We have long extolled the virtues of succession planning for family business owners. Discussions around this topic often focus on the tax, creditor, and control advantages of using trusts to transfer value in the family business to the next generation while the senior level retains control over business operations by retaining all voting stock in the business. Early planning can help ease the stress after a founder’s death that often comes from raising liquidity quickly to pay estate taxes on a business.
Occasionally, though, a family business owner may be unwilling or unable to give or sell a meaningful portion of the ownership of the business to successive generations. Perhaps the founder is reluctant to relinquish ownership of the company she and her spouse have worked so hard to build, or maybe an unexpected death or incapacity makes it legally impossible to proceed with estate planning that is started but incomplete. What can be done to minimize the immediate impact of federal estate tax on the business and family under these circumstances?
The answer may lie in section 6166 of the Internal Revenue Code (IRC), which in certain situations permits the executor of an estate to defer federal estate tax on a closely held business following an owner’s death. If the code’s requirements are met, the executor can elect to defer and spread payment of the estate tax attributable to the decedent over a period of up to 14 years. In the early years of the deferral period, installment payments to the Treasury can be made as interest only.
Estate tax deferral under this IRC section relates solely to the portion of the decedent’s estate that represents his ownership in the company. In addition, it is only available to the extent the decedent’s ownership in the closely held business accounted for at least 20% of the company’s value and more than 35% of the value of his adjusted gross estate at the time of death. If these requirements are met, the executor should consider making the election to defer federal estate tax due on that portion of the estate related to the value of the business.