Hi, thank you for tuning into today’s Emerald GEM, which stands for Get Educated in Minutes. I’m Lisa Ligas, National Director of Wealth Strategies for Wilmington Trust’s Emerald Family Office and Advisory and your host for today’s podcast. In today’s GEM I’m going to answer the question: What are some options for paying or deferring estate tax attributed to business assets?
Broadly speaking, the portion of a decedent’s estate value in excess of an exempt amount, which updates every year based on inflation and current law, is taxed at a federal rate of 40%1, and some states may impose an estate or inheritance tax as well. The federal estate tax is due 9 months after the date of death2, but in some cases, it may not be due until the second spouse passes away. In 2025, the first $13,990,000 is exempt from federal estate tax.3 This exemption may be gifted during the decedent’s lifetime, or applied to the estate’s value at death. In addition, some states have also enacted an estate or death tax. However, this podcast will focus solely on the federal estate tax. Specifically, we will look when a potential deferral of payment may be applicable, as well as potential financing options for payment of the estate tax.
When a decedent’s estate includes a significant and illiquid business asset, the administrator is often faced with making a decision on how to pay a very large tax bill within a very short window of time. While selling assets may be an option, usually this is not the desired outcome, and will often result in a lower price due to the pressure for a quick sale.
So, what are some alternatives?
First, a deferral of estate tax may be permissible. Commonly called a 6166 election, it refers to Section 6166 of the Internal Revenue Code, and may allow for the deferral of all or a portion of the estate tax that is attributed to an active trade or business. Under Section 6166, an estate that meets the statutory requirements may elect to pay the estate tax attributable to the decedent’s interest in the business in up to 10 equal, annual installments. The first installment must be made by the fifth anniversary of the due date of the estate tax that is not deferred, without regard to any extension. An estate may qualify for a 6166 deferral if the decedent’s interest in the closely held business exceeds 35% of the adjusted gross estate, the decedent was a US citizen at the time of death, and the estate makes the proper election with a timely filed federal estate tax return.
If the estate qualifies for the deferral, the estate makes an annual, interest-only payment on the deferred portion of the estate tax during the deferral period. Then, beginning no more than five years after the due date of the Federal estate tax return, the estate must begin making no more than ten annual installments.
By statute, a Federal tax lien attaches for no more than ten years after the date of death, to all assets of the gross estate, with few exceptions. As a result, the government is unsecured for a portion of the payment period. However, the IRS may require a surety bond from an estate to ensure that payments are made, or the estate may grant the IRS an extended estate tax lien that does not expire until the estate tax is paid in full or the tax becomes uncollectable.
It is notable that not all business interests qualify for a Section 6166 deferral. As mentioned earlier, the decedent’s interest must be at least 35% of the value of the gross estate, but it must also be an active trade or business, such as an operating company, a family farm, and some real estate businesses. Not all real estate businesses qualify for deferral – for example, if the portfolio is comprised of triple-net leased properties, this is generally considered a passive business and thus not eligible under 6166. Also, it is important to keep in mind that only the portion of the estate tax that is attributable to the operating trade or business may be eligible for deferral.
What is another option for paying the estate tax attributed to a business?
Let’s look at the estate potentially borrowing money to pay the estate tax. One option is known as a Graegin loan, named after a 1988 US Tax Court case, Estate of Graegin v. Commissioner, in which the decedent had a substantially illiquid estate consisting primarily of closely held stock, and the estate borrowed funds on a 15 year note to pay the estate tax.
A Graegin-style loan is a third-party loan structured with a promissory note that is commercially reasonable, has a market rate of interest, and a prohibition against prepayment. Under the right circumstances, it may be possible to use this type of loan to finance the payment of estate tax as well as administrative expenses. Benefits of a Graegin loan include the ability to deduct the full interest amount as an administrative expense, as long as the interest may be calculated with reasonable certainty and is likely to be repaid. Effectively, this reduces the amount of estate tax that is ultimately paid, which in a higher interest rate environment may be substantial.
Generally speaking, certain criteria are required under IRS section 2053 in order for the interest to be a deductible administrative expense. This includes expenses incurred that are actual and necessary in the administration of the estate, such as payments of debts, collection of assets, and distribution of property to beneficiaries. While loans between an estate and a person such as a beneficiary or an entity such as a family limited partnership may be permissible under certain circumstance, higher scrutiny will be given to these loans. More common are loans from an unrelated entity or financial institution. Additionally, there must be a non-tax reason for the loan, such as an estate that is substantially illiquid, and borrowing must be necessary to avoid a forced sale of assets to pay estate tax.
It is important to remember that with both a Section 6166 election and a Graegin style loan, strict adherence to the rules and requirements is necessary, and close coordination with legal, tax, and accounting advisors is prudent. While they may not be available tools in every estate, both may be useful for estates with significant business or illiquid assets.
These are just two examples of financing options for estate tax in substantially illiquid estates. Other borrowing avenues may exist, including refinancing real estate assets or borrowing against other assets of the estate such as a securities portfolio.
Thanks again for joining us today. Please contact your Wilmington Trust advisor if you have any questions about some of the options for financing or deferring estate tax attributed to business or illiquid assets. We would be glad to help you. See you next time!
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