Business succession: Estate taxes when you never got around to planning
I’m sorry to be the bearer of bad news, but you’re dead.
You lived a good life, had a great family and ran a successful business. You enjoyed life to the fullest by spending every minute you had with your family, having fun or paying attention to the daily struggles and successes of your business. You don’t have many regrets, but one of the things you never got around to doing was planning for the estate tax implications of your business ownership.
Sure, you had a basic estate plan put together, but that was years ago and since that time, the business really took off. Now you’re looking down as your family is struggling with the reality that the business is worth a lot more than what anyone ever really realized and the IRS wants its 40 percent of your taxable estate. It looks like the business may need to be sold.
Hark, here comes your tax advisor to the rescue. You made a big mistake by not planning, but the good news is that your business represents more than 35 percent of the value of your estate. As a result of your estate being “business rich, but cash poor,” your tax advisor is telling your estate’s personal representative that your estate is eligible for an Internal Revenue Code Section 6166 election. Suddenly, the threat of a fire sale of the business isn’t quite as necessary.
According to Section 6166 of the Internal Revenue Code, if a person leaves an estate where the gross-estate value consists of ownership of a closely held business that is more than 35 percent of the total, the personal representative may elect to delay estate-taxes payment, which are due on the estate for up to five years, paying interest only during that time. Payments on the taxes that are due must start before the end of the five-year deferral period and may be paid in annual installments ranging between two and 10 years.
Thus, your personal representative has chosen to postpone payment of your estate taxes for five years and has elected to pay all of the tax due within 14 years after your death.
In this scenario, Section 6166 provided a lifeline that avoided selling the business to pay the estate taxes in a lump sum. However, Section 6166 isn’t available in all circumstances and should not be your succession plan.
The good news is that you are alive and reading this article. The bad news is that Section 6166 is complex (I challenge you to show me a tax law that’s not complex) and comes with many requirements, limitations and traps for the unwary.
Although a successful business succession plan may take considerable time and money, it’s important to consider it an investment in the financial and emotional wellbeing of your family and business.
After all, wouldn’t you prefer to look down from above on your loved ones enjoying the legacy of your hard work rather than on them meeting with your tax advisor to figure out how they are going to divide your estate with the IRS?