Florida Bar Journal

PAVE–A Self-Help Technique for Estate Tax Valuation Methods

Generally, federal estate tax is calculated based upon the date-of-death values of the decedent’s assets. For example, even if $2 million worth of an estate’s assets decrease to $1.5 million shortly after the date of death, the default rule is that estate tax is calculated using the higher, $2 million date-of-death value. ¹ In this age of large securities portfolios and a fluctuating stock market, such a decrease in value is certainly possible. Usually, in such a case, the IRC §2032 alternate valuation method would be elected for the tax calculation, which would use the lower $1.5 million value.

What if the estate could file the federal estate tax return (the “return”) using the date-of-death values and, at the same time, elect to use the alternate valuation only if it becomes available to the estate? For instance, if, at the time of filing, the executor² believed the date-of-death valuation would result in a more favorable tax result for the estate, but later (after filing the return), learned that alternate values would be preferred, the executor could utilize the alternate values if a protective election had been made.

This article evaluates a protective alternate valuation election (PAVE) as a way for the estate to elect alternate valuation under IRC §2032 “just in case” it might produce a better estate tax result. A PAVE allows an executor to use the alternate values and recalculate a lower tax after the return is filed — even if the date-of-death values are used when the return is initially filed. This article submits that if there is no downside to using a PAVE, a preparer might choose to incorporate a PAVE into every estate tax return.

Section 2032 Alternate Valuation Method

Under the default rule, if values substantially decrease, the estate is still forced to use the lower-valued assets to pay taxes based on previously higher values. Practitioners and clientseven the federal governmentrecognize that this is not fair. The federal government has given the taxpayer some relief on calculating the amount of taxes due in this instance.

IRC §2032 allows the executor to use asset values on a date other than the date of death if certain requirements are met. For estates of decedents dying after July 18, 1984, if the alternate valuation will cause a decrease in both the value of the aggregate gross estate and the estate tax, then the executor may use the value of all the assets as of the date six months after the date of death.³ If during those six months, however, any asset is distributed, sold, exchanged, or otherwise disposed of, the value used for that asset is as of the date of that intervening event.⁴ If the gross estate and the tax due do not decrease, the election is not allowed.⁵

While some assets may decrease in value during the six-month period, other assets may increase during that time. If the alternate valuation election is made, the higher value must be used for those assets that increased in value during the six months.

The executor must affirmatively make the election on a federal estate tax return (Form 706).⁶ Once made, the election is irrevocable. Once a return that does not make the election is filed, the alternate valuation election may only be made on a subsequent return that is filed by the due date (including extensions) of the original return.⁷

Because the §2032 election is irrevocable when made and is lost when not made timely, the return preparer is forced to make the decision whether to recommend that the executor elect alternate valuation. Sometimes, the executor may not make the alternate valuation election, and, due to unexpected circumstances, later discovers that it would have been more beneficial to make the election. Because the deadline for making the election has then passed, the executor is precluded from using the alternate valuation.

Typically, when the two §2032 requirements — decrease in aggregate gross value and in net tax due — are met, the alternate valuation is elected. Rather than place the burden and risk of not properly making the election on the executor, the Code could simply allow for an automatic election when the requirements are satisfiedat any stage in the preparation, review, or audit process. Conversely, under a kinder version of the Code, the affirmative election could be to forego an automatic alternate value. Curiously, the ostensible intent of §2032 is to reduce the taxes due when the estate “shrinks” in value within the six months after the date of death, but the burden for obtaining the relief is upon the taxpayer (and, therefore, upon the preparer). In light of these rules, a PAVE could grant the flexibility of, initially, using the date-of-death values and, subsequently, of using the alternate values if preferred. If the alternate values do not result in less estate tax, the estate is not harmed by using a PAVE.

Post-Filing Situations

At least two general situations come to mind when the alternate valuation method becomes desirable after the election period has expired (and the election was not made). In each situation, an automatic election would permit the use of the alternate values (and likely eliminate a professional negligence claim). First, due to circumstances arising after the return was filed, such as an audit, an estate tax liability arises. Second, due to incorrect asset information, the preparer determines that the requirements for the election were not met and, therefore, the election is not available to the estate.

First, consider the situation when an estate tax liability is created after the return is filed without a §2032 election. This situation might arise, for example, if a decedent died owning 100,000 shares of stock in a publicly traded company. On the date of death, the stock was valued at $100 per share. An appraisal of the stock valued all of the shares of stock as of the date of death with a valuation discount for blockage, resulting in a per share value of $80. Within six months after the decedent’s death, the executor a) sold 60,000 shares of the stock at $90 per share and b) distributed the balance of the shares to the beneficiaries when the value without a blockage discount was $95 per share.

With the appraisal information, the executor analyzed the best option for the estate. With the blockage discount, the stock’s date-of-death value would be $1.2 million lower than the alternate value (the sale price or date of distribution value, which would not be reduced by the blockage discount). The risk for the estate in taking the blockage discount, however, was that the IRS would challenge the discount. If the IRS prevailed in its challenge and disallowed the discount, the estate would be required to use the higher, date-of-death value of $100 per share for a total value of the stock of $10 million. As a result, the estate tax would be higher. In such a situation, the executor would likely prefer to use the alternate valuation, which would be the sum of the sale price per share and the date of distribution value per share, or $9.2 million. This would be a reduction in gross estate value of $800,000 from the date-of-death value and would result in a reduction in estate tax.

It is not always a subsequent act by the IRS that causes the alternate valuation election to be needed, however. Consider the second situation in which the executor and the preparer believed they had all the information before them and determined that the estate was simply ineligible for the alternate valuation election. Based upon their information, the alternate valuation amounts did not create either a lower gross estate amount or a lower estate tax liability. For this reason, the election was not made.

As can occur, the information relied upon was incorrect. A split (2:1) of the decedent’s stock had been declared shortly prior to the date of the decedent’s death, but the information was not available as of the date of death. The additional 20,000 shares caused the estatefor which originally no tax was dueto have a tax liability. During the six months after the decedent’s death, the share price of the stock declined such that the total number of shares of decedent’s stock at the alternate value would not create a tax liability. Because the executor did not know of the stock split, he had no reason to consider alternate values for an estate that otherwise had no tax liability using the date-of-death values. (See chart on following page.)

While the estate could, before the due date, file an amended return to elect the alternate valuation, if it does not, the ability to elect is lost and the higher values (and higher tax) apply. Practically, the executors in the two examples needed a manner in which to preserve the alternate valuation election “just in case” the need for such valuation later arose. Because the law does not provide an automatic election, the executor may wish to create his own and file a PAVE.

Protective Alternate Valuation Election (PAVE)

The PAVE, or protective alternate valuation election, allows the executor to make the election now “just in case” the estate later qualifies for it. Currently, one remedy to not having made the election is to file an amended return, on which the election is then made, by the due date (including extensions). This option, however, is an additional and perhaps difficult deadline by which the executor must, once again, make the conclusive determination of whether to make the election. Instead, the executor might use a PAVE on the return as an ideal mechanism by which to preserve the right to use the alternate valuation if it would reduce the estate taxes.

The goal of the PAVE is to preserve the estate’s right to elect the alternate valuation method and to receive the benefits that arise from using alternate values. This mechanism allows the estate both convenience and flexibility. The estate conveniently is able to file timely the return using date-of-death values and other information (such as discounts and deductions) obtained through good faith reliance on the information then available to the executor. Simultaneously, the executor retains the flexibility to use the valuation on the alternate date if it later becomes available. The application of the alternate values is triggered by the occurrence of an event beyond the control of the executor. With this protective mechanism, the preparer should consider incorporating a PAVE into each return prepared.

Because Congress has not granted an automatic election and no current intimations are being made toward specific modification of this aspect of the estate tax, the PAVE is a way for the practitioner to ensure that the alternate valuation is available to the estate. Although a PAVE is not set forth in the Code or the regulations, there is no authority therein prohibiting one. Additionally, nothing in Form 706 or the form’s instructions addresses the protective election. On the contrary, a PAVE works within the confines of the current law and, in fact, has been ruled upon by the Tax Court and permitted in a technical advice memorandum and a private letter ruling.

Mapes v. Commissioner. The propriety of a PAVE was first considered in Mapes v. Commissioner, 99 T.C. 511 (1992). In that case, the decedent owned three parcels of real estate, two of which were used as a farm. On a timely filed estate tax return (Form 706), the decedent’s estate used the date-of-death values for the real estate and also made an election of special use valuation, as authorized under §2032A.⁸ The estate filed a protective alternate valuation election with the return,⁹ to apply in the event that the special use valuation was disapproved.

The court specifically determined that the executor could make a protective §2032 election to use the alternate valuation method. Under the terms of the attachment to the return, the election would become effective only upon the denial of the §2032A special use valuation election.¹⁰ In making its determination, the court held that using the date-of-death values on the return was not an election against alternate valuation since the general requirement under §2031 is for the use of date-of-death values unless the affirmative alternate valuation election is made.¹¹ In Mapes, the executor had used the date-of-death values and made a conditional election under §2032.¹²

The PAVE must be conditional in order to serve its intended purpose as a fallback position. With a PAVE, the §2032 election is “made” only if the condition precedent occurs. The election becomes irrevocable “once made.”¹³ In Mapes, if the election to use the special use valuation was denied, then the election of the alternate valuation method was triggered and the election would then be irrevocable.¹⁴ On the other hand, if the special use valuation election was accepted, then the executor would not have been considered to make an election of the alternate valuation method.¹⁵

1998 Technical Advice Memorandum. While the Mapes case is not the only review of the permissibility of the PAVE, it does provide the most extensive review. Additionally, in 1998 the Service issued a technical advice memorandum concluding that a protective alternate valuation election was effective for federal estate tax purposes.¹⁶ The decedent’s estate tax return had been filed timely with a protective alternate valuation election. The condition precedent that triggered the election was either a) that the support trust under the decedent’s will did not qualify for the marital deduction or b) the surviving spouse exercised her right to receive her elective share under state law. The condition was satisfied when the surviving spouse exercised her right of election, and the revised tax liability was determined by valuing the gross estate under the alternate valuation method.

1999 Private Letter Ruling. In 1999, a private letter ruling dealt with a situation similar to the prior illustration of the shares of stock and a discount for blockage. If the valuation discount was denied, the date-of-death value, which was higher than the alternate value, would be used. The executor proposed to make a protective alternate valuation election. Instead of using a specific event as the condition precedent (as in Mapes with the special use valuation and in the TAM with the spousal elective share), the condition precedent was general. The election stated if the value of the gross estate and the tax using the date-of-death value were higher than the value using the alternate valuation dates, then the alternate valuation method would be elected. The IRS concluded that the protective alternate valuation election was allowed and would be effective if the condition precedent was satisfied.¹⁷

How to File a PAVE

The following requirements for a proper PAVE have been gleaned, initially, from §2032 and fleshed out by the three authorities addressing the issue:

• The election must be subject to a condition precedent that is entirely beyond the taxpayer’s control. For instance, in Mapes, the condition precedent was if the special use valuation election was denied by the IRS. Alternatively, the condition precedent could be a general statement to the effect that if the date-of-death value is higher, as finally determined, and the tax is higher, then the alternate valuation would be used.

• The return must be filed within one year after the deadline (including extensions) for filing the return.¹⁸ If the election is not made before the one-year grace period expires, however, the election is unavailable and the date-of-death values must be used. This occurred in Estate of Eddy v. Commissioner, 115 T.C. No. 10 (2000). In Eddy, the initial return was filed more than 18 months after the extended due date. The Tax Court held that the estate was not eligible to use the alternate valuation date because the return had not been filed within the one-year grace period.¹⁹

• On Form 706, page 2, part 3, line 1, instead of marking either “yes” or “no” to the question, “Do you elect alternate valuation?,” instead insert “See Protective Alternate Valuation Election Attached.”

• The PAVE should be an affirmative statement attached to the returneither immediately after page 2 (for easy reference) or immediately before any supporting attachments. Attached as an appendix to this article is a sample protective election statement.

• The values used on the return should be the date-of-death values. The alternate values will be used only if the condition precedent occurs. The Mapes executor also filed information as to the alternate values, but the court made no comment as to whether that was necessary. If the alternate values are available at the time of filing, submission at that time of the values on the return itself, as an attachment, or on the PAVE seems to be a reasonable practice.

• If the condition precedent is satisfied, thereby triggering the alternate valuation method, the estate should file “Supplemental Information”²⁰ as permitted and recalculate the federal estate tax liability using the value of the gross estate under the alternate valuation method.²¹

Conclusion

A PAVE should be considered as a mechanism by which the executor effectively can make a conditional alternate valuation election. If the condition is never satisfied, then the election is not made. If, on the other hand, the condition is satisfied, the executor has available the benefit of a lower gross estate value and a lower tax liability. A general protective alternate valuation election that could be applicable to every estate is one made conditional simply upon the statutory requirement of both the gross estate value and the estate tax being lower than when using date-of-death valuations. The risk in not filing a PAVE is paying additional estate taxes. Until Congress eliminates this professional negligence trap by making the alternate valuation method automatic when the statutory requirements are met, the practitioner can create his or her own self-help remedy with a PAVE.

¹ The date of death is the standard valuation date. I.R.C. §2031(a).

² “Executor,” as used in this article, is the executor provided for under §2203 of the Internal Revenue Code.

³ I.R.C. §2032(a), (c).

⁴ I.R.C. §2032(a)(1). Also, any interest or estate which is affected by a mere lapse of time, such as a patent, remainder, reversion, or estate for life of a person other than the decedent, is valued as of the date of death instead of a later date. Reg. §20.2032-1(f). Adjustment is allowed for difference in value after the date of death if it is attributable to something other than the lapse of time, such as economic conditions. I.R.C. §2032(a)(3).

⁵ I.R.C. §2032(c).

⁶ Unlike many other elections, the §2032 election does not need to be made on a timely filed return. The return making the election must be filed within one year after the deadline (including extension deadlines) for filing the return. I.R.C. §2032(d). While Treasury Regulation §20.2032-1(b)(2) prohibits an election made after the return’s due date (including extensions), the temporary regulation confirms the Code’s one-year grace period. Temporary Proceed. & Admin. Regs. §301.9100-6T (b)(1).

⁷ Temporary Proceed. & Admin. Regs. §301.9100-6T (b)(1).

⁸ The estate submitted three appraisals: the date-of-death value; the date-of-death value determined pursuant to the method of valuing farms under §2032A; and the alternate value six months after the decedent’s date of death (without any special use valuation).

⁹ The values at issue for the two parcels of land were:

¹⁰ See Mapes, 99 T.C. at 529, 533.

¹¹ Id.

¹² See id.

¹³ Id. at 530 (citing I.R.C. §2032(d)(1)).

¹⁴ Id.

¹⁵ Id.

¹⁶ Tech. Adv. Mem. 98-46-002 (July 13, 1998).

¹⁷ Priv. Ltr. Rul. 99-42-015 (Oct. 22,

1999).

¹⁸ See supra note 6 and accompanying text.

¹⁹ The estate argued that Rev. Proc. 92-85 (1992-2 C.B. 490) gives the IRS discretion to allow an untimely election. The Tax Court found that Rev. Proc. 92-85 applies only where an election must be made by the due date of the return or the extensions; it does not apply to the one-year grace period after the due date, with extensions. Eddy, 115 T.C. No. 10.

²⁰ Reg. §20.6081-1(c).

²¹ See Tech. Adv. Mem. 98-46-002 (July 13, 1998).

ESTATE OF JANE DOE

SSN: 123-45-6789

DOD: 10/11/12

Election 1: Alternate Valuation Election (Question 1)

The Executors elect valuation by the alternative method under I.R.C. Section 2032 in the event, and only in the event, (a) the value of the Decedent’s gross estate on the alternate valuation date or dates is lower than the value of the gross estate determined as of the date of death and (b) the sum of the tax imposed by Chapter 11 and the tax imposed by Chapter 13 of the Internal Revenue Code with respect to property includible in Decedent’s gross estate using the alternate valuation (reduced by credits allowable against such taxes) is lower than the sum of the tax imposed by Chapter 11 and the tax imposed by Chapter 13 of the Internal Revenue Code with respect to property includible in Decedent’s gross estate using the date of death valuation (reduced by credits allowable against such taxes).

S. Dresden Brunner practices with the law firm of Steel Hector & Davis, LLP, Naples, concentrating on estate planning, estate and trust administration and related tax matters. She is a member of the executive council of The Florida Bar’s Real Property, Probate and Trust Law Section and is chair of the Collier County Bar’s Trust and Estate Section. Ms. Brunner received her B.A., summa cum laude, from Western Kentucky University and her law degree, summa cum laude, from The University of Dayton.

Laird A. Lile has joined Lowry Hill, Private Wealth Management, as a financial principal to establish its Florida office. He is a fellow of the American College of Trust and Estate Counsel and is certified by The Florida Bar in wills, trusts and estates law. Mr. Lile has previously concentrated his practice in trust and estate administration, tax matters, and probate-related litigation.

This column is submitted on behalf of the Real Property, Probate and Trust Law Section, J. Michael Swaine, chair, and Brian C. Sparks, editor.