Even with the new for 2014 estate tax exemption of $5.34 million, some estates, and heirs, will still be hit by the federal estate tax. Many of the people likely to be impacted are small business owners. However, as long as certain criteria are met, small business owners may be able to extend federal estate tax payments over 14 years.
Normally, estate taxes must be paid within nine months of the date of death. However, if the estate qualifies, a special election pursuant to IRS code section 6166 can stretch out annual payments for ten years, following a deferral period of five years. Yes, that is 15 years. However, due to the way the payments must be structured, the maximum deferral is 14 years.
In order to obtain this tax advantage, the following criteria must be met:
- The decedent must have been a U.S. citizen;
- An interest in a closely-held business must comprise more than 35% of the decedent’s adjusted gross estate (the gross estate value minus any expenses, debts and losses);
- The personal representative of the estate must make the section 6166 election in a timely manner by filing Form 706;
It is important to note that the deferral only applies to the tax attributable to the business interest. For example, if the business represents 40% of the value of the gross estate, 40% of the estate tax due can be spread out over the 14-year period. The remaining 60% must still be paid within nine months of the estate owner’s date of death. If an election is made to defer the estate tax, interest is due on any unpaid portion of the tax.
Under the regulations, a closely-held business that qualifies for deferral can be:
- A sole-proprietorship;
- An interest in a partnership if 20% or more of the capital interest in the partnership is included in the gross estate, or if the partnership had 45 or fewer partners;
- Stock ownership in a corporation if 20% or more the value of the voting stock is included in the gross estate or if the corporation had 45 or fewer shareholders.
Additionally, the business has to be an active trade or business engaged in manufacturing, mercantile or service functions. So, if for example, the business manages passive assets, the value of the passive assets will have to be taken out of the company in computing the 35% value of the estate.
It is also important to note that the deferred tax may be accelerated in the event of a missed payment or the sale or distribution of the decedent’s share of the business.
The rules for section 6166 are complex and you should not try to use it without competent tax and legal guidance.
It is also important to note that the deferral only applies to federal estate tax and does not apply to any Minnesota estate tax.
To learn more about reducing your estate taxes, visit our free video tips page here.