§12.14 Common Issues Involving Estate and Income Taxation of Estates

• Jurisdiction: Washington

§12.14 COMMON ISSUES INVOLVING ESTATE AND INCOME TAXATION OF ESTATES

The calculation of any estate tax due in an estate involves the valuation of assets, qualification for deductions and exclusions, and deferral of the payment of taxes, and must be considered carefully in the administration of the estate. Consideration is also given to income tax options and elections, ranging from the use and timing of the deductions and distributions to ones regarding partnerships and retirement plans/IRAs. These common issues are discussed briefly below. For a review of federal gift, estate, and generation-skipping transfer (GST) taxes and Washington state estate taxes, see Chapters 7 (Tax Primer) and 8 (Tax Planning) of this deskbook. The subject of estate planning for retirement plans and IRAs is thoroughly addressed in Chapter 9 of this deskbook.

(1) Valuation of estates, discounts, deductions, and estate tax deferral

Washington law applies federal law in determining the value of a decedent's estate, which will, in turn, be used to calculate the Washington state estate tax obligation owed by the decedent's estate. WAC 458-57-115. To a large extent, assets includable in the decedent's federal taxable estate are also includable for Washington estate tax purposes.

(a) Estate tax valuation—generally

The property included in a decedent's estate is valued at its "fair market value" at the time of the decedent's death. Under I.R.C. § 2032, property included in a decedent's gross estate is valued as of the date of the decedent's death. See WAC 458-57-115(2)(a). "[F]air market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts." Treas. Reg. § 20.2031-1(b). In addition, the fair market value of property is to be determined by the sale price to the most likely purchaser of such asset (e.g., the general public or a dealer). Although fair market value is determined as of the decedent's death (or alternate valuation date), if there are relevant facts known (or that

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should have been known) at the date of death, the date-of-death value will be impacted by such facts. Morrissey v. Comm'r, 243 F.3d 1145 (9th Cir. 2001) (value of a noncontrolling interest in a closely held company held by the decedent's estate was determined to be equal to the value of the noncontrolling interests in the company stock that was sold two months after the decedent's death).

Most assets comprising the decedent's estate may have a readily accessible value (e.g., bank account balances, treasury instruments, and publicly traded securities); others (e.g., real estate, business interests, and intellectual property rights) will not. Under the latter circumstances, formal appraisals will be required. In addition, the fair market value of a particular asset may be affected by other factors, including discounts (e.g., if the interest in property held by the estate does not have full control over the property) and premiums (e.g., when the estate's interest in the property is the voting shares of a company that represents only a fraction of the outstanding equity). See, e.g., Eisenberg v. Comm'r, 155 F.3d 50 (2d Cir. 1998) (discount for built-in gains involving a C corporation), acq. 1999-4 I.R.B. 4 (Jan. 25, 1999), action on dec, 1999-01, 1999-1 C.B. 332 (Jan. 28, 1999); Estate of McClatchy v. Comm'r, 147 F.3d 1089 (9th Cir. 1998) (blockage discount of a publicly traded company); Estate of Bright v. United States, 658 F.2d 999 (5th Cir. 1981) (valuation of community property interest in closely held corporation); Hooper v. Comm'r, 41 B.T.A. 114 (Jan. 19, 1940) (discount); Estate of Chenoweth v. Comm'r, 88 T.C. 1577 (1987) (premium); Estate of Smith v. Comm'r, 57 T.C. 650, aff'd, 510 F.2d 479 (2d Cir. 1975), cert, denied, 423 U.S. 827 (1976) (blockage discount for artwork); see also John R. Price & Samuel A. Donaldson, Price on Contemporary Estate Planning §2.14 (2017).

The fiduciary for the estate may elect the alternate valuation date that is six months after date of death. An election to use the alternate valuation date may not be made, however, unless the election will decrease both the value of the gross estate and the sum of the estate and generation-skipping transfer taxes. Furthermore, property distributed, sold, exchanged, or otherwise disposed of within six months of the decedent's death is valued as of the date of distribution, sale, exchange, or other disposition. I.R.C. § 2032(a)(1); RCW 83.100.060.

An election to use the alternate valuation date must be made on an estate tax return filed within one year after the time prescribed (including extensions) for filing. I.R.C. § 2032(d)(2). An election once made is irrevocable. I.R.C. § 2032(d)(1). Property that qualifies for the

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marital deduction, charitable deduction, or any other deduction qualifies for alternate valuation. I.R.C. § 2032(b); see WAC 458-57-115(2)(a).

The alternate valuation election may impact other postmortem planning opportunities by the estate because it affects the value of the gross estate. Qualification for a certain tax election is dependent upon the portion of the overall value of the gross estate that is comprised by a particular asset. See I.R.C. §§ 303, 2032A, 6166; RCW 83.100.046, .048. Furthermore, the alternate valuation date election also determines the income tax basis for purposes of I.R.C. § 1014(a), and thereby it impacts the computation of capital gain upon a future sale of such asset and/or the extent of appreciation deductions with respect to depreciable assets held by the estate. For further discussion, see Price on Contemporary Estate Planning §12.15.

(b) Valuation of real property

Absent unusual circumstances, such as the purchase of the property by the decedent from a third party shortly before death or the sale of the real estate by the personal representative to an independent third party shortly after the date of death (with no change in circumstances between the date of purchase or sale and the date of death), the value of real estate should be determined by an independent appraisal. An independent appraisal is also appropriate to document value for establishing the new income tax basis of the real property, including improvements thereon, which is particularly important if the property is held for investment purposes or is a personal residence that may qualify for the capital gains exclusion under I.R.C. § 121 at the time of sale.

General rule

The assessed value of real property does not establish its value for federal estate tax purposes. Treas. Reg. § 20.2031-1(b).

Reasonably foreseeable circumstances should be taken into account in the valuation. For example, changes in zoning or roadway access may affect estate tax valuation of real property. Ithaca Trust Co. v. United States, 279 U.S. 151, 155, 49 S.Ct. 291, 73 L. Ed. 647 (1929); First Nat'l Bank of Kenosha v. United States, 763 F.2d 891, 894 (7th Cir. 1985); Estate of Van Horne v. Comm'r, 720 F.2d 1114, 1116 (9th Cir. 1983), cert, denied, 466 U.S. 980 (1984); Estate of Spruill v. Comm'r, 88 T.C. 1197, 1228 (1987).

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Discounts

Discounts generally are allowed in valuing undivided interests in real property, including a deceased spouse's community property interest. Propstra v. United States, 680 F.2d 1248 (9th Cir. 1982). The value of an undivided interest in real property typically is less than the corresponding percentage of the value of the entire parcel, because the owner of such undivided interest does not have the same control or pool of potential purchasers. Discounts should be properly documented by a qualified appraisal. Estate of lacono v. Comm'r, T.C. Memo. 1980-520, 41 T.C.M. (CCH) 407 (Nov. 25, 1980); see also Carol A. Kelley & L. Paul Hood, Valuation: General and Real Estate, 830-3d Tax Mgmt. (BNA), Estates, Gifts, and Trusts II.H. (2003). The extent of discount is based upon the facts and circumstances of the particular situation. Barge v. Comm'r, T.C. Memo. 1997-188, 73 T.C.M. (CCH) 2615 (Apr. 23, 1997); Price on Contemporary Estate Planning §2.14.1.

An absorption discount (the real estate equivalent of a blockage discount) may be applicable to multifamily real estate if the properties held in the estate encompass a significant portion of the rental units in the area. Estate of Auker v. Comm'r, T.C. Memo. 1998-185, 75 T.C.M. (CCH.) 2321 (May 19,1998); see also Estate of Folks v. Comm'r, T.C. Memo. 1982-43,43 T.C.M. (CCH) 427 (Jan. 29,1982) (five lumberyards owned in a limited geographical area). Courts have also applied absorption discounts with respect to subdivision lots and multiple dwelling unit properties. Carr v. Comm'r, T.C. Memo. 1985-19, 49 T.C.M. (CCH) 507 (Jan. 10, 1985); Estate of Brocato v. Comm'r, T.C. Memo. 1999-424, 78 T.C.M. (CCH) 1243 (Dec. 29, 1999); Price on Contemporary Estate Planning §2.14.1.

(c) Valuation of publicly traded securities

Publicly traded securities are valued according to the mean between the highest and lowest quoted selling prices on the valuation date. Treas. Reg. § 20.2031-2(b). If there were no sales on the valuation date but there were sales on dates within a reasonable period both before and after the valuation date, the weighted average of the means between the highest and lowest sales on the nearest date before and after the valuation date is used. Estate of McClatchy, 147 F.3d 1089; Treas. Reg. § 20.2031-2(e).

(d) Accuracy-related penalties

Proper valuation of the assets and liabilities of the estate is essential to determining the estate tax due (if any) and planning for

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the payment of the estate tax due within the required time frame. The taxpayer typically is interested in obtaining the "highest defensible" fair market value for real estate, closely held...