What Are the Section 6166 Election Requirements?

The Section 6166 election allows the executor of an estate to defer payment of federal estate tax attributable to an interest in a closely held business. The purpose of this election is to alleviate the pressure on heirs to sell a family business or farm quickly to generate the cash needed to pay estate taxes. Instead of a single lump-sum payment, the tax can be paid in installments over an extended period.

This deferral can extend up to 14 years, with the estate making interest-only payments for the first several years, followed by payments of both principal and interest. Section 6166 aims to support business continuity by providing a structured payment plan when a large portion of an individual’s wealth is tied up in illiquid business assets.

Core Eligibility Criteria for the Estate

To qualify for the Section 6166 deferral, an estate must satisfy two requirements. First, at the time of death, the individual must have been a U.S. citizen or a resident of the United States. Second, the value of the decedent’s interest in a single closely held business must exceed 35% of the decedent’s adjusted gross estate.

This “35% test” is designed to limit the deferral to estates where a business interest represents a significant concentration of the total wealth. To apply the test, one must first determine the “adjusted gross estate.” This is calculated by taking the decedent’s gross estate and subtracting allowable deductions under Internal Revenue Code Sections 2053 and 2054.

These deductions include funeral expenses, administrative costs, debts of the decedent, and mortgages or liens. Deductions for charitable contributions or marital transfers are not subtracted at this stage. For example, if an estate has a gross value of $12 million and $2 million in allowable deductions, the adjusted gross estate is $10 million.

To qualify for the election, the value of the decedent’s closely held business interest would need to be more than $3.5 million. If the business interest was valued at $4 million, it would represent 40% of the adjusted gross estate, thereby meeting the threshold.

Defining a Qualifying Closely Held Business

After an estate meets the 35% threshold, the business interest itself must qualify. The Internal Revenue Code requires the entity to be engaged in an active trade or business at the time of the decedent’s death. This separates active enterprises from passive investment activities, such as the management of a stock portfolio or undeveloped land.

An active business involves manufacturing, mercantile, or service-oriented activities. For real estate ventures, the IRS looks for significant management and operational activities beyond simply collecting rent. This can include providing extensive services to tenants or handling frequent repairs and maintenance.

Beyond the active business requirement, the decedent’s ownership interest must meet thresholds that vary by business type. For a sole proprietorship, any interest qualifies as long as it is an active trade or business. For a partnership, the decedent must have owned 20% or more of the total capital interest, or the partnership must have had 45 or fewer partners.

The rules for a corporation are similar. The decedent must have owned 20% or more of the value of the corporation’s voting stock, or the corporation must have had 45 or fewer shareholders. Only the value of assets actively used in the trade or business can be counted toward the 35% test; passive assets held by the business are excluded.

If a decedent owned interests in multiple businesses that do not individually meet the 35% test, a special aggregation rule may apply. An estate can combine the interests in two or more closely held businesses and treat them as a single interest. This is permitted only if the decedent owned at least 20% of the total value of each business being combined.

Information and Documentation for the Election

Making a Section 6166 election requires the executor to gather specific information and prepare documentation. The election is not automatic and must be made by attaching a formal notice of election to a timely filed estate tax return. This notice must contain all the information needed for the IRS to validate the request.

The required information for the notice of election includes:

• The decedent’s name and taxpayer identification number.
• The amount of tax the estate seeks to pay in installments.
• The date selected for the first installment payment.
• The total number of annual installments, up to ten.
• The specific closely held business properties that qualify the estate.
• A detailed explanation of the facts that led the executor to conclude the estate meets all requirements.

The election is made on the United States Estate (and Generation-Skipping Transfer) Tax Return, Form 706. The executor makes the election by checking the appropriate box in Part 3 and attaching the notice. The business interests themselves are reported and valued on other parts of the return, such as Schedule F for unincorporated businesses.

The executor must perform the calculations to confirm eligibility and articulate the basis for this conclusion in the notice. This includes detailing how the 35% test was met and how the business meets the definition of an active, closely held enterprise.

The Election Process

The election process is initiated by attaching the notice of election to a timely filed Form 706. The package must be filed by the statutory due date, which is nine months after the decedent’s date of death. This deadline can be extended by filing Form 4768 for an automatic six-month extension.

If an estate may not meet the 35% test based on initial values but could qualify after an IRS audit, the executor can make a “protective election.” This is done by filing a notice of protective election with the timely filed Form 706. A protective election does not defer tax payment immediately but secures the estate’s right to make a final election if an audit later qualifies the estate.

After the Form 706 and notice are filed, the IRS reviews the submission for compliance with all Section 6166 requirements. The review verifies the calculations, active trade or business status, and ownership thresholds. The IRS will then formally notify the executor whether the election has been accepted or if it has identified reasons for denial.

If the election is approved, the estate begins making payments according to the installment schedule. The first payment of principal is due up to five years after the original due date of the estate tax return, with interest-only payments made annually during this initial deferral period. Following this period, the deferred tax is paid in up to ten equal annual installments of principal and interest.