Paying Estate Tax in Installments
Section 6166
When the estate includes a family business, the estate tax bill can be enormous, but most of the value is tied up in the business itself. Section 6166 lets the executor spread the estate tax over up to 14 years instead of paying it all within nine months of death. The goal is to keep the business alive instead of forcing a sale to pay the tax.
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The problem Section 6166 solves
Estate tax is normally due nine months after the date of death. For estates where most of the value is in a family business, farm, or professional practice, that timeline creates a liquidity crisis. The estate may owe millions in tax, but the only way to raise the cash is to sell or borrow against the business. Section 6166 provides an alternative: pay the tax over time, in installments, so the business can continue to operate.
Who qualifies
The estate qualifies if the closely held business interest makes up more than 35% of the adjusted gross estate (the total estate value minus debts and expenses). A closely held business includes a sole proprietorship, a partnership with 45 or fewer partners, or a corporation with 45 or fewer shareholders. Family farms, operating companies, professional practices, and manufacturing businesses typically qualify. Passive rental properties held purely for investment generally do not.
How the payments work
The executor can defer the portion of the estate tax that corresponds to the business interest. For the first five years after the return is due, the estate pays only interest on the deferred amount. After that, the estate makes 10 annual payments of principal plus interest. The total deferral can last up to 14 years.
The first portion of the deferred tax qualifies for a special low interest rate of 2%. The rate on the remaining deferred tax is also below the normal IRS underpayment rate. The interest is not deductible on the income tax return, so it is a real cost that must be factored into the decision.
How the deferred estate tax is paid
The IRS lien
In exchange for letting the estate pay over time, the IRS places a lien on the business assets as security. The executor signs a lien agreement identifying the property. This lien stays in place for the entire deferral period and can affect the business's ability to borrow, sell assets, or bring in new partners.
For some families, the lien is a minor inconvenience. For others, especially if the business needs to refinance or sell a division, it creates real friction. We walk through the practical implications before the election is made.
What can go wrong
The biggest risk is acceleration: the entire deferred balance becoming due at once. This happens if the estate sells or distributes 50% or more of the business interest, withdraws 50% or more of the business's money or property, or misses an installment payment. A single missed deadline or an ill-timed transaction can undo the entire deferral.
The executor must track all business transactions for the entire deferral period to stay in compliance. This is a long-term obligation that outlasts most estate administrations.
Deciding whether to elect
The election makes sense when the estate tax is substantial, the business is valuable but illiquid, and the family wants to continue operating it. It makes less sense when the business can be sold at a fair price, when the interest cost exceeds the benefit of deferral, or when the lien would cripple the business's operations.
We model the total cost of the deferral, including 14 years of interest, and compare it to the cost of selling assets, borrowing from a bank, or using life insurance proceeds to pay the tax. The right answer depends on the family's plans for the business.
What we handle
- Determining whether the business meets the 35% threshold and qualifies as an active business
- Calculating the deferred amount and the annual payment schedule
- Preparing the election on the Form 706 and the lien agreement
- Comparing the total cost of deferral to alternative payment strategies
- Monitoring the estate for acceleration triggers throughout the deferral period
- Annual installment payment compliance and IRS correspondence
Frequently Asked Questions
Does our family business qualify for Section 6166?
The business must be an active trade or business, not a passive investment. Qualifying businesses include sole proprietorships, family farms and ranches, operating companies, and professional practices. The business must also make up more than 35% of the adjusted gross estate (the total estate value minus debts and expenses). Rental properties that are purely passive investments generally do not qualify, but real estate operations with substantial management activity may.
How much does it cost to defer the estate tax?
The IRS charges interest on the deferred amount. The first portion of the deferred tax qualifies for a special 2% interest rate. The rest is charged at 45% of the normal IRS underpayment rate, which changes quarterly. The interest is not deductible on the income tax return or the estate tax return. We calculate the total cost of deferral so you can compare it to the alternatives, such as selling assets or borrowing to pay the tax upfront.
What happens if we sell part of the business during the deferral period?
Selling or distributing 50% or more of the business interest triggers an acceleration of the entire deferred balance, meaning it all becomes due immediately. Smaller dispositions do not trigger full acceleration, but the tax attributable to the sold portion does come due. The executor needs to track all sales, distributions, and withdrawals from the business for the entire deferral period.
Can we keep running the business while we pay the tax in installments?
Yes, the business continues to operate normally. However, the IRS places a lien on the business assets as security for the deferred tax. This can affect the business's ability to borrow money, sell major assets, or restructure. The executor should factor in these practical constraints when deciding whether to elect installment payments.
Related services
Federal Estate Tax (Form 706)
The 6166 election is made on the estate tax return. We prepare it with the election and all supporting documentation.
DSUE & Portability
Preserving the unused exemption for the surviving spouse, coordinated with the installment election.
Estate Administration
The full compliance sequence from date of death through closing, including tax payment strategy.