How does one handle the payment of estate taxes after the death of an owner and avoid the need to sell assets to meet estate taxes? According to Internal Revenue Code Section 6166, a personal representative may defer payment of estate taxes if the interest in a closely held business exceeds 35 percent of the decedent's adjusted gross estate. Here are other elements that must be satisfied:
- The decedent must have been a U.S. citizen or resident at death.
- The estate's personal representative must make the Section 6166 election on Form 706, the United States Estate Tax Return, filed in a timely manner.
- The business has to be active; passive ownership interests don't qualify for deferral.
If the estate satisfies all elements, the estate tax attributable to the closely held business may be deferred, with principal and interest on the deferred tax paid over a 14-year period. During the first five years following the due date of the return, only the interest on the deferred tax must be paid. Generally, interest will be charged on the balance of the deferred tax at 45 percent of the rate in effect for underpayments of tax. However, a special 2 percent interest rate applies to a portion of the deferred tax.
The portion of the tax to which the special two-percent rate applies is the lesser of these two figures:
- The full portion of the estate tax attributable to the closely held business.
- The product of multiplying the 40 percent tax rate by the inflation-adjusted taxable value set by IRC Section 6166. Originally $1 million, the amount has been indexed for inflation to $1.49 million for 2017. So, for decedents dying in 2017, the estate tax that the 2 percent estate tax applies to would be $596,000.
(The actual numbers are often adjusted from year to year, so be sure to check with us before making an exact determination.)
Beginning five years after the return is due, the deferred tax and interest are payable in equal annual installments over a 10-year period.
If you're thinking of using Section 6166 to defer estate taxes, the 35 percent of the decedent's adjusted gross estate is calculated by taking the gross estate and subtracting such deductions as debts, funeral expenses, administration costs, mortgages and liens.
These deductions are taken into account prior to applying any charitable and marital estate tax deductions.
Seeking outside advice is wise when you think you're dealing with a looming estate tax bill. The rules and calculations for Section 6166 are complex, so when you analyze whether or not to use this strategy, you should make sure to conduct proper due diligence with us to determine whether Section 6166 is appropriate and cost-efficient.