The Four Steps

There are important tax (income and estate) reasons to have the assets valued at date of death. First, the government wants to know if the estate owes it any estate taxes as a result of the person passing. Depending on the year of death, most people are able to shelter from taxation assets left to beneficiaries, and will not be subject to an estate tax. To that end, Congress provides each of us with an estate tax “coupon” that we can apply against the total value of the assets. Anything below the coupon amount is exempt from estate taxes. Those assets above it are subject to it. Thus, one has to know the value of the asset at the time of death to calculate what is owed, if anything.

Second, the date of death valuation is extremely important to the recipient of the asset for income tax purposes. Most people know that when an asset is purchased the cost to acquire it becomes its tax basis moving forward. If one later sells that asset for more than it was originally paid, there is a capital gain. If one later sells it for less than what was paid, there is a capital loss. In either event, the gain or loss is reported on the owner’s personal income tax return. For example, if someone bought Apple stock for $100 a share and it increases in value to $500 a share, the capital gain is $400 per share for which capital gain income taxes are due, and reported on the Form 1040.

If someone instead dies before selling the asset, the government lets the estate revalue the asset as of the date of the person’s demise. This increase in the value steps up the original basis to the new date of death value. Using the Apple stock example above, the new basis for the heirs would be $500, which was the value on date of death. If the heir then sells the stock for $500, the heir has no gain on the stock sale because the basis stepped up. As you can see, this is a tremendous advantage for the heir since they avoid additional income taxes as a result of the sale. Apply this same idea to a house or other larger value asset, and you can easily see the benefit of the step up in basis for the heir. Heirs need to know this information to properly report sales they make on inherited assets. And, since the burden is always on the taxpayer to substantiate the cost basis, heirs will be looking to the personal representative (executor) or successor trustee for this information.

Finally, it doesn’t matter who inherits the assets, the focus is on ownership. Even if the asset passes to another person by beneficiary designation or operation of law, ownership of the asset at time of death is what triggers the need for the valuation process.

Our office always recommends that a personal representative (executor) or successor trustee publish “notice” to a creditor. We recommend that this be done irrespective of whether one thinks there will be a creditor claim or not. Generally, if one contracts for services (medical services for example) there is a six year statute of limitation to pursue collection of an unpaid invoice. However, by publishing proper notice after someone’s passing, the statute of limitations can be reduced to 120 days. Thus, for the nominal cost of publishing proper notice, the personal representative (executor) or successor trustee can obtain peace of mind knowing that if a creditor has not presented a claim within the 120 day time period that it is safe to make a distribution to heirs. (Think of this in reverse where a distribution is made to heirs and proper notice is not given and a creditor then submits a claim, the personal representative (executor) or successor trustee will have a very difficult time recapturing funds from heirs to pay it, and is arguably personally responsible to pay it themself.)

In Arizona, notice to creditors is required to be published in a general circulation newspaper over three successive weeks. If a creditor is known, then the personal representative (executor) or successor trustee will need to send a copy of the notice to show the creditor received actual notice. A known creditor is anyone who has sent a bill to the personal representative (executor) or successor trustee.

Beneficiaries are also entitled to information from the personal representative (executor) or successor trustee. If the proper information is not provided in the time periods prescribed by Arizona law, the personal representative (executor) or successor trustee can be personally responsible for any resulting harm. A great deal of lawsuits and legal expense can be avoided if this one simple task is done properly. If you are an heir of someone’s trust or estate and want to learn more, please visit our webinar “Are You an Heir” for more information.

This step requires the personal representative (executor) or successor trustee to collect assets, identify and pay creditor claims, and file final tax returns. Let’s consider separately each one of these steps.

First, assets need to be collected. This may be as simple as removing a deceased person’s name from an asset. If there is a beneficiary designation on the asset, this may be accomplished by simply filing a claim. For example, if the asset is life insurance, ownership is likely (but not necessarily) with the deceased person. Life insurance usually has a beneficiary designated to receive it. This asset is collected by filing a claim form, and the other necessary documents required by the life insurance company. Thus, issuance of payment by the life insurance clears title as it pays out the death benefits according to the beneficiary designation in the contract. Other assets require different steps depending on the type of asset being marshaled, and collected.

Next, creditor claims are assessed, accepted and rejected. At a minimum, there are always last illness expenses that need to be paid. For example, the remains will incur burial or cremation expense depending on the wishes of the deceased person and his or her family. All other expenses, and in what order they are paid, needs to be evaluated by the personal representative (executor) or successor trustee. Generally, there is a hierarchy of how these claims are paid before any distribution can be made to heirs. The order is more fully set forth under Arizona law at A.R.S. § 14-3805. This is a trap for the unwary so it is important to review this carefully to avoid preferring one type of creditor to the detriment of another. One also needs to be knowledgeable about how community property plays a role as well as the use of statutory allowances that protect the welfare of the surviving spouse and dependent children.

Lastly, the personal representative (executor) or successor trustee is required to make any appropriate tax filings. Unless someone passes away on the last day of the year, most people will have a short tax year filing as well as an estate return filing. (For example if someone died on March 31, he/she would have one tax year that runs from Jan to March 31, and his/her estate would have a tax year than runs from April 1 to December 31st.) Although beyond the scope of this discussion, what tax returns need to be filed, and when, is different depending on if the deceased utilized a trust or will based plan, or died intestate. At a minimum, one should consult with a certified public accountant (CPA) about what is required. Also, make sure that the CPA you consult is experienced in dealing with estate tax return filings.

Once you have completed all of the other steps above, it is time to make a distribution according to the terms of the will, trust, Arizona intestacy law or asset beneficiary designation. Start by reviewing the document that describes how the distribution is required to be made. Some distributions are very simple – the beneficiary clause states to whom the insurance company should pay the death benefits – and others are far more complex – such as transferring IRA accounts or making the division of assets to capture an estate tax “coupon”. If a personal representative (executor) or successor trustee fails to do this properly, then they open themselves up to any damages that result. This is by far one of the biggest sources of beneficiary disputes that our office is contacted about. Thus, it is important to review this carefully, provide beneficiaries with all the information that they are entitled, and get acknowledgements indicating the beneficiary’s receipt of the distribution and release of any further responsibility by the personal representative (executor) or successor trustee to account for it.