Installment Payments of Estate Tax
Section 6166

Qualification requirements

The estate must meet a single threshold: the value of the closely held business interest must exceed 35% of the adjusted gross estate. The adjusted gross estate is the gross estate minus allowable deductions under Sections 2053 and 2054 (debts, expenses, losses). If the business interest falls below that line, the election is unavailable regardless of how large the business is in absolute terms.

A closely held business for Section 6166 purposes includes a sole proprietorship, a partnership with 45 or fewer partners (or where the decedent owned 20% or more of the capital interest), and a corporation with 45 or fewer shareholders (or where the decedent owned 20% or more in value of the voting stock). Interests in two or more closely held businesses can be aggregated if the decedent held at least 20% of each.

What qualifies as a business interest

Section 6166 requires an active trade or business, not merely passive investment activity. Rental real estate held for investment generally does not qualify unless it rises to the level of a trade or business. Holding companies whose sole activity is managing a portfolio of investments are typically excluded.

The distinction between an active business and a passive holding can be fact-intensive. Farms and ranches, operating companies, professional practices, and manufacturing businesses are straightforward. Real estate operations with substantial management activity can qualify, but the executor must be prepared to demonstrate that the activity constitutes a trade or business under Section 162.

The payment schedule

The election defers the estate tax attributable to the business interest. The deferred tax is paid in up to 10 annual installments, but the first installment is not due until five years after the original due date of the return. During that initial five-year deferral period, the estate pays only interest on the deferred amount. The total deferral window is up to 14 years from the return due date.

The estate tax attributable to the business interest is calculated proportionally. If the business represents 60% of the adjusted gross estate, then 60% of the estate tax is eligible for deferral. The remaining 40% is due on the normal schedule.

Interest rates

Section 6601(j) provides a special 2% interest rate on the estate tax deferred on the first portion of the closely held business interest, up to an inflation-adjusted threshold (the "2-percent portion"). The 2% rate applies to the estate tax attributable to the first $1,940,000 of taxable value of the closely held business interest for 2026 decedents ($1,000,000 indexed for inflation). Estate tax deferred on business value above that threshold bears interest at 45% of the annual underpayment rate.

The interest paid under Section 6166 is not deductible for income tax or estate tax purposes under current law. This is an important planning consideration: the after-tax cost of the deferral must be weighed against the cost of selling assets or borrowing to pay the tax at the normal due date.

Lien and security requirements

The IRS imposes a lien under Section 6324A on the business assets (and potentially other estate assets) as security for the deferred tax. The executor must provide a written agreement consenting to the lien and designating the property subject to it. In practice, the lien can affect the business's ability to borrow, sell assets, or restructure during the deferral period.

Alternatively, the estate can offer a surety bond or a letter of credit in lieu of the lien. Each option has cost and practical implications that must be evaluated in the context of the business's operations and financing needs.

Acceleration events

The deferred tax becomes due in full if certain triggering events occur. The most common acceleration triggers are:

• Disposition of 50% or more of the business interest (whether by sale, exchange, or distribution to someone who is not an eligible heir)
• Withdrawal of 50% or more of the money or property of the trade or business
• Failure to make a timely installment payment of principal or interest
• Failure to comply with the lien agreement

Partial dispositions below the 50% threshold do not trigger full acceleration, but the deferred tax attributable to the disposed portion does become due. The executor must track all business dispositions, withdrawals, and distributions throughout the entire deferral period to avoid an inadvertent acceleration.

Protective elections

If the qualification of the business interest is uncertain at the time of filing (for example, pending appraisals or disputes about the nature of the business), the executor can make a protective Section 6166 election. This preserves the right to defer if the final values support qualification, without committing the estate to installment payments if they turn out to be unnecessary.

Interaction with other elections

Section 6166 can interact with the alternate valuation date election under Section 2032, the Section 303 stock redemption rules, and the special use valuation election under Section 2032A. Each of these elections can change the composition and value of the gross estate, which affects whether the 35% threshold is met and how much tax is eligible for deferral. The interplay must be modeled before any elections are made.

What we handle

• Evaluating whether the business interest meets the 35% threshold and the active business requirement
• Computing the deferred amount, the 2-percent portion, and the installment schedule
• Preparing the election on the Form 706 and the lien agreement
• Tracking disposition and withdrawal limits to prevent acceleration
• Annual compliance: installment payments, interest calculations, and IRS correspondence
• Coordinating with Section 303 redemptions, Section 2032A, and other estate tax elections
• Advising on the cost of deferral vs. alternative liquidity strategies

Related services