New proposed Internal Revenue Service regulations to determine the value of a taxable estate may create a series of traps for unwary executors and tax preparers, according to the American Institute of CPAs.Moreover, the regulations lead to the situation where an estate must be held open for a number of years to determine the amount of the deduction for a contingent obligation.

"Heirs and executors need closure, and would possibly incur many additional costs and burdens in filing annual refund claims every year for 25 or more years under certain circumstances," the AICPA's Trust, Estate and Gift Tax Technical Resource Task Force said in comments to the IRS.

The amendments to the existing regulations would prohibit using the date-of-death value as the amount of the deduction for a claim against the estate or debt of a decedent if there were any existing contingencies with regard to either claim or debt.

"It's the inability to achieve finality that we question," said task force chair Gordon Spoor, of St. Petersburg, Fla.-based Spoor & Associates PA. "It puts a requirement for the valuation of debt separate and apart from what they require on assets."

"Let's say you have a small business that has a debt or contingent obligation," he explained. "In valuing the company, you will assess some figure to it because it will reduce the value of the corporation. But on the examination side, there's no similar requirement to look behind the corporation and realize that there is a need for an estimate."

"They're trying to make a perfect world where it doesn't exist," said Spoor. "They responded to some potential abuses, especially in the area of litigation settlements, but they are sweeping with such a broad brush that it will have a negative effect on smaller estates."

The IRS gave multiple reasons to illustrate its position that valuation of claims against the decedent's estate at the date of the decedent's death is not the proper way to value these claims.

Determining a date-of-death value requires the taxpayer and the IRS to retry the substantive issues underlying the claims against the estate in a tax controversy setting, according to the preamble to the proposed regulations.

In most cases, according to the IRS, the tax controversy is addressed after the issue either has been settled, or has been argued, by parties with adverse interests in a court of competent jurisdiction that is more familiar with the nuances of the underlying applicable law.

"Furthermore," it said, "this approach has proven to be expensive, both in terms of appraisal and litigation costs. In addition, this approach generally results in a deduction that is different from the amount actually paid on disputed claims. Finally, the date-of-death valuation approach often forces the taxpayer involved in actively defending against a claim to take contradictory positions on the estate tax return and in the substantive court pleadings, and may actually increase the taxpayer's potential liability."


Example 9 in the proposed regulations illustrates the problems that can arise under the proposal, according to the AICPA. In it, an annuity obligation owed by the decedent ceases with the death or remarriage of the recipient. The example concludes that the only deduction allowed equals the actual payments made by the time the estate tax return is filed.

To deduct any future payments, the estate must file a protective claim for refund to keep the statute of limitations for the return open for the duration of the annuity.

The task force pointed out that with a young annuitant, this could go on for decades. "When a stream of payments owed by the decedent is treated as contingent under the proposed regulations, the estate is forced to over-pay the estate tax when the return is initially filed, then collect a series of refunds over the years as the annuity is paid," it said. "The stream of actual annuity payments could ultimately be large enough that the entire estate tax could be recovered along with statutory interest."

"Take a $4 million estate," said Spoor. "It has some of these valuation issues, so you leave the estate open. Every time you incur more expense to pay off an obligation, you reduce the estate tax, even though it was incurred later on. The beneficiaries end up paying it."

"There has to be a way to arrive at the value of the estate similar to what we do for assets," he added.


Meanwhile, some observers see advantages in the proposals.

"The IRS has some legitimate concerns," said New York-based estate attorney Lawrence J. Peck. "On the positive side, the regulations provide certainty that wouldn't otherwise exist, and the IRS is right that it will involve less time and money in fighting these claims."

He continued, "On the negative side - and it can be a big negative in the right situation - if the estate has contested claims, it first has to pay the estate tax without being able to deduct those claims, and then file a claim for refund once the claim is paid. That may create liquidity issues, and the question is whether the service will grant extensions of time to pay the estate tax when the estate has significant contested claims and liquidity issues."

"There is an obvious mismatch in the sense that if the estate has a claim, it has to value it for estate tax purposes, but if there is a claim against the estate it can't deduct the amount until it actually pays it," he explained, "so in theory you can have a situation where someone sues the estate and the estate counterclaims. The estate has to report the counterclaim as an asset of the estate and pay estate tax on it, but it will not be able to deduct the claim against the estate. There should be some netting in that situation."

For its part, the American Bar Association Tax Section agreed with Peck. "We recommend that the regulations, when finalized, allow a decedent's estate to net the value of the various claims and counterclaims by and against a decedent's estate in the same or substantially related litigation matter on the initial Form 706 (using values as of the date of death or the alternate valuation date)," it stated in its comments.

The ABA declined to address the position taken by the AICPA task force.

"Despite credible arguments in favor of the date-of-death valuation approach for claims against an estate, we recognize that Treasury and the service thoughtfully considered and rejected those arguments in favor of the view that the amount of a deduction for a claim against an estate be limited to the amount ultimately paid by the estate," it stated. "Therefore, except in a few specific instances, we have limited these comments to making the approach adopted by the service in the proposed regulations clearer and more workable."

"I can see both sides of what they're trying to do," said Roger Harris, president of Padgett Business Services and a former chair of the IRS Advisory Council. "There are instances where the new rules will make it more difficult, but there are also instances where, in some of the less complex returns, it's not so difficult to ascertain the actual value."

"The AICPA task force is talking about events that drag out and keep the return open for extended periods of time," he added, "or where you have to continue amending and applying for refunds. Where there is uncertainty in valuation it can take years."

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