Estate Tax Alternate Valuation Method

In my article “IRAs and the AVM” (Trusts & Estates, January 2009), I discussed how the estate tax alternate valuation method (AVM) under Internal Revenue Code Section 2032 applies to individual retirement accounts. Now, newly issued proposed regulations under IRC Section 2032 tackle various post-death planning strategies for all types of assets while answering most of the questions I raised in my 2009 article.

Though typically assets are valued for federal estate tax purposes as of the date of death (DOD), Section 2032(a) provides that, generally, if the estate so elects, "In the case of property distributed, sold, exchanged, or otherwise disposed of, within 6 months after the decedent’s death such property shall be valued as of the date of distribution, sale, exchange, or other disposition. In the case of property not distributed, sold, exchanged, or otherwise disposed of, within 6 months after the decedent’s death such property shall be valued as of the date 6 months after the decedent’s death."

2008 Proposed Regulations

In 2008, the Treasury issued proposed regulations attempting to codify the rule that “changes in value due to post-death events other than market conditions” may not be taken into account for alternate valuation method purposes. The Treasury was targeting post-death transactions designed to artificially reduce the value of a decedent’s taxable assets as of the alternate valuation date (AVD), transactions such as subjecting assets to restrictions on transfer and distributing a partial interest in a wholly-owned property, both of which depress the value of the estate’s (remaining) interest without regard to general market conditions.1

New Approach

The Treasury has now withdrawn the 2008 proposed regulations and issued new ones dealing with the AVM.2 The withdrawn 2008 proposed regulations dealt with frowned-upon post-death events by ignoring them for valuation purposes. Commentators criticized this approach, because it required executors to obtain valuations of hypothetical assets. The 2011 proposed regulations take a different approach: A transaction that changes the asset’s value by more than 5 percent closes the AVM period, and the “alternate value” of the affected asset will be its value immediately before the transfer.

Issues Clarified

Here are other issues that the new proposed regulations clarify:

Events that count as a distribution. They provide much greater detail than any previous version regarding what events and transactions fall within the definition of “distributed, sold, exchanged or otherwise disposed of,” that is, what transactions trigger closing of the AVM period. The list now explicitly includes some corporate transactions (such as contributing assets to a newly incorporated entity or a merger) whenever the transaction to reduces the value of the estate’s holdings by more than five percent—regardless of whether the transaction is income-taxable.3 Prior versions seemed to treat an entity reorganization as closing the AVM period only if it was income-taxable.

When assets are distributed. Under the IRC and prior versions of the regulations, it wasn’t always clear to practitioners what it meant for an asset to be “distributed.” An executor could “distribute” an estate-owned asset out of the estate, but what did the term mean as applied to joint property passing by right of survivorship or retirement benefits?

The proposed regulations clarify that the transfer of ownership of an asset that occurs upon the death of a decedent, from a decedent to a beneficiary, isn't a “distribution” for purposes of the AVM—regardless of whether the property passes by operation of law (for example, through joint ownership) or under a contract (for example, a beneficiary designation under a retirement plan).4 Accordingly, registering the formerly joint account as a sole account in the name of a surviving joint owner or registering a decedent’s IRA as an “inherited IRA” in the name of a beneficiary, wouldn’t be a “distribution” that would fix the AVD.5

Questions regarding inherited IRAs. The regulations also answer other questions regarding inherited IRAs. For example, the division of an inherited IRA left to multiple beneficiaries into separate inherited IRAs for each beneficiary isn’t a “distribution” that triggers closing of the AVM period.6 A distribution from the inherited retirement plan closes the AVM period with respect to that distribution, but not as to the rest of the account—unless the distribution alters the fair market value of the total asset. If the sum of the value of the distribution and the value of the remaining account is less than the value of the account before the distribution, the distribution closes the AVM period for the entire account.7

Beneficiary’s ability to sell or dispose of assets inside retirement plan. Finally, and most importantly, the regulation confirms that assets can be “sold or disposed of,” inside a retirement plan, by a beneficiary of the plan. If a beneficiary of (for example) an inherited IRA causes an asset to be sold “inside” the IRA within six months after the decedent’s death, the sale date is the AVD for the sold asset. An executor can’t simply value the retirement plan on the DOD and then do so again six months later—the estate tax return preparer will need to determine what purchases and sales took place inside the account during the AVM period.8

Remaining Question

One question remains regarding IRAs and the AVM. A surviving spouse who's the sole beneficiary of her deceased spouse’s IRA can hold the IRA as an inherited IRA (just like any other beneficiary) or can elect to treat the IRA as her own IRA. The surviving spouse can accomplish the same result by taking money out of the inherited IRA and “rolling” it to her own IRA. While the proposed regulations make clear that a distribution from a retirement plan closes the AVM period with respect to the distributed property, they don’t discuss a spousal election to treat an inherited IRA as the spouse’s own IRA. Some practitioners read “Example 9” to mean that a spousal election doesn’t close the AVM period, while a distribution/rollover would close it. An alternative view is that the IRS simply didn’t address this subject and didn’t necessarily mean that the two routes should be treated differently.
For further discussion of the proposed regulations, see Michael J. Jones’ upcoming “Retirement Benefits” column in the January 2012 issue of Trusts & Estates.
Endnotes 1. See Proposed Treasury Regulations Section 20.2032-1(f). 2. See Prop. Treas. Regs. Section 20.2032-1 issued 11/18/11. 3. See Prop. Treas. Regs. Section 20.2032-1(c)(1). 4. Prop. Treas. Regs. Section 20.2032-1(c)(2). 5. Prop. Treas. Regs. Section 20.2032-1(c)(5), Example 9. 6. Prop. Treas. Regs. Section 20.2032-1(c)(5), Example 12. 7. Prop. Treas. Regs. Section 20.2032-1(c)(5), Example 11. 8. Prop. Treas. Regs. Section 20.2032-1(c)(5), Example 10.