When the owner of a closely-held business dies, his or her estate immediately encounters what may be a major challenge: liability for the estate tax resulting from the value of the decedent’s interest in the closely-held business.  In general, this tax must be paid within nine months of the decedent’s death, and it is often the case that neither the estate nor the business has sufficient liquid assets from which to satisfy the estate tax: it is not unusual for the decedent’s interest in the business to represent the most valuable asset of the estate.  In order to satisfy this liability, the estate may be faced with a “forced” sale of the business, or it may have to leverage the business and other assets, relying upon the cash flow from the business to service the debt.

Section 6166 to the Rescue

Fortunately for the estate, there are alternative options to consider that may allow it to avoid the immediate sale or leveraging of the business.  One such option is found in Section 6166 of the Internal Revenue Code.  Under this provision, which was enacted to help preserve closely-held businesses, the estate may elect to pay the estate tax attributable to the value of the decedent’s interest in the closely held business over a period of ten years.  Furthermore, these payments are due beginning five years after the estate tax return is filed (with only interest payable until the fifth year).

In order to qualify for this benefit, the value of the interest in the closely-held business must exceed 35% of the decedent’s adjusted gross estate.  In addition, the business entity must be carrying on an active trade or business.

However, the estate is not in the clear just yet: if any portion of the interest in the closely-held business is distributed, sold or otherwise disposed of, or if money or other property is withdrawn from the business, and the aggregate of such transactions equals or exceeds fifty percent of the value of such trade or business, then the extension of time for payment of the tax ceases to apply, and the IRS may demand payment of the unpaid portion of the estate tax.

The logic behind this acceleration rule is fairly obvious.  If the interest is sold, for example, and the estate thereby becomes liquid, then the justification for installment payments—to preserve the interest in the closely-held business—no longer exists.

An Exception to the Acceleration Rule: Reorganizations

But what if the disposition involves neither a sale, nor a withdrawal of cash, and is undertaken for a valid business reason?  The IRS addressed this issue in a recent letter ruling.

The decedent died owning interests in various closely-held businesses, including a real estate partnership that owned several properties.  His estate elected to pay the estate tax in installments under Section 6166.

For what were represented to be good business reasons, the real estate partnership proposed to distribute each of its real properties pro rata to the estate (as the successor to the decedent’s interest) and to the other partners.  Thereafter, these distributees would contribute their respective interests in the properties to separate LLCs in return for pro rata interests therein.  Each LLC would own a separate real property and would continue the active business previously conducted by the partnership with respect to the particular property.

The IRS ruled that the proposed distributions from the partnership and the subsequent contributions to the various LLCs, would not constitute proscribed distributions or dispositions that would terminate the installment privilege, because they did not materially alter the business or the interest of the estate in the business.  Rather, the relative ownership interests were not changed, the operation of the business continued in substantially the same manner as before, and no money or other property was withdrawn from the business formerly conducted by the partnership.


This ruling, and several others, demonstrate that it may be possible for a decedent’s estate to restructure the business entity in which the decedent held an interest without sacrificing the benefit of paying the estate tax in installments, provided the conditions set forth in the ruling are satisfied.  It also reflects a practical approach by the IRS in recognizing that an estate may have valid business reasons for a reorganization of its holdings. Thus, for example, it may be possible to remove the assets of a business from a corporation and contribute them to an LLC, without losing the installment privilege.  However, it is important to consider the potential impact of income taxes before embarking on any restructuring, including the change in the adjusted basis of a decedent’s interest in a business that occurs upon his death.