IRS 6166 Form: How to Obtain a Federal Estate Tax Extension for Non-Liquid Assets?

Assets worth over $12.92 million are subject to federal estate tax at rates ranging from 18% to 40%. However, this threshold will be reduced to $5 million starting from January 1, 2026, so the IRC Section 6166 election can be extremely useful.

Under the current regulations, you can make a 6166 Section election if you inherit an estate subject to estate tax and cannot collect enough cash to pay the liability.

It’s important to clarify that obtaining Form 6166 Certification of US Tax Residency is only necessary if you own a company that conducts business abroad.

Section 6166 election, on the other hand, is a way to postpone paying estate taxes for the interest you own in a closely held business. The section enables you to pay federal estate tax for the non-liquid assets you inherit in up to ten annual installments.

Let’s look at who can make Section 6166 election and how to use it to obtain a federal estate tax extension.

Overview of Section 6166

Failing to consider estate liquidity is one of the most common estate planning mistakes. Estates that include closely held businesses, in most cases family businesses, often don’t have sufficient liquid assets to cover the federal estate taxes.

A closely held business acts as a non-liquid asset because the heir needs substantial time to sell it at the fair market value and receive the funds they need to pay the federal estate tax.

Beneficiaries of such estates have two options. They can sell non-liquid assets, such as interest in a closely held business, settle the estate tax or make Section 6166 election.

If the estate qualifies for this election, Section 6166 mandates the IRS to act as a lender. The agency’s goal is to allow beneficiaries or personal representatives of an estate to continue to run their businesses or sell them at a reasonable price.

Making Section 6166 Election to Defer Federal Estate Taxes

According to IRC Section 6166, the heirs of the descendant’s estate can defer federal estate taxes:

‘If the value of an interest in a closely held business which is included in determining the gross estate of a decedent who was (at the date of his death) a citizen or resident of the United States exceeds 35 percent of the adjusted gross estate, the executor may elect to pay part or all of the tax imposed by section 2001 in 2 or more (but not exceeding 10) equal installments.’

Consequently, making this election enables you to defer estate taxes for up to fourteen years. You’ll only have to pay 2% interest compounded daily of the interest exceeding the estate tax basic exclusion amount or federal gifts for the first five years.

Afterward, you must make up to ten annual payments to settle the remaining estate tax liability. However, the estate only qualifies for this election if its descendant was a US citizen or resident at the time of their death.

Understanding Closely Held Businesses Under Section 6166

A company must meet specific criteria to qualify as a closely held business under Section 6166.

These criteria aren’t the same for all business entities, so your ability to defer estate taxes will depend on the structure of your business or the company’s stock percentage you own, among other factors.

Here’s the overview of business entities that can qualify as closely held businesses under Section 6166:

• Sole Proprietorship: Your company automatically meets the closely held business requirements if registered as a sole proprietorship, and you’re its only owner. Only the assets actively used to conduct business qualify for tax deferral.
• Corporations: If you own 20% or more of an S corporation or some other corporation type, that stock is treated as an interest in a closely held business if it is included in your gross estate or the corporation has fewer than 45 shareholders.
• Partnerships: The same rules apply to corporations and partnerships, with the only difference being that at least 20% of the partnership’s capital interest must be included in your gross estate.
• Holding Company: You or your private representative must file an election requiring the IRS to treat the holding company’s stock as stock in a business company. Remember that your holding company may have to meet other requirements to qualify as a closely held business under Section 6166.

Passing the 35% Test

You cannot make Section 6166 election if the value of your interest in a closely held business that comes with the gross estate you inherited is under 35% of the adjusted gross estate.

The term gross estate refers to the taxable portion of an estate, including gifts. On the other hand, the adjusted gross estate encompasses certain losses and expenses such as executor fees, foreign death taxes, funeral expenses, or unpaid mortgages.

Benefactors who own interests in two or more closely held businesses can combine them to pass the 35% test if their gross estate features at least 20% of each business’s value.

Passive Assets

Section 6166 defines passive assets as all assets that aren’t actively used in business operations. Hence, passive assets are excluded from the 35% test as their value doesn’t contribute to the value of the benefactor’s interest in a closely held business.

The following assets are treated as passive for the 35% test:

• Cash or all other liquid assets.
• Sole proprietor’s life insurance.
• Owning stock in another corporation. This rule doesn’t apply to active corporations.
• Rental businesses that focus on investment management.
• Real property, although some rental properties can be regarded as active assets.

Filing Form 706 and Making Section 6166 Election

The estate’s representative must make Section 6166 election up to nine months after the descendant’s death. The IRS rejects all untimely filed elections even if they meet all other criteria.

The deadline for making the election is usually the same as the estate tax filing deadline. To make the election, the executor must check the appropriate box when filing Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return.

Estate representatives can use Form 4768 to apply for an automatic six-month extension to file Form 706, 706-A, 706-NA, or 706QDT if they cannot meet the estate tax filing deadline.

Besides a correctly filled out Form 706, an executor must also include a statement titled ‘Notice of Election’ with the estate tax return containing the information below:

• The decedent’s name and TIN.
• The interests in closely held businesses, their item number, and appropriate schedules.
• The list of reasons the estate qualifies for the election.
• The number of installments and the amount of each installment.
• The first installment’s due date.

Estate beneficiaries should consult their representatives and consider the cost-benefit of the Section 6166 election and other factors before opting to use this estate tax relief method.

Moreover, the IRS may place a tax lien on the estate or require a security bond to protect its interest in its tax liability if you use Section 6166 to defer taxes.

The election is considered accepted after the necessary documents are filed. The IRS will contact the estate’s representative if it denies the election.

Estimating Maximum Estate Tax Deferral

After the IRS approves the Section 6166 election, an estate doesn’t have to start paying estate taxes until year five. During that time, the estate is responsible for paying a 2% interest on the first $1.75 million, while the interest rate for any excess amount is 45%.

The maximum amount of estate deferrable under Section 6166 election equals the taxes assessed to the beneficiary’s interest in a closely held business. The estate’s executor must calculate the annual installments when filing for the deferral.

Estate Tax Acceleration

Overpaying an annual installment decreases the amount an estate must pay in subsequent installments. Moreover, estates that make Section 6166 elections can claim refunds if they don’t accelerate payments or participate in an ongoing court case.

Aside from making an estate ineligible for a refund, falling behind on installment payments can trigger tax acceleration. In other words, you’ll be forced to pay the entire estate tax liability if you miss an installment.

Selling a non-liquid asset or generating undistributed net income you failed to direct toward paying the postponed estate taxes can also trigger tax acceleration.

Frequently Asked Questions

Using 6166 to Defer Your Estate Tax Liability

Inheriting a family business can put financial pressure on you if you don’t have enough liquid assets to pay the estate tax. Section 6166 of the IRC allows you to defer estate taxes for up to fourteen years and eliminates the need to sell the estate’s non-liquid assets.

You can make the Section 6166 election if your interest in a closely held business included in the gross estate is over 35% of the adjusted gross estate.

Consulting with your estate’s representative is the best way to determine if you meet the criteria to make this tax relief election. If you need more information about how to use IRC Section 6166 to defer estate taxes, please go to choicerelieftax.com or call 866-8000-TAX to speak with a tax professional who can guide you through the process.