What’s the Best Way to Pay a Business Owner’s Estate Taxes

September 28th, 2022 by admin Leave a reply »

IRC Section 6166 permits the legal representative of the business owner’s estate to pay the portion of the estate tax attributable to the business in installments. During the first four years,Guest Posting interest only is due. Thereafter, annual installments of both interest and principal are due over 10 years.

While Section 6166 can be useful, it does have several drawbacks. First, in order to qualify under Section 6166, the business interest must exceed 35% of the business owner’s adjusted gross estate. Second, interest accrues at the rate of 2% on the deferred tax on the first $1,340,000 (indexed for inflation) of the business interest in excess of the applicable estate tax exclusion amount. But the interest rate on the deferred tax in excess of that amount bears interest at 45% of the rate applicable for tax underpayments (i.e., the short-term applicable federal rate plus 3% adjusted quarterly). Moreover, the interest paid under IRC Section 6166 does not qualify as an administration expense and is not deductible on either the estate tax return (Form 706) or on the estate’s income tax return (Form 1041). Third, the IRS can place a tax lien on the business until all installment payments are met. This lien may make it difficult for the business to borrow from banks and other lenders. Finally, the IRS can demand immediate payment of all unpaid taxes if the estate misses one scheduled payment, or if there is a sale or exchange of one-half or more of the business.

IRC Section 303

IRC Section 303 permits heirs to get cash out of a corporation (either a C corporation or an S corporation) with minimal or no income tax consequences to the extent needed to pay federal and state death taxes, costs of estate administration, and funeral expenses. Thus, Section 303 can help an estate escape a forced sale of the business to pay estate taxes, without having a partial stock redemption taxed as a dividend.

But Section 303 is not without its disadvantages. First, the stock’s value must exceed 35% of the deceased shareholder’s adjusted gross estate to qualify. Second, where will the cash to redeem the decedent’s stock come from? The corporation may not have excess cash with which to redeem stock. And, if the corporation attempts to accumulate cash to redeem stock, it may be subject to a 15% accumulated earnings tax. IRC Sections 531-537. Finally, like any other redemption, a Section 303 redemption can alter the ownership percentages of the surviving shareholders.

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