Identifying tax opportunities on stock received from an estate.

• Author: Ellentuck, Albert B.

Editor's note: This case study has been adapted from "PPC Tax Planning Guide--S Corporations," 16th edition, by Andrew R. Biebl and Gregory B. McKeen, published by Practitioners Publishing Company, Fort Worth, Tex., 2002 ((800) 323-8724; www.ppcnet.com).

Facts: Wilson was a 25% shareholder in a calendar-year S corporation. He died in an auto accident on Aug. 23, 2002. At the beginning of 2002, Wilson's stock had a $10,000 adjusted basis; at his date of death (DOD), it had an estimated $100,000 fair market value (FMV). Based on the value of other assets Wilson owned, his estate will have to file a return and pay estate tax. Wilson's heirs seek advice from their tax adviser as to how Wilson's death affects his S stock, noting that an opportunity may exist to sell the stock in the near future. The corporation has no income in respect of a decedent. Issue: What tax consequences and opportunities arise from an S shareholder's death?

Analysis

The adviser first tells Wilson's heirs that his stock was an asset includible in his gross estate; the estate tax value is determined by the stock's FMV, either (1) at the time of death, under Sec. 2031 or (2) using the Sec. 2032 alternate valuation date (which could be up to six months later) if allowed and elected. The adviser provides balance sheet and prior income information on the S corporation to assist in computing the FMV of Wilson's stock, including a possible discount of the FMV for Wilson's minority position and the stock's lack of marketability.

Income or Loss Allocation

A shareholder's death terminates his or her interest in an S corporation, requiring an allocation of income, deductions, losses and credits for the portion of the year the decedent held the stock. There are two methods for allocating S-year income to the period of stock ownership--the general per-share, per-day allocation method and the specific-accounting allocation method. The resulting allocable share of the corporation's income, deductions, losses and credits to the DOD is reported on the corporation's Schedule K-1 and included in the decedent's final Form 1040.

Depending on the decedent's personal tax situation, the chosen allocation method could save income tax on his or her final-year return. If the corporation elects to use the specific-accounting method, affected shareholders must consent to the election. Affected shareholders are those whose interests terminated and those who acquired shares during the tax year. If the...