By: Randall A. Denha, Esq.
For individuals who own interests in one or more successful family or privately owned businesses, the potential estate tax liability attributable to those interests may be of great concern. These business interests will be included in the owner’s gross estate for federal estate tax purposes and, to the extent estate tax is due, the business owner may be concerned that there are insufficient liquid assets in his/her estate to pay the tax and his/her surviving family members will be forced to sell the business in order to pay the tax. When the level of estate tax is significant but an immediate payment would require the untimely liquidation of one or more assets, the ability to defer payment of the estate tax can be quite important to all involved. A section of the Internal Revenue Code (Section 6166) sets forth the requirements for deferring the tax on the value of a closely held business included in the estate. In effect, Congress has provided a method for opting to pay this tax in installments rather than in a lump sum soon after the death of the business owner.
If an “interest in a closely-held business” is part of an individual’s gross estate and the value of such business interest exceeds 35% of the adjusted gross estate, then the payments of the related estate tax (i.e., the tax attributable to the value of the business interest) can be deferred for five years. Interest on the tax is required to be paid during the first four year period, after which the tax (and accrued interest) is required to be paid in installments, beginning on the fifth year and over the succeeding ten years. The rate of interest required to be paid is significantly less than the rates typically available through commercial borrowing. You are allowed to pay the entire amount of tax early any time you want, but if you stay on the maximum ten payment schedule, the taxes will be completely paid off in ten years.
The family business can be owned directly as a partnership, a limited liability company, or as a corporation. If it is a partnership, you must own at least 20% of the partnership at the time of your death to qualify for the 6166 extension. If it is a corporation, you must own at least 20% of the voting shares. A partnership or corporation must also have 45 or fewer owners of the business to qualify. In addition, the portion of the business you own must be valued at your death at 35% or more of your total estate value. You can add together the value of two or more businesses to cross this 35% threshold as long as you and your spouse together own at least 20% of each business.
The primary issue in determining eligibility for the estate tax deferral under Section 6166 is whether the business interest constitutes a qualifying “interest in a closely-held business” versus mere management of investment assets. This issue has been particularly relevant to individuals who own interests in real estate (e.g., residential rental properties, commercial properties and entities that own such property). The 6166 extension is designed to help active family businesses stay in business by giving family members an extended period of time to pay the estate taxes related to the value of the business. Many types of family businesses qualify for this tax extension, including retail stores, service companies, manufacturing companies, companies active in management of real estate, and lending and financing businesses. Merely investing in the stock market or holding cash is not considered a business for purposes of Section 6166.
Your estate and family can use the 6166 estate tax payment extension if you need extra time to make the business-related estate tax payment. Remember, however, that Section 6166 does not reduce estate taxes for your family. It merely helps your family make payments over a longer period of time.
During your life, you can make planning choices to leave Section 6166 available as a payment option for your estate as a part of your overall estate plan. If there are more than 45 owners of the business, you can keep at least a 20% ownership in the business instead of selling it all or giving it away during your lifetime. You may also choose to sell or give away different assets in order to increase the percentage the family business bears to the overall value of your total estate in order to meet the 35% test.
After your death, your family members and your business managers have requirements they must follow to allow the 6166 extension to continue for the full 14 years. Restrictions will be imposed on their ability to transfer or sell more than 50% of the business and the amount of cash that they can remove without using the cash to make an estate tax payment. If these restrictions are broken, for example, if the family sells the business to an outside buyer, then the full amount of unpaid estate taxes becomes due and payable.