CLOSELY HELD BUSINESS LEADER: Deferring estate taxes

DATED MATERIAL: 2 minute read – the gift and estate tax exemption amount is high enough ($12.92 million in 2023) that you may not think you need to worry about transfer taxes after you die. But if you have significant wealth in an illiquid closely held business, this may not be the case. One possible solution can be found in Internal Revenue Code Section 6166. This provision enables the estates of closely-held family business owners to defer estate taxes and pay them in installments.

First off, let’s start by saying this article’s solution is written from an advanced life insurance advisor solutions perspective. The best plan, like a winning NASCAR driver and vehicle, have a few very important people that make up the pit-crew. In this case, an estate planning attorney, a CPA familiar with this subject, and then the experienced insurance advisor.  But, most importantly, the “Driver”, or client who is willing to listen and learn, bringing all thoughts and questions to the table.

1. When may An Installment Election under IRC SEC. 6166 Be Made:

According to the Internal Revenue Code section 6166, a personal representative may defer payment of estate taxes if the interest in a closely held business exceeds 35 percent of the decedent’s adjusted gross estate. Section 6166 spells out several criteria that must be satisfied before the estate may be eligible to defer the payment of federal estate taxes:

• The decedent must have been a U.S. citizen or resident at death.
• An interest in a closely held business must comprise more than 35 percent of the decedent’s adjusted gross estate.
• The estate’s personal representative must make the section 6166 election on a Form 706 Federal Estate Tax Return filed in a timely manner.

2. The Benefits of Tax Deferral under IRC SEC. 6166:

When a timely election is made under IRC SEC. 6166, certain estate taxes may be deferred temporarily up to 5 years, with the balance paid in installments, over a maximum of 14 years. IRC SEC. 6166, a low 2% interest rate applies to a portion of the outstanding tax owed for the duration of the installment period.

3. How Does Life Insurance Fit In Here:

First-off, this helps temporarily relieve the tax burden that results form ownership of the business, it does not apply to the other assets in the estate. In other-words, the estate could still face an immediate estate tax burden that would not be able to defer under IRC SEC. 6166.

Life insurance provides cash when the estate needs it. Regardless of whether the estate qualifies under this. The death benefit supplies liquidity needed to meet all estate tax obligations. It also helps satisfy future liquidity pressures which often reduce the net estate payable to applicable heirs. Additionally, gifting of premiums during your lifetime reduces the size of the taxable estate.

Summarized:

1. FIRE SALE: Cash from the life insurance policy eliminates the need for a forced sale of the business or other assets to meet the estate tax obligations.
2. TAX EFFICIENT: Life insurance in this case may be a tax-efficient  complement to the tax deferral election under this.
3. EXACTNESS: Life insurance provides estate liquidity exactly when its needed, regardless of whether the estate qualifies for tax deferral under IRC SEC. 6166. Eliminating uncertainty about how future tax installments will be met.
4. ESTATE VALUE: Gifted premium payments on the life insurance policy reduce the taxable state.

CONCLUSION:

Liquidity to meet the estate tax burden ca present challenges when a large portion of the estate consists of an interest in a closely-held business. Options are always nice to consider, and in this case, the option to defer some estate taxes, and then pay it in installments through IRC SEC. 6166 can be very timely and useful. This provides considerable enhancements when used in combination with the properly designed life insurance policy, providing solid standalone source of liquidity without the limitations that apply with 6166.

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