Tax opportunities associated with stock received from an estate.

• Author: Ellentuck, Albert B.
• Position: Case study

Facts: Wilson was a 25% shareholder in a calendar-year S corporation. On August 23, he died in an auto accident. At the beginning of the current year, Wilson's stock had an adjusted tax basis of $10,000 and an estimated fair market value (FMV) of $100,000. Based on the value of his other assets, Wilson's estate will be required to file an estate tax return and to pay estate tax. Wilson's heirs seek advice from their tax adviser as to the implications of Wilson's death on his S stock, noting that an opportunity may exist to sell the stock in the near future. Issue: What tax consequences and opportunities arise on the death of an S shareholder?

Analysis

The tax adviser first advises Wilson's heirs that his stock was an asset includible in his gross estate, with the estate tax value being determined by its FMV, either at the time of death or alternate valuation date (which can be up to six months later if so elected).The tax adviser provides balance sheet and prior income information on the S corporation to assist in computing the FMV of Wilson's stock, and provides computations regarding a possible discount for Wilson's minority position and the lack of marketability associated with closely held corporate stock.

From an income tax standpoint, the following issues are among those involved on an S shareholder's death.

Allocation of Income or Loss

The death of a shareholder is considered the termination of an interest in the S corporation, requiring an allocation of income, deductions, loss and credits for the portion of the year during which the decedent held the stock. Two methods are available for the allocation of the S year income to Wilson's period of stock ownership--the general per-share, per-day allocation method and the specific accounting allocation method. The resulting allocable share of S income, deductions, loss and credits to the date of death is reported on the Schedule K-1 of the corporation and included in Wilson's final Form 1040.

Depending on the decedent's personal tax situation, the use of one allocation method could save income tax on the decedent's final-year tax return. If the corporation elects to use the specific accounting method, all the shareholders affected by the stock disposition must consent. Affected shareholders include all shareholders who disposed of shares and all shareholders who acquired shares during the tax year. If the shares were transferred to the corporation, all shareholders who owned stock during...