When to elect the alternate valuation date
The stock market goes up, the stock market goes down. Just consider recent history. In 2018, stocks took one of their worst beatings since the Great Depression, with the Dow Jones Industrials Average (DJIA) falling 5.6% for the year and the S&P 500 down 6.2%. But the markets rebounded early in 2019, with both the DJIA and S&P 500 posting gains of more than 7% during the first six weeks of this year.
Of course, you likely can expect more stock market volatility in the near future. Not only does this affect your net worth, and perhaps your lifestyle, it might have an impact on estate taxes, too. Specifically, your family might owe an unexpected tax bill if a death occurs before the value of stocks or other assets drop precipitously.
Selecting a valuation date
Under the Tax Cuts and Jobs Act (TCJA), the federal estate tax exemption has been doubled from $5 million to $10 million, indexed for inflation, effective for 2018 through 2025. The indexed figured for 2019 is $11.4 million (up from $11.18 million in 2018). At the same time, the TCJA retains the top federal estate tax rate of 40%, as well as the unlimited marital deduction.
Typically, assets owned by the deceased are included in his or her taxable estate, based on their value on the date of death. For instance, if a taxpayer owned stocks valued at $1 million on the day when he or she dies, the stocks are included in the estate at a value of $1 million.
Despite these favorable rules, a small percentage of families still must contend with the federal estate tax. However, the tax law provides some relief to estates that are negatively affected by fluctuating market conditions. Instead of using the value of assets on the date of death for estate tax purposes, the executor may elect an “alternate valuation” date of six months after the date of death. This election could effectively lower the federal estate tax bill.
Take a simplified example where the value of the taxable estate exceeds the exemption amount by $2 million. If the estate’s value drops to $500,000 above the exemption amount, the family would save $600,000 in federal estate tax ($1.5 million x 40%).
Election requirements
This special election is permissible only if the total value of the gross estate is lower on the alternate valuation date than it was on the date of death. Of course, the election generally wouldn’t be made otherwise. If assets are sold after death, the date of the disposition controls. The value doesn’t automatically revert back to the date of death.
Furthermore, the ensuing estate tax must be lower by using the alternate valuation date than it would have been using the date-of-death valuation. This would also seem to be obvious, but that’s not necessarily true for estates passing under the unlimited marital deduction or other times when the estate tax equals zero on the date of death.
Take note that the election to use the alternate valuation date must be made within one year of the estate tax return filing date. Generally, an estate tax return is due within nine months of the date of death. This provides a small window of opportunity for electing the alternate valuation date when the value of assets has declined.
All-or-nothing proposition
The alternate valuation date election can save estate tax, but there’s one potential drawback: it must be made for the entire estate. In other words, the executor can’t cherry-pick stocks to be valued six months after date of death and retain the original valuation date for other stocks or assets. It’s all or nothing.
This could be a key consideration if an estate has, say, sizeable real estate holdings in addition to securities. If the real estate has been appreciating in value, making the election may not be the best approach. The executor must conduct a thorough inventory and accounting of the value of all assets.
Account for state estate taxes
It’s important to be aware of the rules for any applicable state death taxes. This could tilt things one way or another. Fortunately, you don’t have to decide matters on your own. Contact your estate planner for guidance concerning your family’s situation.