IRC 6166: Extension of Time for Estate Tax Payment Explained

Estate taxes can create liquidity challenges, especially when much of an estate consists of illiquid assets like real estate or a family business. Selling these assets quickly to cover tax liabilities may not be ideal, so the IRS allows certain estates to defer payments under IRC Section 6166.

This provision lets eligible estates extend tax payments over time rather than paying the full amount immediately. Understanding its terms and conditions helps executors manage tax obligations without forcing the premature sale of valuable assets.

Qualifying Estates

Not every estate qualifies for the extended payment option. To be eligible, at least 35% of the adjusted gross estate must consist of a closely held business interest, ensuring the provision benefits estates that would face financial strain if required to pay estate taxes immediately.

A closely held business includes sole proprietorships, partnerships, and corporations. If the business is a corporation or partnership, the decedent must have owned at least 20% of its total value or the entity must have had no more than 45 owners. These restrictions prevent large, widely held businesses from using a provision designed for family-run or small enterprises.

Real estate rental businesses often raise eligibility questions. The IRS generally does not consider passive rental activities as an active trade or business unless the estate can demonstrate significant management involvement. Estates with substantial real estate holdings must prove active participation in operations to qualify.

Payment Schedule

Executors electing the deferral under IRC Section 6166 can extend estate tax payments for up to 14 years. Payments are structured in two phases: an initial deferral period followed by installment payments.

For the first five years, only interest on the deferred tax is due annually. Beginning in the sixth year, both principal and interest must be paid in equal annual installments over the next ten years.

Missing a payment or underpaying can result in the IRS accelerating the full tax liability, eliminating the deferral benefit. Executors should establish a structured payment plan and monitor deadlines closely to avoid penalties.

Interest Calculation

The IRS applies a reduced interest rate to deferred estate tax payments. As of 2024, the first $1.75 million of deferred tax is subject to a 2% interest rate, while any amount exceeding this accrues interest at 45% of the IRS’s standard underpayment rate.

Interest accrues annually and must be paid on time to maintain the deferral agreement. Unlike the principal, which follows a structured installment plan, interest payments begin immediately. Failure to meet interest obligations can result in penalties and termination of the deferral.

Termination of Extension

The ability to defer estate tax payments depends on continued compliance with IRS requirements. Certain events can trigger immediate termination, making the full outstanding tax liability due.

A primary reason for termination is a substantial disposition of the closely held business interest. If more than 50% of the business is sold, exchanged, or transferred—excluding transfers to heirs under IRC Section 6166(g)(1)—the IRS may revoke the extension.

Failure to meet payment obligations also jeopardizes the deferral. If an estate misses a deadline or underpays, the IRS can accelerate the entire remaining balance. While short-term relief may be available under IRC Section 6161, repeated delinquencies can lead to termination.

Administrative Requirements

Electing the estate tax deferral requires strict adherence to IRS filing procedures. Executors must formally elect the deferral by attaching a written notice to a timely filed Form 706, the United States Estate Tax Return. This notice must include details such as the decedent’s interest in the closely held business, the percentage of the estate composed of that business, and a calculation demonstrating that the 35% threshold is met. Errors or omissions can result in the IRS denying the election.

Once the election is made, estates must submit annual payments on time and may need to provide financial updates if requested by the IRS. If the estate amends its valuation of the business or other assets, it must notify the IRS, as changes could impact eligibility. Executors should maintain detailed records of business operations and ownership structure, as the IRS may audit the estate to verify continued qualification. Given the complexity of these requirements, many estates engage tax professionals to ensure compliance and avoid costly mistakes.