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The 6166 Estate Tax Deferral for Closely Held Business: Q&As

August 29, 2019

 

MARKET TREND: For many business owners, their business interests are their biggest asset, which necessitates careful planning to preserve the business while managing the potential estate exposure.

SYNOPSIS: Internal Revenue Code (“Code”) §6166 is an estate tax deferral provision for estates of decedents holding concentrated positions in qualifying closely held business interests. The Code §6166 permits payment of the estate taxes attributable to those business interests over a maximum 14 year-period, with interest potentially lower than commercially available rates. Yet attaining the benefits of this deferral requires the satisfaction of strict eligibility standards and significant post-election administration. Failure to comply can result in termination of the election and acceleration of the entire deferred liability. In addition, the election does not minimize the estate’s overall tax liability nor defer the taxes associated with non-business assets. 

TAKE AWAYS: In business succession planning, a §6166 deferral election may provide a powerful post-mortem planning tool to help minimize the initial strain on the estate and prevent a forced sale of the estate’s business interest. However, the election’s complex administrative and compliance requirements and the potential for payment acceleration make it an insufficient substitute for lifetime succession planning. Other planning options, such as life insurance, which can be used instead of, or in conjunction with, a contemplated §6166 election, may offer a simpler and more certain approach to the funding of both business and non-business estate tax liabilities. 

Many closely-held business owners have their net worth concentrated in their business, but they may fail to plan for the transition of that business at death, potentially leaving their estates and families unprepared and scrambling to find resources to pay expenses and potential estate tax liabilities. Identifying methods to manage the estate tax payment without jeopardizing the business or forcing the liquidation of estate assets becomes critical in these cases. Under the right circumstances, a Code §6166 deferral election may provide a solution.

WHAT ABOUT SIMPLER OPTIONS?

The §6166 election can offer a powerful post-mortem planning option for estates holding qualifying CHB interests, particularly if the business owner is uninsurable, but rarely will it be a sufficient substitute for lifetime business succession planning given its compliance and administrative complexities and other limitations. Advanced planning that proactively prepares for transition of the business and addresses the potential estate tax liability will generally be the best solution for minimizing confusion, conflict, and the possible loss of a business after a key owner’s death.  Implementing buy-sell arrangements or using lifetime gift or sale strategies to transfer business interest out of the estate to intended successor family members can help manage the estate tax concerns.  

In terms of simplicity, however, acquiring life insurance is one of the most straightforward ways to address estate liquidity needs. It can provide readily-available cash for estate taxes and other expenses promptly after the insured’s death, without the qualification and administrative complexities associated with a §6166 deferral. The policy death benefits should be paid without income tax, and if held in an irrevocable trust, should not be includible in the decedent’s estate. Depending on the product and premium costs, life insurance may be more cost-effective than a §6166 election, or coverage could be acquired in conjunction with a contemplated §6166 election to support payment of the non-deferred estate tax liability and/or as a future funding source for the deferred taxes.

 

 

This material is intended for informational purposes only and should not be construed as legal or tax advice. It is not intended to replace the advice of a qualified attorney, tax advisor, or plan provider.

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