United States: By The Grace Of … The IRS. Deferred Estate Tax Accelerated For Failure To Make Required Payments

Executors are once again on notice. The United States Tax Court reiterated its position that estate tax deferral and related benefits under Internal Revenue Code (IRC) section 6166 "are privileges granted to the taxpayer by Congress as a matter of legislative grace ... [and that] the provisions of section 6166 which grant such privileges should be given a strict and narrow construction." Adell v. Commissioner, TC Memo 2013-228 (September 30, 2013).

Because the estate failed to make timely payments of required interest, the IRS terminated a previously granted extension of time for payment of estate tax attributable to certain interests in closely held businesses.

Section 6166 – Basics

Under IRC section 6166, a personal representative may elect to defer the estate taxes attributable to an interest in a closely held business and pay the taxes, after a five-year deferral, in ten annual installments.

During the five-year deferral period, the estate pays only interest on the deferred estate tax. For estates of individuals dying in 2013, the interest rate on the unpaid tax is 2 percent on the tax attributable to the first $1,430,000 of value of closely held business interests (or $572,000 of tax) and 45 percent of the interest rate applicable to underpayments of tax (1.35 percent with the current underpayment rate of 3 percent). The 2 percent rate was intended to be a "bargain" interest rate, but when, as now, the rate applicable to underpayments is below 5 percent, the first $572,000 of deferred tax bears interest at the higher rate.

If the extension of time for payment of estate tax is granted, the IRS may terminate the extension and accelerate the payment of the deferred estate tax under the following circumstances:

  • Upon the distribution, sale, exchange or other disposition of 50 percent or more of the value of the decedent's interest in the closely held business,
  • Upon the withdrawal of 50 percent or more of the value of the closely held business, or
  • Upon the failure to pay any unpaid tax within six months from the date the late payment is due.

Adell

In the Adell case, the estate's first representative requested an extension of time to file the estate tax return and pay the estate tax. When the return was filed in the fall of 2007, the representative elected to defer estate tax attributable to certain closely held business interests owned by the decedent (the "deferred estate tax") and to pay the balance of the estate tax due (the "non-deferred estate tax"). The representative did not pay the interest due on the non-deferred estate tax at that time, although it did make timely payments of assessed interest on the deferred estate tax in 2008 and 2009.

The IRS continued to assess interest on the non-deferred estate tax. The number and identity of the estate's representative(s) changed frequently during the administration of the estate due to contentious litigation between the original representative and certain beneficiaries. Throughout that litigation and a contemporaneous estate tax return audit, the estate's representative(s) requested additional extensions of time to pay the interest due, and the extensions were granted in several circumstances.

At the end of 2010, the IRS concluded the audit and issued a notice of deficiency with an upward adjustment of approximately $90 million for the value of certain assets in the decedent's estate. No payment of interest, related to deferred or non-deferred estate tax, was made in 2010. Throughout 2011, the IRS sent notices of interest due, and the estate's representatives failed to make any such payments. In October and November 2011, the IRS issued a final notice and demand for payment of interest and penalties due with a statement that the failure to make such payments would terminate the IRC section 6166 election and all deferred estate tax would be due.

The estate's representatives appealed both the determination of the value of the estate assets and the decision to terminate the estate tax deferral. The estate's representatives made no argument during the appeal as to why the estate tax deferral should not be terminated for failure to make required payments. All matters being considered by the Appeals Officer were unagreed.

The estate's representatives took the matter to the United States Tax Court but found no relief. The Tax Court noted that no payments of interest were made in 2010 and 2011, and no exceptions existed that would prevent the termination of the election to defer estate taxes. The IRC section 6166 deferral terminated as a matter of law, and the court held that all unpaid deferred estate tax, interest and penalties are required to be paid upon demand of the IRS.

Practice Pointers

The executor or personal representative of an estate that elects to defer estate tax under IRC section 6166 should keep the following in mind during the period of administration:

  • Monitor and respond to all notices from the IRS.
  • Make all required payments to the IRS on time, including non-deferred estate tax, interest and penalties.
  • If the estate cannot make a required payment, request an extension of time to pay and explain the circumstances in detail. In the Adell case, the IRS granted several extensions of time to pay the required interest due. It was only when the payments went unpaid and extensions were not granted that the deferred tax was accelerated.
  • An extension of time to pay required tax or interest, once granted by the IRS, may relieve the taxpayer from a late payment penalty, but the taxpayer will owe interest on the tax or interest from the time the payment is due until the payment is actually made.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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