February 2002

Alternate Valuation Revisited

By Bernard Gitlitz, CPA, Lewis, Kramer & Weingarten, LLC

The sudden downturn of the stock market may require reassessment of electing the federal estate tax alternative valuation. The fair market values of many estates have declined substantially between the date of death and the filing of the Federal estate tax return.

A permanent, progressive tax on all lifetime gifts and death time transfers was first proposed by President Theodore Roosevelt in 1906 and became law in 1916. When the stock market crashed in 1929, some estates were wiped out by estate taxes that were based on the date of death values, not the much lower sales proceeds. The federal estate tax alternate valuation election in IRC section 2032 was introduced to help mitigate this perceived unfairness. Given the continuous rise in securities and real estate, electing the alternate valuation date would generally result in lower estate taxes.

Executors of estates can elect alternate valuation by checking the box on page two, Part 2, line 1 of the Federal Estate Tax Return, Form 706. Once made, the election is irrevocable. No election can be made if the return is filed more than one year after its due date, including extensions. It is only available if, at the alternate valuation date, the election decreases the gross estate and the estate tax. It therefore cannot be elected, regardless of the size of the gross estate, if all assets pass to the surviving spouse under the marital deduction, or if the tax is zero. Once the election is made, the income tax bases of all the assets in the estate are stepped up or down to the alternate value.

In determining the gross estate, the executor may not use the date of death value for some assets and the alternate date value for others. Internal Revenue Code Section 2032(a) provides that the executor may value all the property in the gross estate as follows:

• Property distributed, sold, or disposed of within six months of death is valued at the date of such disposition.
• Property on hand six months after date of death is valued as of that date.
• Any interest whose value is affected by the mere lapse of time is included at its value on date of death. For example, if the decedent owned Series E bonds or zero coupon bonds that increased in value because of the accrual of interest, the date of death and alternative values would be the same.

If an asset decreased in value between the date of death and the alternate valuation date and was sold at a profit, it would be subject to a higher capital gains tax than if the executor did not make the election. Since the estate tax savings will always be at least 37% of the difference in value between the date of death and the alternate date, the alternate valuation date election will always reduce the overall income and estate tax. It may, however, shift the tax burden from one beneficiary to another.

If taxes are paid out of the residue of the estate, the alternate valuation election will reduce the estate taxes, thereby increasing the amount passing to beneficiaries. It will also increase the potential capital gains tax on the sale of appreciated assets passing to the beneficiaries because the tax bases are stepped down.

Another favorable technique is the protective alternate valuation election, upheld in IRS Letter Ruling 9846002. Events occurring after the date of death may affect whether there will be any federal estate tax liability. For example, the decedent's will may leave everything to the surviving spouse, generating no estate tax because of the marital deduction. If the surviving spouse disclaimed property, in order to make full use of the federal estate tax unified credit or the decedent's lower estate tax bracket, there may be an estate tax upon the death of the first spouse. The executor may reflect the alternate value election at question 1, Part 3 of Form 706 and report both the date of death and alternate values. If there is no estate tax, the date of death values are reflected on page 1 of the return. If the surviving spouse disclaims assets or exercises other rights subsequent to the filing of a Form 706 resulting in a federal estate tax, the return would be amended and the estate taxes redetermined from the alternate values.

If the decedent's state death tax is based on the Form 706 federal state death tax credit, the alternative valuation election will reduce the tax. Some states, however, have a separate inheritance or death tax. And some states do not conform to the federal estate tax valuation election, requiring the use of date of death values.

This may result in different federal and state income tax bases for inherited assets. The estate tax alternate valuation election is one of the most powerful post mortem estate tax tools still available. It should not be overlooked.

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