What is the Section 6166 election for estate tax deferral?

IRC § 6166 allows an estate to defer payment of estate tax attributable to a closely held business interest over up to 14 years when the business comprises more than 35% of the adjusted gross estate. The estate pays only interest for the first 4 years, then installments of principal and interest over the remaining 10 years.

What events can accelerate the deferred estate tax payments under Section 6166?

Acceleration events include disposition of 50% or more of the business interest, withdrawal of 50% or more of the business value, failure to make a scheduled installment payment, and other events indicating the estate no longer holds a substantial interest in the closely held business that justified the deferral.

The Section 6166 Election: Deferring Estate Tax for Closely Held Business Interests | Lynch Law

When a business owner dies, the estate tax bill can present a liquidity crisis. The estate may hold a valuable closely held business interest but lack the cash to pay the estate tax within the normal nine-month deadline. Selling the business to raise funds defeats the purpose of succession planning, and borrowing against the business may not be feasible. Congress addressed this problem decades ago with IRC § 6166, which allows an estate to defer the payment of estate tax attributable to a closely held business interest over a period of up to fourteen years. For qualifying estates, the § 6166 election can be the difference between preserving the family business and being forced to liquidate it.^[1]

Eligibility Requirements

The § 6166 election is available when the value of a closely held business interest included in a decedent's gross estate exceeds 35% of the adjusted gross estate. The adjusted gross estate is the gross estate less deductions for expenses, debts, and losses under §§ 2053 and 2054. This threshold is measured at the date of death (or the alternate valuation date, if elected), and it is the single most important eligibility requirement.

A "closely held business interest" for § 6166 purposes includes a sole proprietorship, a partnership interest (if 20% or more of the total capital interest is included in the decedent's gross estate, or if the partnership has 45 or fewer partners), and stock in a corporation (if 20% or more in value of the voting stock is included in the decedent's gross estate, or if the corporation has 45 or fewer shareholders). For purposes of the 20% and 45-partner/shareholder tests, the decedent is treated as owning the interests held by certain family members through attribution rules.^[2]

Multiple business interests can be aggregated to meet the 35% threshold if the decedent owned at least 20% of the total value of each business. This aggregation rule can be critical when the decedent held interests in several related entities, none of which individually exceeds 35% of the adjusted gross estate.

The Deferral Period

If the election is made, the estate may defer the payment of estate tax attributable to the closely held business interest for up to five years (paying only interest during this initial deferral period), followed by up to ten annual installments of principal plus interest. The total deferral period is therefore up to fourteen years from the original due date of the estate tax return. The first installment of principal is due five years and nine months after the decedent's date of death.

The interest rate on the deferred tax is favorable. For the first $1,750,000 (indexed for inflation; $1,750,000 for 2024 estates) of taxable value attributable to the closely held business, the interest rate is 2% per year. For amounts above this threshold, the rate is 45% of the annual underpayment rate under § 6621. Even at the higher rate, this is typically below commercial lending rates, making the § 6166 deferral an attractive financing mechanism.^[3]

Making the Election

The § 6166 election is made on the estate tax return (Form 706) by attaching a notice of election that identifies the closely held business interest, the amount of estate tax to be deferred, and the number of installments. The election must be made by the due date of the return, including extensions. A protective election may also be filed when there is uncertainty about whether the estate will qualify — for example, when the value of the closely held business interest is being disputed with the IRS and the outcome of the dispute will determine whether the 35% threshold is met.

The executor should carefully consider whether to make the election before the return is filed. Once made, the election is generally irrevocable. Conversely, failing to make the election on a timely filed return can result in the permanent loss of the deferral opportunity, though the IRS has granted relief in some cases involving reasonable cause.

Acceleration Events

The deferred tax can be accelerated — meaning the entire unpaid balance becomes due — if certain events occur during the deferral period. The most significant acceleration triggers are: (1) the distribution, sale, exchange, or other disposition of 50% or more of the value of the closely held business interest; (2) the withdrawal of 50% or more of the value of the assets of a trade or business; and (3) the failure to make a timely installment payment and the continued failure after notice from the IRS.^[4]

The disposition trigger requires careful planning. If the estate or its successors contemplate selling a portion of the business, redeeming stock, or making significant distributions of business assets during the deferral period, they must calculate whether the cumulative dispositions will reach the 50% threshold. A well-intentioned partial sale or redemption — undertaken, perhaps, to raise funds for other estate obligations — can inadvertently trigger acceleration of the entire deferred tax.

Careful structuring of the business succession plan can mitigate acceleration risk. Transfers to family members who are eligible to continue the § 6166 deferral, and certain tax-free reorganizations, generally do not constitute dispositions for acceleration purposes. But these rules are technical and require careful navigation.

Practical Considerations for Estate Planning

The § 6166 election should be part of the estate plan for any client who owns a closely held business that may represent a significant portion of the gross estate. While the election is made after death by the executor, the planning must occur during life. The estate plan should be designed to ensure that the closely held business interest represents more than 35% of the adjusted gross estate — which may involve structuring other assets, managing debt, and coordinating the business interest with other estate planning vehicles such as trusts and family limited partnerships.

The executor's role is critical. The executor must identify the § 6166 opportunity, gather the information necessary to make the election, and file the election on a timely basis. The executor must also manage the deferral period — making timely interest and principal payments, monitoring for acceleration events, and working with the IRS on any issues that arise. Given the stakes involved, the executor should be working with experienced tax counsel from the outset.^[5]

References

^[1] IRC § 6166 (extension of time for payment of estate tax where estate consists largely of interest in closely held business).
^[2] IRC § 6166(b) (definitions of closely held business interest, including the 20% ownership and 45-partner/shareholder tests); IRC § 6166(b)(2)(D) (attribution rules).
^[3] IRC § 6601(j) (2% interest rate on deferred tax attributable to the first portion of closely held business value); IRC § 6166(a) (installment payment schedule: 5-year interest-only deferral plus 10 annual installments).
^[4] IRC § 6166(g) (acceleration events: disposition of 50% or more of business interest, withdrawal of 50% or more of business assets, failure to make timely installment payment).
^[5] See Estate of Roski v. Commissioner, 128 T.C. 113 (2007) (addressing protective § 6166 elections and the interaction between valuation disputes and eligibility).