IRS Proposes New Regulations under

Section 2032 - Alternate Valuation for Estate Tax Purposes

By: Hugh Drake, Chair, RPTE Business Planning Group

Section 2031(a) of the Internal Revenue Code of 1986 requires a decedent’s

property to be valued as of the decedent’s date of death, for purposes of determining

the decedent’s taxable estate. Code § 2032(a) provides that an executor may elect to

value all of the property included in the decedent’s gross estate as late as six months

after the decedent’s death (the “alternate valuation date”). Any property that is sold,

exchanged, or otherwise disposed of during the six-month period after the decedent’s

death must be valued as of the date the property is sold, exchanged or otherwise

disposed. Any interest or estate that is affected by the mere lapse of time is valued at

its date of death value with adjustments for any difference in its value as of the later

date that is not due to the mere lapse of time. No election is allowed unless it will

decrease the value of the decedent’s gross estate and the sum of the decedent’s

federal estate and generation-skipping transfer taxes.

The predecessor to Code § 2032, Code § 302(j), was enacted in 1935 in

response to the Great Depression. Prior to the enactment of Code § 302(j), a

decedent's gross estate was valued in all cases as of the decedent's date of death. With

the dramatic decline of the stock market between 1929 and 1934, property valued as of

the decedent's date of death was, in many cases, worth far less by the time estate taxes

were paid. Many estates were entirely consumed by estate taxes. In response to this

inequity, Congress gave executors the option of electing to value property on the date

one year after the decedent's death. The one year date was subsequently reduced to

six months by an amendment to Code § 2032 in 1970.

While the stock market crash of 1929 was the impetus for the enactment of

optional valuation, the policy reason for the amendment was primarily to ensure

equitable treatment of estates when the value of property in the gross estate drops

dramatically after the decedent's death.

On July 25, 2006, the U.S. Tax Court, in Kohler v. Commissioner, 92 T.C.M. 48

(2006), held that valuation discounts attributable to certain transfer restrictions on newly

issued closely held stock resulting from a tax-free reorganization of the Kohler Company

approximately two months after the decedent’s death can be taken into account in

valuing the Kohler stock on the alternate valuation date. The Kohler decision was

unacceptable to the Internal Revenue Service and on March 3, 2008, the Service

nonacquiesced to the Tax Court opinion in Kohler v. Commissioner, 92 T.C.M. 48 (Mar.

3, 2008).

On April 25, 2008, the Service issued proposed regulations to amend § 20.2032-

1 of the Treasury Regulations to clarify that the alternate valuation election under Code

§ 2032 is available only to estates that experience a post-death reduction in the value of

the gross estate due to “market conditions.” The proposed definition provided for

“market conditions” would have been extremely limiting, particularly when applied to

estates with closely held business interests. The proposed regulations defined “market

conditions” as “events outside the control of the decedent (or the decedent’s executor or

trustee) or other person whose property is being valued that affect the fair market value

of the property being valued.”

The RPTE Business Planning Group submitted its comments to the Service on

July 18, 2008. Nothing else had been heard regarding the proposed regulations until

recently.

On November 17, 2011, the Service revised its approach considerably in the

newly issued Proposed Treasury Regulations §20.2032-1(f)(1). Under the new

approach, post-mortem changes will affect the federal estate tax value of assets only if

they are attributable to 1)”economic or market conditions” or 2) uncompensated theft or

casualty losses that are not deducted under §2054. The proposed regulations go into

detail about events that accelerate the valuation date, which events would trigger

valuation at the moment immediately prior to that event. The acceleration of the

valuation date would avoid valuation reflecting any post-mortem events. The

acceleration events include:

sales; reinvestments; estate distributions; the creation, recapitalization, reorganization or merger of an entity; redemptions or other changes in the ownership structure of an entity that

alter the value of the Decedent’s interest in that entity; and post-mortem distribution of a fractural interest in an asset or in an entity

that would otherwise justify a fractional or minority interest discount. The Kohler-type fact pattern is addressed in Example 1 of the proposed regulations.

Example 1 describes a situation where a decedent’s personal representative and the

decedent’s family form a new business entity and fund it with marketable assets in

return for ownership interests. Example 1 doesn’t address whether the restrictions

associated with the new interests produce a discount for lack of marketability or lack of

control, but determines that the transfer of assets by the estate into the entity

accelerates the valuation date. Under the new proposed regulations, any similar post-

mortem transaction will be considered a disposition and will accelerate the valuation

date.

The proposed regulations also clarify alternate valuation as it pertains to

retirement accounts. It was unclear whether retirement benefits were to be considered

under an alternate valuation election, which, if not available, would put those estates

consisting largely of retirement benefits at a huge disadvantage in the event of a market

downturn in the six months after death. Under the new proposed regulations, property

is not considered to be “distributed” just because it passes directly at death under a

beneficiary designation or by operation of law. Additionally, retitling a retirement

account in setting up an inherited IRA will not be treated as a distribution. However,

alternate valuation will be applied on an asset by asset basis, so if a beneficiary sells an

asset within the retirement account, then the alternate valuation date for that sold asset

would be the date of sale.

The RPTE Business Planning Group has convened a committee to review the

new proposed regulations and expects to provide comment to the Service within the

coming weeks.