Paying Estate Tax in Installments Under Section 6166

Estate tax is a tax on value, and value is not cash. An estate whose main asset is a family business, a manufacturing company, a farm, or an operating real estate business can owe millions in estate tax with nothing like that sitting in the bank.

Without relief, the executor's choices are ugly: sell the business in a hurry, borrow at whatever terms a lender will offer, or strip the company of working capital. IRC 6166 gives a better option. If the estate qualifies, the executor can elect to defer the tax attributable to the business for up to five years and then pay it in up to ten annual installments.

The 35 percent test

IRC 6166(a)(1) allows the election when the value of an interest in a closely held business included in the gross estate exceeds 35 percent of the adjusted gross estate. The decedent must have been a U.S. citizen or resident.

The adjusted gross estate, defined in IRC 6166(b)(6), is the gross estate reduced by deductions allowable under IRC 2053 (funeral and administration expenses, debts, mortgages) and IRC 2054 (casualty and theft losses). The marital and charitable deductions are not subtracted.

The test is applied using estate tax values, determined immediately before death. Two or more businesses can be combined under IRC 6166(c) if the estate includes 20 percent or more of the total value of each.

IRC 2035(c)(2) has an anti-gaming rule for property transferred within three years of death, so a decedent cannot qualify an estate by giving away other assets shortly before dying.

What counts as a closely held business

IRC 6166(b)(1) defines an interest in a closely held business as:

• An interest as a proprietor in a trade or business carried on as a proprietorship.
• An interest as a partner in a partnership carrying on a trade or business, if 20 percent or more of the total capital interest is included in the gross estate, or the partnership had 45 or fewer partners.
• Stock in a corporation carrying on a trade or business, if 20 percent or more in value of the voting stock is included in the gross estate, or the corporation had 45 or fewer shareholders.

Family attribution rules in IRC 6166(b)(2)(D) treat interests held by family members as owned by the decedent for counting partners and shareholders.

The phrase "carrying on a trade or business" does real work. IRC 6166(b)(9) excludes the value attributable to passive assets held by the business. A holding company that owns a portfolio of marketable securities, or rental property that the owner passively collects rent on, may not qualify. Active management of real estate can qualify, but the facts matter and the IRS looks closely.

How much tax can be deferred

Not all of the estate tax qualifies. Under IRC 6166(a)(2), the deferrable amount is the portion of the estate tax that bears the same ratio to the total tax as the closely held business amount bears to the adjusted gross estate. If the business is 60 percent of the adjusted gross estate, up to 60 percent of the estate tax can be paid in installments. The rest is due at nine months.

The payment schedule

Under IRC 6166(a)(3), the executor selects the date of the first installment, up to five years after the normal due date. During that deferral period, under IRC 6166(f)(1), the estate pays only interest, annually.

After that, the deferred tax is paid in two to ten equal annual installments, with interest paid along with each one. A ten-installment schedule after a full five-year deferral stretches the last payment to about fourteen years after the original due date.

The interest rate

IRC 6601(j) provides a favorable rate. Interest on the "2-percent portion" of the deferred tax is 2 percent. For decedents dying in 2026, Rev. Proc. 2025-32 sets the dollar amount used to compute the 2 percent portion at $1,940,000. Interest on the deferred tax above the 2 percent portion is 45 percent of the regular underpayment rate.

There is a trade-off. Interest paid on 6166 deferred tax is not deductible for estate tax or income tax purposes. The low rate is the benefit; the lack of a deduction is the cost.

Making the election

IRC 6166(d) requires the election to be made no later than the due date of the Form 706, including extensions. It is made by attaching a notice of election to a timely filed return with the information the regulations require, including the decedent's name and identification number, the amount of tax to be paid in installments, the date of the first installment, the number of installments, and the facts showing the estate qualifies.

An estate that misses the election on the original return has a narrow second chance. IRC 6166(h) lets a qualifying estate elect installment treatment for a deficiency within 60 days after notice and demand, as long as the deficiency is not due to negligence, intentional disregard of rules, or fraud.

A protective election is also possible when it is unclear whether the estate will qualify, for instance because a valuation is likely to be challenged. That preserves the option if final values satisfy the 35 percent test.

Security: bond or special lien

The IRS can require security for deferred tax under IRC 6165, typically a bond of up to double the deferred amount. As an alternative, IRC 6324A lets the executor and the beneficiaries agree to a special lien on specified property, often the business interest itself or real estate, valued at least equal to the deferred tax plus a measure of interest.

The 6324A lien matters because the ordinary estate tax lien under IRC 6324 expires ten years after death, while a 6166 schedule can run longer. The special lien covers the gap. It also counts as the bond for purposes of an executor's discharge under IRC 2204.

Acceleration: how the deferral ends early

IRC 6166(g) lists events that end the installment arrangement and make the remaining tax due on notice and demand:

1. Dispositions and withdrawals of 50 percent or more. Selling, exchanging or otherwise disposing of the business interest, or withdrawing money or property from the business, in an aggregate amount equal to 50 percent or more of the value of the interest. Transfers to heirs under the will or by intestacy are excepted, as are certain section 303 redemptions used to pay estate tax.
2. Missed payments. If a principal or interest payment is not made on time, the deferral ends, unless the payment is made within six months. In that case, the 2 percent rate is lost for that payment and a penalty of 5 percent per month applies.
3. Undistributed estate income. If the estate has undistributed net income in any year after the first installment is due, it must apply that income to the deferred tax.

Families running a business under a 6166 election need a calendar and a policy on distributions. A sale of the business in year eight can be the right decision, but it is a tax event for the estate too.

The statute of limitations

Under IRC 6503(d), the period for collecting the deferred tax is suspended for the period of the extension. The IRS has as long as it needs to collect the installments.

When 6166 is not the answer

Estates that do not meet the 35 percent test, or whose problem is temporary illiquidity rather than a business, may qualify for an extension of time to pay under IRC 6161, which requires reasonable cause. Others may be better served by borrowing or selling non-business assets. The math depends on interest rates and the family's plans for the business.

And everything starts with values that will hold up. If the business is valued aggressively low to save tax and later adjusted upward, the 35 percent test, the deferrable amount and the installment schedule all move. See estate valuation disputes.

If an estate's wealth is tied up in a business and the Form 706 deadline is approaching, call (813) 229-7100. Let's talk.