an appraisal, appraisal review, or appraisal consulting assignment. An appraiser must state the intended use and intended users of the opinions and conclusions in a report. Shannon P. Pratt, the oft-cited and oft-published authority on valuation of closely held businesses, states in his book, Valuing a Business: The Analysis and Appraisal of Closely Held Companies (Fifth Edition) No single valuation method is universally applicable to aN appraisal purposes. The context in which the appraisal is to be used is a critical factor... Many business appraisals fail to reach a numberrepresenting the appropriate definition of value because the appraiser failed to match the valuatfon methods to the purpose for which it was being performed. The result of a particular appraisal can also be inappropriate if the client attempts fo use the valuation conclusion for some purpose other than the intended one. The valuations compiled by Lucker, Kennedy & Felmeden of the Estate of Robert M. Mumma for use in preparing the federal estate tax return and the underlying valuations of Pennsylvania Supply Company, Kim Company, Union Quarries, Inc., Nine Ninety Nine, Inc., and Pennsy Supply, Inc. all bear such a limiting legend. The following language is from that of Pennsylvania Supply Company: The common stock valuation determined is to be used in the valuation of the Estate of Robert M. Mumma and is not to be used for any other purpose. This rule is particulazly important here. Estate valuations and the preparation of an estate tax return are actions of advocacy. The taxpayer generally wants the lowest supportable valuation, and the I.R.S. generally wants the highest supportable valuation. Whether an appraisal is obtained for an estate tax return depends on what support an executrix wants and whether a qualified appraisal would, in fact, support the estate's position. In funding a marital trust, however, the fiduciaries are required to weigh the rights of different beneficiazies and not to favor one class over another. Using an estate tax valuation, which presented the lowest supportable valuation, will generally not result in equity to both JOSEPH D. C. WILSON III C EISIlIED PUDLiC ACCOUNTANT Barbara Mumma September 28, 2009 Page 6 groups, particularly where the same fiduciaries are on both sides of the transaction, and there are no independent fiduciaries. Absence of qualified appraisals: The valuations on which the estate tax return was based were not appraisals, but were compiled by Lucker, Kennedy &Felmeden, CPA's. These were compilations, and a compilation indicates that the CPA firm did little other than to take the client figures and put them in a readable format. It says nothing about the quality of those figures. As the accountants' certificate on the valuation of the Pennsylvania Supply Company (and those for the Estate, Kim Company, Nine Ninety Nine, Inc., Union Quarries, Inc., and Pennsy Supply are similar or identical) states: We have compiled the valuation of common stock per share of Pennsylvania Supply Company as at April 12, 1986 on the basis as presented in Exhibit A... Because of the nature of the assignment, we do not express an opinion or any other form of assurance on the valuation amount. And, as Mr. Hadley testified on August 8, 2009 (Vol. X, p. 2228): Basically, a compilation is the lowest level of service we provide. We take a client's information, look at it. We don't do many tests or procedures. We type it up on our letterhead and put a compilation in and we scan to see if it looks reasonable, make sure it is mathematically accurate. It was a low level of service and a low level of assurance. As far as I could determine, with one exception, no separate, independent appraisal of the assets distributed to fund the Marital Trust was obtained at the time of funding, nor, for that matter, at any other time. There is a complete absence of any qualified appraisal in connection with the transfer of any non-cash assets to or from the marital trust. The one exception, an appraisal by Touche Ross & Co. of one operating company, prepared 10 months after Mr. Mumma's death and 10 months before the initial funding of the Marital Trust, demonstrates how improper the Lucker, Kennedy 8z Felmeden valuations were for determining. Marital Trust funding values. Timing of an appraisal: In the instant case, relying on valuations used to prepare the estate tax return to determine the funding of the Marital Trust is particularly egregious because so much had changed in that period. CRH, and other potential purchasers, had expressed interest in acquiring the Pennsylvania Supply companies. The executrices had interviewed and then hired someone to negotiate a sale. The properties were actively being marketed. I do not know when the family had begun marketing the properties, but they and Arthur Klein had met on August 12, 1987 (four months before funding the Marital Trust with non-cash assets) with W. Lloyd JOSBPH D. C. WILSON III CtITIlISD PUlLIC ACCOUN?ANT Barbara Mumma September 28, 2009 Page 7 Snyder III to discuss "using WLSIII as `investment banker' in offering and negotiating [the) sale of PSI and related quarries." The methodotoav used in deriving,the valuations used on the estate tax return: Mr. Hadley testified that the appraisals made by Helsel for the real estate assets in the estate did not include an amount for the mineral reserves because that value was only realizable after quarry operations were established. (pp. 2311- 2312, Auditor's Hearing Transcript, August 8, 2009; and p. 2318, Auditor's Hearing Transcript, August 8, 2009): Q. Who evaluated the mineral reserves on this properly? A. Basically, they were considered to be part of the operating companies. THE AUDITOR: Mr. Hadley, did you testify that the mineral reserves were assigned to operating company values? Is that your testimony? THE WITNESS: Essentially, yes. What t said was that the Hummelstown - what I think I said was that the Hummelstown properties were essentially valued as real estate; that the minerals are included as part of the operating -they are part of the consideration of value in the operating assets. According to this testimony, the quarry properties, themselves, were valued as farmland and the value of the quarry operations and the reserves were considered to belong to the operating companies. Yet, the valuations of the operating companies prepared by Lucker, Kennedy & Felmeden put equal weight (or 50% of equal weight) on book value (which included -0- for the reserves) as on operating income. Similarly, the valuations of the operating companies prepared by Lucker, Kennedy & Felmeden put equal weight on the dividend paying history of the entities as on operating income, even though dividends from closely held companies were generally minimized at that time due to the high individual tax rate on dividends. Valuations were prepared by Lucker, Kennedy & Felmeden for Pennsylvania Supply Company, Kim Company, Union Quarries, Inc., Nine Ninety Nine, Inc., and Pennsy Supply, Inc. for use on the estate tax return. Those valuations were prepared on the following bases: Pennsylvania Sup~l~om~any: Asset basis, solely. No consideration was given to income, even though PSC owned and received royalties from the Hummelstown quarry. Kim Com~X: Asset basis, solely. No consideration was given to income. The value given to its ownership of Union Quames was determined as set forth here following. Union Quarries, Inc.: The average of the prior five years {ending June 30, 1986) income was capitalized by a factor of eight and then given a weight of two. The average of the prior five years' dividends were capitalized at 6% and then given a weight of one. The June 30, 1986, JOSEPH D. C. WILSON III CHfTIHIHD PVHLIC ACCOUNTANT Bazbaza Mumma September 28, 2009 Page 8 book value (with a zero value for land or reserves) was given a weight of one. The four factors were then arithmetically averaged to come up with a valuation for the entity. Nine Ninety Nine. Inc.: Asset basis, solely. No consideration was given to income. The value given to its ownership of Pennsy Supply, Inc. was determined as set forth here following. Pennsy Supply and subsidiaries): The average of the prior five years (ending June 30, 1986) income was capitalized by a factor of eight and then given a weight of one. The average of the prior five years dividends were capitalized at 6% and then given a weight of one. The June 30, 1986 book value, with no write up to FMV for any asset, was given a weight of one. The three factors were then arithmetically averaged to come up with a valuation for the entity. Thus, the Luckey, Kennedy & Felmeden valuations were strongly influenced by dividend-paying history and were influenced not at all by the value of any mineral reserves. Evidence of significantly higher fair market values: If the estate tax valuations have no probative value, is there any other contemporary evidence that the values were understated, and is there any contemporary evidence of the actual fair mazket values of the properties transfezred to the Mazital Trust? In fact, there was an appraisal of part of the business, there were earnings flowing from the entities, there were spread sheets allocating the expected sales price in connection with the proposed sale in 1988/1989 and the actual sale in 1993 of the operating and quarry assets, and there aze memoranda indicating that the advisors to the executrices knew that significantly higher values were called for. Evidence to the contrary: The inadequacy of the Luckey, Kennedy & Felmeden's methodology can be seen from the one company for which there was prepazed an independent, qualified appraisal. On May 20, 1987, Touche Ross & Co. issued a valuation report on its analysis of Pennsy Supply, Inc. and its subsidiaries as of February 28, 1987. That valuation was $10,200,000, which includes a discount of 20% for lack of marketability, not a relevant discount for a company being marketed, and a thin management discount of 10%, perhaps also not an appropriate discount for a company being mazketed. Even so, the Touche Ross value is dramatically higher than the valuation of $5,000,000 used by Luckey, Kennedy & Felxneden in its valuation of Pennsy Supply's 100% parent, Nine Ninety Nine, Inc. Further, Luckey, Kennedy & Felmeden's valuation of Nine Ninety Nine, Inc. then included a 30% "Lack of Marketability Discount." Even if such a discount was appropriate for use on the estate tax return, which was a return prepazed for an advocacy setting and prepazed for a date when the properties were not being actively mazketed, it was certainly not appropriate in computing fair mazket value when the entity was being actively mazketed nor in computing fair mazket value for a transfer to a trust where the rights of parties on both sides of the transaction were to be considered. Indeed, because having control of the various entities in order to JOSEPH D. C. WILSON III C E1T[!]ED PUELIC ACCOUNTANT Barbara Mumma September 28, 2009 Page 9 actively market them was important to the executrices/trustees, aswill be shown later, a control premium was more appropriate than a lack of marketability discount. In any case, the stock of Pennsy Supply, Inc. was valued at $3,500,000 ($5,000,000 less 30%) in computing the value of Nine Ninety Nine, Inc. when funding the Marital Trust, rather than at something approaching the $10,200,000, or $12,000,000, if the discounts are ignored, determined by Touche Ross in its independent, qualified appraisal, prepared as of 10 months before, issued 7 months before, and forwarded by Mr. Hadley to Barbara McK. Mumma and Lisa Mumma Morgan one month before the transfers to fund the Marital Trust. A $7,000,000 - $9,000,000 difference is substantial, even when reduced to reflect the estate's mere 43 %i% allocable interest in Nine Ninety Nine, Inc. It is clear that Mr. Hadley, the Morgan, Lewis &Bockius lawyers, and the executrices all knew that values at a multiple of the values used on the Form 706 were required. Because Pennsy Supply, Inc. is apparently the only entity for which an independent, qualified appraisal was obtained, we could simply assume that all the entities were undervalued by the same 65 - 75%, but there is significant other evidence that all the other properties transferred to the Marital Trust were similarly substantially undervalued. Morgan, Lewis &Bockius Memoranda: As many professionals are aware, an estate receives astepped-up basis to date of death value for property included in a decedent's taxable estate. On December 15, 1988, Robert E. Slots of Morgan, Lewis & Bockus (1VII.&B) wrote an internal memorandum at the request of Arthur L. Klein an the issue of whether an estate is bound by the value reported on the estate tax return in determining its subsequent basis, or whether it can use a higher basis than the value reported on the estate tax return. Apparently, the estate was considering using a different, higher basis for the assets in a sale to CRH and believed there was sufficient evidence to overcome the substantially lower values shown on the estate tax return. Before going on to discuss the doctrine of collateral estoppel, Mr. Slots wrote: First, it is dear that the Mumma Estate is not absolutely bound by the value reported for estate tax purposes in determining its basis in the property upon a later sale... The value of an asset for estate tax purposes is not absolutely determinative of the asset's basis in the hands of one who takes the property from a decedent, but it is prima fade evidence of such basis. This presumption can be overcome by convincing evidence that the actual value at the date of death was different than that reported or agreed upon for estate tax purposes. Further, on November 4, 1986, the executrices met with George Hadley and lawyers from ML&B to discuss whether to liquidate Kim Company and Pennsylvania Supply Company ("PSC" in Mr. Klein's summary memorandum of the meeting) before the December 31, 1986, effective date of the 1986 Tax Reform Act. Mr. Klein noted, "we reviewed every asset in both corporations..." With respect to the JOSBPH D. C. WILSON III C {2TIlIHD PULL/C ACCOUNTANT Barbara Mumma September 28, 2009 Page 10 Hummelstown quarry, which the attendees planned to incorporate as a separate entity in order to limit potential operating risks, Mr. Klein noted: We discussed whether the incorporation of Hummelstown, which represents a substantial portion of PSC's value (perhaps a third), might cause the application of the liquidation reincorporation doctrine... If Hummelstown were worth "perhaps a third" of PSC's value, then using even the Estate's low valuation for PSC ($9,144,473, or $9,795,024, as adjusted by the I.R.S.), would put the value of the estate's 98+% interest in Hummelstown in the range of $3,000,000 to $4,000,400 (vu~ith the gross-up) rather than the $799,082 used as the value in funding the Marital Trust. In this case, the undervaluation was in the range of 75-80%. Later, Mr. Klein noted, with respect to Union Quarries, Inc., which was then held in "C Corp" form, The quarry operation is quite profitable and excess cash is building up, presenting an accumulated earnings tax problem. This again demonstrates the irrelevancy of using dividends paid by a closely held corporation as evidence of value. Earnings in a closely held corporation were seldom paid out until they had accumulated to a point that the I.RS. would force tipsy-out or impose a confiscatory tax. Lucker, Kennedy & Felmeden's equal weighting of dividends with income in valuing Union Quarries makes no sense. Of course, the equal weighting of book value, which included nothing for the mineral reserves, also makes no sense. In its valuation of Union Quarries, Inc., Lucker, Kennedy & Felmeden also assessed a 30% "Discount for Minority Interest." Such a discount also makes no sense. Apart from the fact that Kim Company owned exactly 50%, not a minority interest, in the entity, Union Quarries, Inc. is run by a trustee for the benefit of its co-owners. As such, the trustee has a fiduciary obligation not to favor one owner over the other, and the trustee has a fiduciary obligation to maximize the income and the value for the owners. How can there then be a minority discount? That discount was an additional $460,000 reduction in the value used in transferring Union Quarries, Inc. from the Estate to the Marital Trust. The same Arthur L. Klein memorandum emphasizes the executrices' interest in maintaining control of the operating assets and the possibility of disproportionate distributions in the upcoming liquidation. Obviously, if some (or all) of the non-cash assets were misvalued, then any disproportionate distributions would have been financially unequal. Indication of value from income received: Although we have only one appraisal, Fair Market Value is generally considered to be the current value of the future income stream from an asset. Because of their combination with other assets in the pre- death and pre-liquidation ownership structure, and because of the limited information available to me, I ~OSBPH D. C. WILSON III CHItTIlIHD PUHLIC ACCOUNTANT Barbara Mumma September 28, 2009 Page 11 was unable to review the income of these assets for the period prior to funding the Marital Trust. I was, however, able to review the income earned by the Marital Trust from most of these assets for the 66 months of Marital Trust ownership before the sale to CRH. A comparison of income earned by each asset to the value assigned upon distribution by the Estate to fund the Marital Trust is as follows: Value Assigned Upon Transfer to Marital Trust December, 1987 Bender & Grove (Mt. Holly) Hummelstown Quarries Union Quarries Income Earned During the Following 6!6 Months (until sale to CRH) Notes: The income for Union Quarries is for the following 6 years (72 months) because that entity was not included in the sale to CRH. The similar figures for Nine Ninety Nine are not included because that entity was a C Corp and so its income was not derivable from the federal income tax returns of the Marital Trust. As can be seen from this schedule, the cumulative accumulated income for each of the entities for the following 66 months is substantially in excess of (indeed, a multiple of) the values assigned to them by the executrices. This again shows the Boss undervaluation of the assets upon their transfer to the Marital Trust. Comparisons: Finally, the values used for the transfers to the Marital Trust (first column, below) can be compared to the allocated values with regard to the offer made by CRH in 1988 - 1989 and the sale in 1993 to CRH. The allocations from the earlier offer are based on a spreadsheet prepared in late December 1988 by Mr. William S. Pilling III of the Stradley Ronon firm, which was negotiating the transaction. Those figures come from a letter of intent dated December 19, 1988. The third column of figures are from a similar sheet prepared by Mr. Pilling in early March 1993, and the fourth column of figures came from the proceeds actually received, as reflected in the Marital Trust accountings. From the information available to me, I cannot explain the differences between the third and fourth columns (especially with regard to Bender & Grove), whether it represents a change in the purchase price, a reallocation of the purchase price, the unwanted assets that were distributed, or simply a too rapid reading of the accountings on my part. The total consideration is not readily apparent because of a net worth adjustment and the existence of and the deferred receipt of notes receivable, liquidation corporations, and escrow accounts. Further, because I do not know the source of the $5,000,000 in unwanted assets, nor how they were distributed, I ]OSBPH D. C. WILSON III C {1TIiIED PUlLIC ACCOUNTANT Barbara Mumma September 28, 2009 Page 12 cannot allocate that to the various entities' bases. The comparison is not perfect, but the scope of the undervaluation is clear. Value Used Allocated Value Allocated Value Allocated Sales in Funding from from Proceeds Marital Trust 12/19/88 Letter March 1993 Offer July, 1993 Nine Ninety Nine 2,921,165 14,897,581 12,029,811 10,496,922 Hummelstown Quarries 799,052 3,433,014 3,196,628 2,796,211 Bender 8< Grove (Mt. Holly 277,185 5,500,000 4,475,000 1,373,180 Union Quarries, Inc. is not included in this chart because Union Quarries, Inc. was not included in the sale to CRH. However, in computing the principal value of the Marital Trust in order to determine the 5% withdrawal in 1994 -which was the first year after the sale of the other operating assets to CRH, the value of Union Quarries was increased from $1,300,000 to $3,000,000. In light of the other valuations, the issues previously discussed, and given that b'/z years of reserves had been excavated, that suggests the value of Union Quarries at December 1987 was at least $3,000,000. With respect to the December 1988 offer and letter of intent, the allocaxion is, of course, hypothetical, but so is any appraisal, even an independent, qualified appraisal. A transaction is the best evidence of value; that is why appraisals (e.g., Touche Ross & Company's appraisal cited above) often use comparables to public companies. Even though public companies are inherently dif~'erent from private companies, the values of their shares reflect actual transactions. The December 1988 offer was more than just an offer, due diligence had been performed, and the offer was lost not because of an absence of value, but, because of litigation risk or because of market conditions. Even if the December 1988 offer did not close, it represents a range of values and provides clear evidence of substantial undervaluation and substantial evidence of how much the values should be increased. CONCLUSIONS: Because the fair market values of the distributions to the Marital Trust were substantially undervalued, then the Marital Trust was significantly overvalued, in my opinion, by an amount in the range of at least $12,500,000 and perhaps as much as $25,000,000. Consequentially, the 5% withdrawals were substantially overpaid. Based on an overfunding of the Marital Trust of $15,000,000, those overpayments were cumulatively in the range of $10,000,000 - $10,500,000, to which interest at the statutory rate of 5% should be added, totaling an additional $b.5 - $7.0 MM. JOSBPH I~. C. WILSON III C RliIRI[D PQILIC ACCODNiANi Barbara Mumma September 28, 2009 Page 13 Further, the 5% withdrawals were paid in stock of Nine Ninety Nine, Inc. and Hummelstown until the sale to CRH. Because the value of the stock in those entities was so significantly undervalued, the 5% withdrawals were substantially overpaid. Those overpayments are cumulatively in the range of $1,500,000 - $2,000,000, to which interest at the statutory rate of 5% should be addled, totaling an additional $650,000 - $750,000. Statutory interest was paid in-kind on the delayed funding of the Marital Trust. That interest was paid in significantly undervalued stock of Nine Ninety Nine, Inc. That overpayment amounts to approximately $500,000, to which interest at the statutory rate of 5% should be added, totaling an additional approximately $500,000. Finally, there remains the miscalculation of the amount of the marital trust by $861,018, to which statutory interest of 5% should be added. Not only should an appraisal have been made of the assets funding the Marital Trust, particularly with the same fiduciaries on both sides of the transaction and with the same advisors on both sides of the transaction, and not only should the executrices and their advisors have known that the assets were substantially underfunded, they did know. The Marital Trust was exorbitantly overfunded to the detriment of the residual beneficiaries. OTHER ISSUES: Sailfish Point condo: A condominium at Sailfish Point in Stuart, Florida appears on the Form 706, but does not appear on the accountings for the Estate until its sale is reported in September 1998. Interestingly, it was sold for approximately its value as reported on the Form 706, 12'/z years earlier. Although the asset does not appear on the accountings, the expenses related to the condo do appear. Interest was appropriately charged to the account during the 12 '/2 year period, but all other expenses (approximately $292,000) were charged to principal. Although there may have been some portion of this (amounts aggregating less than $50,000) paid to the owners' association as assessments for capital expenditures (the records are not detailed enough to make that determination, most of these expenses are items which should have been properly charged to income such as telephone and utilities, insurance, condo owners' association fees, real estate taxes, recurring repairs and maintenance, and apparent transfers to a local account. Twelve years is simply too long to hold an asset to adnunister an estate. Some portion of these expenses must have been chargeable against income. JOSEPH D. C. WILSON III C ElTI11E0 PIIEI,IC ACCODNTANS Barbara Mumma September 28, 2009 Page 14 I was unable to review expenditures regarding other properties or general expenses or fees to determine the correctness of their allocation between principal and income, but if the allocations were similar to the Sailfish Point expenses, then the allocation of these expenditures would be equally improper. Sincerely yours, ~ .~~~ ~"~ Joseph D.C. Wilson III Certificate of Service I hereby certify that the foregoing Fraecipe was served this date by first-class mail, postage pre- paid, addressed as follows: Joseph D. Buckley, Esquire 1237 Holly Pike Carlisle, PA 17013 (Court Appointed Arbitrator) No V. Otto, II, Esquire George B. Faller, Jr., Esquire Jennifer L. Spears, Esquire Mattson Deardorff Williams Otto Gikoy & Faller Martson Law Offices 10 East High Street Cazlisle, PA 17013 Brady L. Green, Esquire Morgan, Lewis &. Bockius LLP 1701 Mazket Street Philadelphia, PA 19103-2921 Robert M. Mumma, II 840 Mazket Street, Suite 164 Lemoyne, PA 17043 Ms. Linda M. Mumma 512 Creekview Lane Mechanicsburg, PA 17055 Dated: November 13, 2009 ,~ plc.. ~?~I Bazbara M. Mumma 541 Bridgeview Drive Lemoyne, PA 17043 -2-