Imagine your parents work all their lives to grow and develop a successful business. The intention is to pass it down to their children, keeping it in the family, providing for the family long after they have passed. When that time comes, the value of their estate is large enough that estate tax is due. You, as the beneficiary, now bear the brunt of making an estate tax payment, which could be a significantly large amount, 9 months from the date of their passing. It might seem that your only option is to sell that family business, or part of it, to pay those estate taxes. However, Congress acknowledged this issue and in 1976 enacted IRS Code Section 6166 allowing for an election to be made to grant some relief.
What is an “election” for IRS Section 6166?
The IRS Code Section 6166 “election” means an executor/trustee of an estate can elect or request an extension of time to pay the portion of estate tax allocated to the value of your closely held business. When the value of a closely held business is more than 35% of the entire value of the estate, there is an option to pay the estate taxes over a period of 10 years, starting 5 years from the due date of the original estate tax return. The first 4 years of payments are interest only payments.
Example: 50% of the adjusted gross estate value is made up of a complying closely held business. You have $500,000 of estate tax due (after the correct calculations per your accountant) on your entire adjusted gross estate. You can defer up to 50% of that or $250,000. The estate would make interest-only payments for the first 4 years after the original due date of your return (9 months after the date of death) with an interest and principal payment due in year 5 through year 14.
What is the interest rate on the installment payments?
The IRS allows for a preferred interest rate of 2% on deferred tax up to $740,000 for 2024 (adjusted each year for inflation). The interest rate on any tax over $740,000 is 45% of the federal underpayment rate, which is currently 8%. That means the interest rate on any additional tax is 3.6% as of the first quarter of 2024. It is important to note that the interest on these payments is not deductible. Code section 6166 defers to Code Section 6601(j) for calculating interest on the deferred tax.
How does an estate make this election?
Executors MUST work with an experienced estate tax attorney or CPA to determine if the estate qualifies and to make the election on the estate tax return. The Executor must make the election on an originally filed estate tax return.
It is recommended that you make a protective election if you are unclear whether the estate qualifies to make a section 6166 election.
Anything else we should know?
The IRS can require a Bond or Tax Lien Requirement, which means they place a bond or lien on property as collateral under the election.
The election is not available for passive assets.
Things that could terminate the election, resulting in the acceleration of payments:
- Funds are withdrawn, or a portion of the closely held business is disposed of.
- When an installment payment is delinquent.
- When sufficient collateral is not maintained.
Rental real estate reported on Schedule E and other issues
Don’t automatically assume an estate holding significant amounts of rental real estate will not pass the rules for the 6166 election. Check with your advisors for things to consider when determining if rental real estate qualifies as a trade or business.
Many more issues arise as laws evolve and with each family’s situation. The best advice is to pay attention to new regulations and continue working with your CPA and attorney.
Conclusion:
The estate tax exemption is expected to sunset in 2026, going from $13.61 million per person in 2024 to $5 – $7 million in 2026 (depending on inflation). This means many more individuals could be subject to estate tax. Most people would be hard-pressed to come up with hundreds of thousands of dollars in the nine months following a decedent’s death to cover a larger estate’s tax bill. Even if they could borrow the money, they would be paying today’s higher interest rates, or they may have to put themselves in an unfortunate negative cash flow position. The very worst case, they may have to sell off assets and shutter a closely held business that has been in the family for decades.
Effective and Preemptive estate tax planning can prevent situations like this. But it is important to know that if you do find yourself in a “worst case scenario”, you may have options, and the Section 6166 election is one of them.
DISCLAIMER: We hope this short article on a complicated topic will remind you and encourage you to talk with your attorney and tax advisor now and also when “the time” comes. Don’t put off planning for your and your family’s future.
QUESTIONS? Please get in touch with LSL CPAs.
