Alternate Valuation of Individual Account Plans and IRAs
IRC § 2032(a) provides that, if an executor so elects, all property included in a decedent’s gross estate (the “decedent’s interest”) may be valued under the alternate valuation method rather than being valued as of the decedent’s date of death, provided that, in accordance with IRC § 2032(c), the effect of the election will be to reduce both the value of the gross estate and the combined estate and generation-skipping transfer (GST) taxes (net of allowable credits). The alternate valuation method permits a decedent’s estate to reduce the tax payable in a post-death falling market. Under the alternate valuation method, the decedent’s property is valued as of the date six months after the decedent’s death (the “6-month date”) or, if any of the property has been “distributed, sold, exchanged, or otherwise disposed of” within the six-month alternate valuation period, that property is valued as of the date of its distribution, sale, exchange, or other disposition (the “transaction date”) immediately before the transaction event. IRC § 2032(a) does not further delineate how the phrase “distribution, sale, exchange, or other disposition” applies to the variety of assets that may constitute a decedent’s gross estate. If the executor elects the alternate valuation method under IRC § 2032, all property interests existing at the date of decedent’s death that form a part of the decedent’s gross estate as determined under IRC §§ 2033 through 2044 are valued in accordance with the provisions of that election. These property interests are referred to as “included property” for purposes of the alternate valuation rules even though they change in form during the alternate valuation period by being actually received, or disposed of, in whole or in part, by the estate. By contrast, property earned or accrued after the decedent’s death and during the alternate valuation period is called “excluded property.” Treas. Reg. § 20.2032-1(d).
Until the recent (November 18, 2011) publication of proposed amendments to Treas. Reg. § 20.2032-1 relating to the use of the alternate valuation method, it was impossible to determine the proper manner in which to report IRAs and qualified plan benefit accounts containing investment portfolios such as 401(k) or 403(b) plan accounts if a decedent’s executor chose to elect the alternate valuation method. The threshold question has been whether an IRA is (1) a unitary asset for purposes of the alternate valuation rules so that a single value can be assigned to the account at the time of the decedent’s death that may be compared to a single value on the six-month date or (2) a portfolio of individual investments, each of which must be reported as of each valuation date. If the unitary asset approach applied, there would be no need to identify and track individual account investments that were sold, exchanged, or otherwise disposed of during the alternate valuation period and no concern that the sale of any one investment might cause the entire account to be deemed to be sold. It is also unclear from the existing regulations and case law whether a number of post-death account changes (such as minimum required distributions, retitling of the account as an account in the name of the decedent for a named beneficiary, the division of an account into separate accounts for each of multiple beneficiaries, or rollovers of accounts to inherited IRAs or spousal IRAs) represent a distribution or other disposition of the account. To understand the manner in which the proposed regulations address (or fail to address) these questions, it is helpful to review some of the basic concepts that are part of the alternate valuation method and to place the current proposed regulations in the context of the previous attempt made in 2008 to formulate a rule to deal with internal and external changes to a decedent’s interest in entity investments that occur during the alternate valuation period.
Parsing “Distributed, Sold, Exchanged, or Otherwise Disposed of”
The proposed regulations retain the following statement in the pre-amended regulations (referred to hereafter as the existing regulations): “[T]he phrase ‘distributed, sold, exchanged, or otherwise disposed of’ comprehends all possible ways by which property ceases to form a part of the gross estate.” Prop. Treas. Reg. § 20.2032-1(c)(1)(i). Because a decedent’s gross estate is a tax concept and almost certainly will include interests in property that are not directly held by the estate’s executor or trustee (nonprobate, nonrevocable trust property), the determination of the point in time at which a particular property ceases to be a part of the decedent’s gross estate requires different rules for different kinds of property. The existing regulations bifurcate the phrase “distributed, sold, exchanged, or otherwise disposed of” for further amplification into a discussion of “distributed” and a discussion of “sold, exchanged, or otherwise disposed of.”
A decedent’s interest in property included in the gross estate under IRC § 2035 (certain gifts made within three years of a decedent’s death), IRC § 2036 (transfers with a retained life estate), IRC § 2037 (transfers taking effect at death), IRC § 2038 (revocable transfers), and IRC § 2041 (powers of appointment) may be “distributed” either by the executor or by a trustee of the property. The property is considered to be “distributed” on the first to occur of:
- the entry of an order or decree of distribution, if the order or decree subsequently becomes final,
- the segregation or separation of the property from the estate or trust so that it becomes unqualifiedly subject to the demand or disposition of the distributee, or
- the actual paying over or delivery of the property to the distributee. Treas. Reg. § 20.2032-1(c)(2).
In holding that a decedent’s property was distributed on the date of the probate court’s order of distribution (rather than the later date on which the actual distribution occurred), it was held that the word “distributed” as used in IRC § 2032 means the “shifting of economic benefits of the property” to the distributee, rather than formal delivery. Estate of Hertsche v. United States, 244 F. Supp. 347 (D. Or. 1965), aff’d per curiam, 366 F.2d 93 (9th Cir. 1966). When the assets of a revocable trust included in a decedent’s gross estate were distributed to separate successor trusts and the original trust ceased to exist, the original trust’s property was considered to be distributed. Rev. Rul. 73-97, 1973-1 C.B. 404. By contrast, the allocation by an executor of estate assets into separate accounts corresponding to trusts described in a decedent’s will within six months of the decedent’s death was not a distribution because the executor retained dominion and control of the assets in the absence of a probate court order. Rev. Rul. 71-396, 1971-2 C.B. 328. The regulatory description of “distributed” does not include among the enumerated estate inclusion sections IRC § 2040 (joint tenants) or IRC § 2039 (annuities) the section that requires the inclusion in a decedent’s gross estate of IRAs or qualified plan benefits (the value of a payment receivable by any beneficiary by reason of surviving the decedent under any form of contract or agreement if the decedent possessed the right to receive the payment during the decedent’s lifetime). The proposed regulations insert the statement: “[P]roperty is not considered ‘distributed’ merely because property passes directly at death as a result of a beneficiary designation or other contractual arrangement or by operation of law.” Prop. Treas. Reg. § 20.2032-1(c)(2).
Estate property can be “sold, exchanged, or otherwise disposed of” by its “holder,” triggering an alternate valuation date for the property. The existing regulations list five categories of persons able to sell, exchange, or otherwise dispose of property includable in the gross estate, including (1) the executor, (2) a trustee or other donee to whom the decedent during his lifetime transferred property included in his gross estate under IRC §§ 2035 through 2038 or IRC § 2041, (3) an heir or devisee to whom title to property passes directly under local law, (4) a surviving joint tenant or tenant by the entirety, or (5) any other person. Treas. Reg. § 20.2032-1(c)(3). The proposed regulations expand category (3) above to read: “(iii) An heir, devisee, or other person to whom title to property passes directly on death by reason of a beneficiary designation or other contractual arrangement or by operation of law.” Prop. Treas. Reg. § 20.2032-1(c)(3)(i)(C). In the case of a surviving joint tenant who transferred the property following the deceased joint tenant’s death to a revocable trust, the transfer was held not to be a disposition for alternate valuation purposes because the surviving joint tenant did not relinquish any authority or power of ownership over the property as a result of the transfer. Rev. Rul. 59-213, 1959-1 C.B. 244.
Evolution of Entity Approach
The primary impetus for revisions to the IRC § 2032 regulations first proposed, in part, on April 25, 2008, was the Tax Court’s decision in Kohler, which applies the existing regulations’ definition of “otherwise disposed of” as a transaction event to conclude that an estate’s income-tax-free exchange of stock for restricted stock in a IRC § 368 reorganization that occurred during the alternate valuation period was not a disposition of the stock for IRC § 2032 purposes and that the lower restricted stock value on the six-month valuation date applied. Kohler v. Commissioner, T.C. Memo 2006-152, nonacq., 2008-9 I.R.B. 481. The existing regulations, after stating that the term “otherwise disposed of” applies to money on hand at the date of a decedent’s death that is thereafter used for the payment of funeral expenses or to money on hand that is invested during the alternate valuation period, state that the term also includes the surrender of a stock certificate for corporate assets in complete or partial liquidation of a corporation under IRC § 331. The existing regulations go on to state that the term “otherwise disposed of” does not extend, however, to transactions that are mere changes in form (a statement omitted from the proposed regulations). The existing regulations look to the income tax consequences of corporate transactions and conclude that, if there is no tax, the transaction is merely a change in form. Thus, the term “otherwise disposed of” does not include exchanges of property for stock on which no gain or loss would be recognized under IRC § 351 or an exchange of stock in one corporation for stock in another corporation in a merger, recapitalization, reorganization, or other transaction described in IRC § 368(a) or in IRC § 355, in which no gain or loss is recognized under IRC §§ 354 or 355. Treas. Reg. § 20.2032-1(c)(1). In AOD 2008-01 (Mar. 4, 2008), the Chief Counsel’s Office explained that in deciding Kohler “the court erred in focusing on whether a disposition had occurred rather than on whether it should take into account a change in the character of the property that had occurred during the alternate valuation period.”
The now superseded 2008 proposed regulations stated that IRC § 2032 permits estate property to be valued as of the alternate valuation date only to the extent that the change in value during the alternate valuation period is the result of market conditions (defined as events outside of the control of the decedent or the decedent’s executor or trustee) that affect the fair market value of the property being valued. Changes because of post-death events other than market conditions were to be ignored in determining the value of the decedent’s gross estate under the alternate valuation method. Prop. Treas. Reg. § 20.2032-1(f)(1), withdrawn by issue of the 2011 proposed regulations. The concern that the alternate valuation method could be manipulated is addressed in the currently proposed regulations by listing an expanded set of transactions that illustrate the meaning of the phrase “distributed, sold, exchanged, or otherwise disposed of,” new rules that apply to entities included in the decedent’s gross estate, and 13 examples that apply the definition and rules. Prop. Treas. Reg. § 20.2032-1(c)(1).
Example Transactions Triggering Alternate Valuation
The proposed regulations enumerate nine nonexclusive transactions by which property is considered to be “distributed, sold, exchanged, or otherwise disposed of.” Prop. Treas. Reg. § 20.203-1(c)(1)(i)(A) through (I). Three are included in the existing regulations—those involving the use of cash to pay expenses of the estate, the use of cash to invest in other property, and the surrender of stock for corporate assets in complete or partial liquidation of a corporation (or similar transactions involving partnerships or other entities). The fourth is the contribution of cash or other property to a corporation, partnership, or other entity whether or not gain or loss is recognized for income tax purposes. A fifth transaction is the exercise of employee stock options. A sixth is the distribution by the estate (or other holder) of included property. The seventh is a transfer or exchange of property for other property whether or not gain or loss is currently recognized for income tax purposes. The eighth transaction triggering alternate valuation is the exchange of interests in a corporation, partnership, or other entity (“entity”) for one or more different interests (for example, a different class of stock) in the same entity or in an acquiring or resulting entity or entities provided that, if the fair market value of the interest or interests in the same entity or in the acquiring or resulting entity or entities received by the estate in the transaction equals (or differs by 5% or less from) the fair market value of the interest in the entity exchanged, the transaction does not result in an exchange or disposition. Prop. Treas. Reg. § 20.2032-1(c)(1)(i)(H) and (ii).
The final listed transaction is any other change in the ownership structure or interests in the assets of a corporation, partnership, or other entity including, for this purpose, a trust (including an IRA, Roth IRA, 403(b), 401(k), Thrift Savings Plan, and so on), bank account or similar asset, an interest that is includable in the gross estate such that the included property does not reasonably represent the included property at the decedent’s date of death. Such a change in the ownership structure or interest in the assets of an entity includes, without limitation, (1) the dilution of the decedent’s ownership interest because of the issuance of additional ownership interests in the entity, (2) an increase in the decedent’s ownership interest because of the entity’s redemption of another owner’s interest, (3) a reinvestment of the entity’s assets, or (4) a distribution of included property by the entity (other than expenses paid in the ordinary course of business) with the effect that the fair market value of the entity before the distribution does not equal the fair market value of the entity immediately thereafter. Prop. Treas. Reg. § 20.2032-1(c)(1)(i)(I). Notwithstanding the above paragraph (4)’s triggering an alternate valuation event on a distribution that reduces an entity’s fair market value, a special rule provides that a distribution or disbursement (a payment) is not an alternate valuation event if a payment of included property is made from an entity and the sum of (1) the fair market value of the payment made to the estate or other holder of the decedent’s interest in the entity and (2) the fair market value of the decedent’s interest in the entity (not including any excluded property) after the payment equals the fair market value of the decedent’s interest in the entity before the payment was made. Prop. Treas. Reg. § 20.2032-1(c)(1)(iii). If this requirement is met, the alternate valuation date of the payment is the date of the payment but the alternate valuation date of the decedent’s remaining interest in the entity is the six-month date (or the later transaction date if a subsequent payment is made). For purposes of applying this rule, a payment is deemed to consist first of excluded property, if any, and then of included property.
Examples Applied to IRAs
Four of the 13 examples included in the proposed regulations that illustrate the meaning of “distributed, sold, exchanged, or otherwise disposed of” apply to IRAs, Roth IRAs, 403(b) plan accounts, or 401(k) plan accounts and describe when various actions taken during the alternate valuation period result in alternate valuation dates. Prop. Treas. Reg. § 20.2032-1(c)(5), exs. 9, 10, 11, and 12. Examples 9, 10, and 11 describe a brokerage account, titled in the names of husband and wife with rights of survivorship, which on the husband’s death holds marketable securities, corporate bonds, municipal bonds, certificates of deposit, and cash. The examples state that the results of the analysis of actions taken during the alternate valuation period for the brokerage account would be the same if the invested assets were held in the husband’s retirement account and the wife’s ownership were the result of a contract (a beneficiary designation form) rather than operation of law. In example 9, the brokerage account was transferred at the wife’s direction to an account in her sole name during the alternate valuation period. The example concludes that the retitling of the account is not a transaction resulting in an alternate valuation date for the brokerage account assets because “title to the joint account passes to the wife at the moment of husband’s death by operation of law.” The example notes that the value of the assets held in the brokerage account owned by the wife will be includable in the husband’s gross estate at their fair market value on the six-month date. Finally, the example states that the result would be the same if the brokerage firm automatically transferred the account into the wife’s name or if the wife changed the beneficiary designation for the account.
Example 10 confirms that the direction of the sale of an asset held in the brokerage account (or the maturation of a bond) is an alternate valuation event, effective on the date of the sale. If there are no other distributions, sales, exchanges, or dispositions of account assets, the balance of the account assets will be valued on the six-month date. Similarly, if cash is withdrawn or other disbursements of included property are made from the account during the alternate valuation period, each is a distribution triggering an alternate valuation date. Prop. Treas. Reg. § 20.2032-1(c)(5), ex. 11. Assuming the fair market value of the account before each distribution (not including excluded property) equals the sum of the included property distributed and the fair market value of the account’s included property immediately after the distribution, each distribution will have its own alternate valuation date and the balance of the account assets will be valued on the six-month date. Prop. Treas. Reg. § 20.2032-1(c)(1)(iii)(A). Finally, example 12 describes an IRA for which the deceased account owner named his three children, in specified shares, as beneficiaries. The division of the IRA into three IRAs, each in the name of a different child and funded with that child’s share of the original account during the alternate valuation period is not a distribution, sale, exchange, or other disposition of the original account so that the alternate valuation date for each of the new accounts is the six-month date. Prop. Treas. Reg. § 20.2032-1(c)(5), ex. 12.
If the proposed regulations under IRC § 2032 are adopted as proposed, all of the transactions listed as distributions, sales, exchanges, and other dispositions triggering the alternate valuation date will apply to an IRA or plan benefit account on an asset-by-asset basis. The triggering of the alternate valuation date for an account asset will not accelerate alternate valuation of the entire account. The payment of a minimum required distribution to the account’s beneficiary (or holder) will be a transaction event for that payment (but not the account).
It is clear that the division of a decedent’s IRA during the alternate valuation period to create inherited IRAs—the regulatory example says “in the name of” each of the three children but likely means to say in separate accounts in the decedent’s name for the benefit of each child—does not represent a disposition that triggers an alternate valuation date for the account’s assets. Unfortunately, the use of a joint brokerage account example when a surviving spouse titles the account in her “sole name,” the results of which are to apply equally to an IRA, does not contemplate the alternative methods of titling an IRA inherited by a spouse as beneficiary. Retitling the account in the decedent’s name for the benefit of the surviving spouse as beneficiary would be most comparable to the titling of the divided IRAs for children and would not accelerate the valuation of the account. If the deceased account owner died before reaching his or her required beginning date, this form of titling the account may be desirable either to defer the required commencement of minimum required distributions or to permit an under-age-59½ surviving spouse to receive account distributions without the imposition of the premature distributions tax that would apply to an IRA in the surviving spouse’s name. On the other hand, a surviving spouse may wish to redesignate the account as an account in the surviving spouse’s own name, which, depending on the circumstances, may defer the commencement of required minimum distributions and will reduce the amount of such distributions required when the distributions begin. Because the spouse is the “holder” of the IRA, such a retitling would also seem not to be an accelerating event. Because the regulatory examples do not focus on the unusual nature of IRAs and plan accounts (as compared to the “outright” inheritance of joint property), more explicit examples in the final regulations would be helpful.
In the case of an IRA or plan account of which an estate or trust is beneficiary, the distribution by the executor or trustee (the “holder” of the account) to an estate or trust beneficiary (someone other than the holder of the account) would likely be treated as a distribution that would result in the entire account being subject to alternate valuation on the distribution date. A traditional rollover that involves the distribution of a plan account or IRA to the beneficiary seldom involves an in-kind distribution and the liquidation of the account would be an alternate valuation event. A trustee-to-trustee transfer of the account assets to a spousal IRA may be a workable alternative, but frequently a number of account assets would need to be liquidated because they are mutual funds or other investments unique to the transferring trustee or custodian. Under most estate settlement circumstances, the six-month alternate valuation period will pass by before the transfer or retitling of the account is completed in any event, so that the planned deferral of account transfers or rollovers to avoid triggering the alternate valuation before the six-month date is a viable option in most cases.