Loving Your Business from the Grave: Preserving Liquidity through IRC 6166 Estate Tax Deferment

Internal Revenue Code Section 6166 lays out criteria for helping to preserve wealth and dealing with estate liquidity issues when federal estate tax may be due and the decedent owned one or more closely held entities.

One of the ways successful family businesses lose value upon the death of a majority owner is by the need to sell assets to satisfy estate taxes. Under IRC 6166, a personal representative may defer the payment of estate taxes if the interest in the closely held business exceeds 35% of the decedent’s adjusted gross estate.

Section 6166 spells out several criteria that must be met before the estate may be eligible to defer the payment of federal estate taxes (IRC 6166(a) and (d). These criteria are:

1. The decedent must have been a US citizen or resident at death;
2. The interest in the closely held business must be at least 35% of the decedent’s adjusted gross estate (not the taxable estate); and
3. The estate’s personal representative must make the Section 6166 election on a Form 706 filed in a timely manner

The Adjusted Gross Estate is calculated by taking the Gross Estate and subtracting allowable deductions under IRC Section 2053 and 2054. The Gross Estate is calculated by adding together the fair market value of all assets the decedent owned, or had an interest in, at death, inclusive of cash, securities, real property, insurance, trusts, annuities, business interest and other tangible and intangible assets.

Section 2053 deductions include funeral expenses, administration expenses, claims against the estate, real property taxes, mortgages, liens, and outstanding taxes on pre-death income attributable to the decedent. Section 2054 deductions include losses from fires, storms, shipwrecks, or other casualties, or from theft, when such losses are not compensated for by insurance or otherwise. These 2053 and 2054 deductions are taken into account PRIOR to applying any available charitable or marital deductions, or other deductions to calculate the “taxable estate”.

If the estate meets the Section 6166 requirements, the PR may elect and qualify the estate to pay the estate tax attributable to the decedent’s interest in the closely held business in up to 10 equal, annual installments over a 14-year period.

The first of these annual payments must be made by the 5^th anniversary of the due date of the estate tax liability that is not deferred (i.e. the due date of the estate tax return), or 9 months from date of death, with an available 6 month extension.

If the estate qualifies, the estate pays a reduced rate of interest (2% for the first $1.9M of the business value for 2025) on the portion of the estate tax deferred under 6166. The interest is payable annually during the entire deferral period and in most cases, interest-only payments are required during the first four years of the deferral period (IRC 6166(f) and 6601(j)). Then, the deferral tax is payable in more than ten equal, annual installments beginning on a date that is no more than five years after the initial due date of the federal estate tax return (IRC 6166(a)(1) and (3)).