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Stretch Out Estate Tax Payments

(posted: July 8th, 2016)

Lighten estate tax load with installment payments

The generous $5 million federal estate tax exemption, indexed to $5.45 million in 2016, gives most families plenty of leeway. But some heirs may still have to pay the 40% federal estate tax rate.

Strategy

Lighten up the load via installment payments. You can provide instructions on this matter to the executor of your estate of benefit when you inherit assets.

With the installment method, the family stretches out payments for more than a decade if business interests comprise a significant percentage of the deceased person's estate.

Here's the Whole Story

Normally, estate tax must be paid within nine months of death. However, if the estate qualifies, a special election can stretch out annual payments for 10 years following a deferral period of five years. (Technically, the maximum deferral period is 14 years, not 15, because of the way the payments are structured).

This estate tax break is available only if the estate includes a farm or closely held business with a value exceeding 35% of the “adjusted gross estate” (i.e., the gross estate value minus any expenses, debts and losses). For this purpose, a closely-held business may include:

  • A sole proprietorship
  • An interest in a partnership if 20% or more of the total capital interest in the partnership is included in the gross estate, or if the partnership had 45 or fewer partners
  • A stock ownership in a corporation if 20% or more of the value of the voting stock is included in the gross estate or if the corporation had 45 or fewer shareholders.

Reminder

The estate tax deferral only applies to closely-held business interests. For example, if those interests represent 50% of the gross estate, 50% of the estate tax may be spread out over the 14-year period. The remaining 50% must be paid within nine months of the estate owner's death.

If the election is made to extend estate tax payments, the heirs will owe interest annually on the unpaid portion of the tax. However, the estate is required to pay just a 2% interest rate on the amount attributable to the first $1 million, indexed to $1.48 million in 2016, of the taxable value of the business interest.

Tip: The normal IRS interest rate for tax underpayments applies to amounts above the indexed threshold.

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Images: 123RF

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