In 2006, the Tax Court held that post-death changes in the character of stock owned by a decedent pursuant to a tax-free reorganization would be allowed to affect the alternative valuation date value of the stock for estate tax purposes. Herbert V. Kohler, Jr., et al., TC Memo 2006-152. Under Code Section 2032, an estate can elect to value its assets for estate tax purposes on a date that is six months after the death of the decedent, instead of on the date of death. Thus, an estate can reduce its estate taxes if the overall value of those assets has declined in that six month period.
In Kohler, during the six month period restrictions on transfer were placed on the stock of the company, including shares owned by the decedent's estate. Such restrictions reduced the value of the shares, and thus use of the alternate date value saved estate taxes for the estate.
Taxpayers need to be wary upon relying on Kohler for precedent. The IRS has issued an Action on Decision announcing that it does not acquiesce to the Kohler case. This means that the IRS does not accept the legal conclusions of that case, and on similar facts will argue that no valuation adjustment for post-death voluntary changes in the character of corporate stock is allowable.
The rationale of the IRS is that the purpose of Section 2032 is to provide relief for estates when the MARKET causes a substantial dimunition in value of an estate asset - that is, if unfavorable market conditions (as distinguished from voluntary acts changing the character of the property) result in a lessening of its fair market value. In this case, the value change did not relate to changes in market conditions, but came from the affirmative and voluntary act of the corporation and its shareholders changing the character of its outstanding stock.
While the position of the IRS sounds reasonable, one has to wonder that if such an exception to the use of Section 2032 is allowed to stand how many cases will be litigated over the question whether a change in value is due to changes in market conditions vs. a voluntary act?
Action on Decision 2008-001, 3/4/2008