If you’re like many people, you may assume that filing a federal estate tax return is pretty cut-and-dried. The executor or professional representative completes the return, pays the requisite amount of tax, if any, and that’s the end of the matter. But there’s more to this than meets the eye. In fact, a savvy move by an executor might save a wealthy family hundreds of thousands of estate tax dollars, or even more, by making a timely election to use the “alternate valuation date” for assets.

A silver lining to a down market

This election is especially beneficial when the value of the deceased’s securities or other assets plummets soon after death. It can allow the family to avoid estate tax on value that has essentially disappeared.

One noteworthy opportunity involved estates of individuals who died just before the economic downturn of 2008. Similarly, if a family member died before the stock market plunged this past January, the alternate valuation election may reduce estate tax liability.

Estate planning 101

The top federal estate tax rate of 40% applies to the entire taxable estate after the unlimited marital deduction and the available estate tax exemption are taken into account. The unlimited marital deduction completely shields from tax assets transferred from one spouse to another. In addition, assets passing to nonspouse beneficiaries may be covered by the $5.45 million estate tax exemption.

Normally, assets are included in the taxable estate based on their value on the date of death. For instance, if you own stocks valued at $1 million on the day you die, the stocks are included in your estate at a value of $1 million.

Alternate valuation date in action

Despite available deductions and exemptions, a small percentage of families still must contend with an onerous federal estate tax. However, tax law provides relief to estates negatively affected by fluctuating market conditions. Instead of the value of assets on the date of death, the alternate valuation date of six months after the date of death may be elected. This could effectively lower the federal estate tax bill.

For example, let’s say Burt, a widower, died on January 1, 2016, leaving his entire estate to his two children, John and Bridget. On the date of his death, Burt owned securities valued at $10.45 million. Following his death, the stock holdings declined in value to $7.45 million at the end of January. By July 1, 2016, the value had recovered to $8.45 million.

Using the regular date of death to value the assets, the estate would owe tax on $5 million after the $5.45 million exemption is applied, resulting in an estate tax of $2 million (40% of the remaining $5 million). Conversely, if the alternate valuation date of July 1 is elected, the estate tax is reduced to $1.2 million (40% of $3 million). Ultimately, the strategy saves the family $800,000 in estate tax. In reality, other factors will likely come into play, but this simplified example provides a rough idea of the potential tax savings.

Qualifications

To qualify for an alternate valuation date, the following requirements must be met:

• The total value of the gross estate must be 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 and before the alternate valuation date, the asset is valued at the amount equal to the sales price.
• The amount of estate tax must be lower using the alternate valuation date than it would be on the date of death. This would seem to always be true if the first requirement is met, but that’s not necessarily so for estates passing under the unlimited marital deduction or times when the estate tax is equal to zero on the date of death.
• Any assets that decline in value solely due to the passage of time (for instance, a vehicle that depreciates) must still be valued as of the date of death.
• The election to use the alternate valuation date must be made within one year of the estate tax filing date. That is, even if the return is filed late, you still have a way to make the election. Once made, the election is irrevocable.

An estate tax return is due within nine months of the date of death. Thus, when the value of assets has declined, there is a small window of opportunity for electing the alternate valuation date.

Election covers the entire estate

Be aware that the alternate valuation election must be made for the entire estate. In other words, you can’t cherry-pick stocks to be valued six months after the date of death and keep the original valuation date for others. Therefore, if other assets such as real estate have substantially increased in value since the date of death, electing the alternate valuation date might not be the best approach.

Consult with your estate planning advisor regarding your family’s situation. Also, be aware of varying rules for state estate taxes.