Legal Definitions - blockage rule

The blockage rule is a principle used in tax law, particularly for valuing assets like stock shares. It recognizes that a very large block of shares in a company, even if individually traded on a stock exchange, might be worth less per share than the current market price if sold all at once. This is because attempting to sell such a significant quantity of shares simultaneously could flood the market, creating an oversupply that drives down the price.

Essentially, the rule allows for a discount on the valuation of a large block of stock for tax purposes, reflecting the practical difficulty and potential market impact of selling such a substantial holding without depressing the price.

Here are a few examples to illustrate the blockage rule:

• Estate Valuation: Imagine an elderly investor, Mr. Henderson, passes away, and his estate includes 5 million shares of "Tech Innovations Inc.," a publicly traded company. At the time of his death, individual shares of Tech Innovations Inc. are trading at $100 each. However, 5 million shares represent 8% of the company's total outstanding stock. If Mr. Henderson's estate were to try and sell all 5 million shares on the open market at once, it would likely overwhelm buyers and cause the stock price to drop significantly. Due to the blockage rule, the estate's tax valuation for these shares might be set at a discounted price, perhaps $90 per share, rather than the full $100 market price, acknowledging the practical challenge of liquidating such a large block.

• Gift Tax Planning: Ms. Chen, a wealthy philanthropist, decides to donate 2 million shares of "Global Energy Corp." to her family's charitable foundation. These shares constitute 3% of Global Energy Corp.'s total shares. On the day of the gift, Global Energy Corp. stock is trading at $75 per share. For gift tax purposes, the Internal Revenue Service (IRS) needs to determine the fair market value of this donation. Ms. Chen's tax advisor might argue for a valuation discount under the blockage rule, explaining that if the foundation were to sell such a large quantity of shares, it would likely depress the market price for Global Energy Corp. stock, making the true value of the gift for tax purposes less than 2 million multiplied by $75.

• Business Succession: Mr. Davies, a founder of "Retail Solutions Inc.," a publicly traded company, decides to transfer a substantial portion of his ownership—specifically, 10% of the company's outstanding shares—to his children as part of his retirement and estate plan. While individual shares are currently trading at $25, the sheer volume of shares being transferred (10% of the company) means that if the children were to sell them, it would be difficult to do so without negatively impacting the stock's market price. Therefore, for gift tax calculations on this transfer, the blockage rule could be applied, allowing for a lower per-share valuation than the prevailing market price to reflect the practical challenges of selling such a large block.