Recent stock market conditions, particularly the volatility of the markets, during the last year have no historical precedent.  

Daily moves in the market of several hundred points have been common in the last quarter of 2008 as marquee financial and industrial concerns imploded and sought financial assistance from the federal government. The volatility in the markets has devastated investor confidence and driven stock prices down by annual percentages not seen since the Great Depression. This perfect storm of financial events has presented serious challenges to estates that are comprised largely of stock holdings because federal and state estate taxes must be paid nine months after the death of a decedent.

If a decedent died in 2008 and his estate was worth more than $2,000,000, then his estate was most likely subject to federal estate tax. And, if his estate was mostly comprised of stock holdings then its value dramatically decreased during the last three months of 2008, although its value was in a pattern of decline from the beginning of the year. In fact, estates with large stock holdings will likely have insufficient assets to pay both the estate taxes and distributions to beneficiaries equal to the amounts that the beneficiaries would have received had the estate’s assets been invested in certificates of deposit.

Indeed, because of market volatility, the entire year has been a difficult one for an executor in terms of timing the liquidation of an estate’s stock holdings in order to pay estate taxes. If the stocks were sold too soon, then the market might then go up and the estate miss out on an opportunity for appreciation in order to have more funds with which to pay estate taxes. If the executor waited too long, then the estate might have insufficient assets with which to pay its estate tax liabilities and not suffer a very large capital loss.

A section of the Internal Revenue Code allows an estate to file an application for an extension of time in which to pay estate taxes. The extension is granted at the discretion of the Director of the Internal Revenue Service and, if granted, is for one year. The extension may be reapplied for on an annual basis for up to ten years. If the extension is granted, the estate is relieved from the payment of penalties for failure to timely pay the tax, but is not relieved from the payment of interest.

The provision that allows for extensions of time is typically applied to illiquid assets such as small businesses or land that cannot be easily marketed. The law is not intended to permit an extension where the estate’s assets have a ready market, as in the case of the stock market. However, the law does allow for an extension where the assets must be liquidated at fire sale prices in order to pay the estate taxes. The problem is that the law does not specifically address stocks and does not speak to the recent and unprecedented volatility in the stock market. And, there is no formal guidance from the IRS as to how it might consider an application for more time to pay under the present circumstances.

If the IRS grants an application under the present circumstances, the benefits for the estate and the beneficiaries could be very significant. Allowing more time in which to pay the taxes would allow more time for the stock markets to recover and for the beneficiaries to minimize, if not eliminate, a loss. If such applications are denied, then the value of the assets passed on to the beneficiaries will be permanently and very substantially reduced by the forced liquidation of those stocks that are needed to pay the estate taxes.

The Ohio Department of Taxation has already granted such an application for time in which to pay Ohio estate taxes. Applications are presently pending before the IRS in the District Director’s Office that covers Ohio. However, IRS has not issued a ruling on those pending applications. Stay tuned for further developments.

News Bulletin:

On January 26, 2009, the Internal Revenue Service granted an estate’s request for a one year extension of time in which to pay federal estate taxes where the decedent’s estate was principally composed of stock holdings. While the IRS could have required that a bond be posted to assure payment of the estate tax at the end of the one year extension, the bond requirement was waived. The law provides the opportunity for the estate to apply for additional one year extensions in the event that the stock market does not sufficiently recover within that initial one year period in order that the estate may prevent a permanent impairment of the value of its holdings through premature liquidation to pay the tax. However, the estate remains liable to the IRS for interest that accrues in the interim on the tax that is due.