Installment Payment of Estate Tax

Generally the most significant liquidity need of an estate is its liability for federal estate taxes. These taxes are due nine months from the date of the decedent’s death. Recognizing that closely-held businesses are likely to face serious liquidity problems, and attempting to create a relief provision to make it unnecessary to sell the business interest to pay death taxes, Congress enacted a provision to permit the deferral of estate tax payments. §6166.

§6166 is available only if the decedent was a U.S. citizen or resident at the time of death, and the value of the decedent’s interest in a closely-held business exceeds 35% of the value of the decedent’s adjusted gross estate (defined in the same manner as under §303. §6166(a)(1). If these tests are met, the personal representative of the decedent’s estate can elect to defer for 5 years payment of the portion of the estate taxes attributable to the closely held business interest (multiply the total estate tax liability times the ratio of the value of the business interest to the value of the adjusted gross estate) and thereafter pay the deferred portion in up to 10 annual installments. The estate tax attributable to non-closely held business assets is due at the regular time, 9 months from the decedent’s date of death.

Chapter 22 of Business Planning Succession describes the installment payment of estate tax and the intricacies of using that method of paying federal estate taxes.

Redemptions to Pay Taxes

Redemptions of stock may be necessary to pay death taxes attributable to stock ownership in closely held corporations. Congress enacted a special relief provision, § 303 of the Internal Revenue Code. § 303 treats as an exchange (and not a dividend) a redemption of the decedent’s stock so long as more than 35% the decedent’s adjusted gross estate consists of the stock of the closely held corporation.

Chapter 21 of Business Succession Planning deals with redemptions to pay taxes pursuant to this provision and explains the requirements of § 303 and important preparatory strategies if it is foreseeable that § 303 will be used.

Gifting of Ownership Interests

Consistently business owners are told by tax advisors that it is better to not own a business interest at the time of death. From the point of view of the owner’s estate, there is the problem of having to include the value of the business interest in the estate. Aside from the issues involving payment of the tax, there is the issue of the appropriate value to place upon the business interest and whether that value will be attacked by taxing authority. From the point of view of the business, there is the problem of who will become the new owner or owners of the business interest. Will the new owner or owners also be managers of the business? If they are not managers, will the aspect of investment return on the owners’ interest be emphasized in a way it was not before?

There is no panacea in simply gifting business interests to children. Frequently much of the wealth of the family is in the business. There are tax and natural incentives to transfer the business to the children. There usually is a strong, if not overwhelming, desire on the part of the parent to treat children equally. Frequently not all of the children will be involved in the business. When this is the case, the effect of having inactive or non-managing owners should be carefully considered as a part of the overall estate planning process. The tension between owner-managers and passive owners is usually that certain benefits are available from the business to owner-managers. These may include fringe benefits, life style enhancements involving travel, automobile use, and other business-related expenses that will not be available to passive owners. The value of these benefits will be difficult to develop, but it will affect the profit of the business, which will be the primary concern of the passive owner.

Chapter 20 of Business Succession Planning deals with the means by which the gift of a business interest can be accomplished and the factors involved with that process. The chapter covers why the gifting of a business interest is more attractive from an estate tax perspective than a gift at death. The difference in the basis acquired by the donee as compared to a purchaser of a business interest is explained. Also techniques of gift giving are explained.