Making a Section 6166 election allows an estate to defer and pay federal estate taxes attributable to a closely held business interest in installments, providing significant liquidity relief to the heirs.
What is a Section 6166 Election?
Section 6166 of the Internal Revenue Code permits the deferral of federal estate taxes for up to 14 years when a significant portion of a decedent's estate consists of an interest in a closely held business. Instead of a single lump-sum payment, eligible estates can make interest-only payments for the first four years, followed by up to 10 annual installments of principal and interest.
Eligibility Requirements for Section 6166
To qualify for a Section 6166 election, an estate must meet specific criteria:
- Decedent's Status: The decedent must have been a U.S. citizen or resident at the time of their death.
- Business Interest Threshold: An interest in a closely held business must constitute at least 35% of the decedent's adjusted gross estate. The adjusted gross estate is the gross estate less certain deductions (e.g., funeral and administration expenses, debts, and certain losses).
- Closely Held Business Definition: The law defines a "closely held business" broadly, including:
- A sole proprietorship.
- A partnership interest if 20% or more of the capital interest is included in the gross estate, or the partnership has 15 or fewer partners.
- Stock in a corporation if 20% or more of the voting stock is included in the gross estate, or the corporation has 15 or fewer shareholders.
Steps to Make a Section 6166 Election
The process for making a Section 6166 election primarily involves the estate's personal representative (executor or administrator) and proper tax filing:
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Verify Eligibility:
- Confirm the decedent's citizenship or residency.
- Accurately value the closely held business interest and the entire adjusted gross estate to ensure the 35% threshold is met. This often requires professional valuation services.
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Prepare Form 706:
- The estate's personal representative must make the Section 6166 election on Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return.
- This form is used to figure the estate tax imposed by Chapter 11 of the Internal Revenue Code.
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Attach an Election Statement:
- While Form 706 contains a checkbox for electing Section 6166, it's crucial to attach a detailed statement to the return. This statement typically includes:
- A clear declaration that the election under Section 6166 is being made.
- The amount of tax to be paid in installments.
- The total number of annual installments (up to 10).
- The due date for the first installment.
- A comprehensive list of the properties that constitute the closely held business interest, providing their values.
- The facts that support the estate's eligibility for the election.
- While Form 706 contains a checkbox for electing Section 6166, it's crucial to attach a detailed statement to the return. This statement typically includes:
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Ensure Timely Filing:
- The completed Form 706, along with the Section 6166 election statement, must be filed in a timely manner.
- Generally, Form 706 is due nine months after the date of the decedent's death. An extension to file Form 706 (Form 4768) does not automatically extend the time to pay the tax. However, the election itself must be made with a timely filed return (including extensions).
Key Considerations
- Interest Accrual: While the tax payment is deferred, interest accrues on the unpaid balance. A special low interest rate applies to a portion of the deferred tax.
- Acceleration: The deferral can be terminated, and the unpaid balance become immediately due, if certain events occur, such as a significant disposition of the business interest or withdrawal of funds from the business.
- Professional Guidance: Given the complexities of estate taxation, business valuation, and the specific requirements of Section 6166, it is highly recommended to consult with experienced estate attorneys and tax professionals.
By meticulously following these steps and understanding the underlying requirements, an estate's personal representative can effectively utilize Section 6166 to manage estate tax obligations related to a closely held business.
