Section 6166: Paying Estate Tax on a Family Business Over Time

How it works

Estate tax is normally due 9 months after death. For a family whose wealth is an operating business, that can force a fire sale. Section 6166 lets the executor elect to pay the part of the estate tax attributable to a closely held business in 2 or more (but not more than 10) equal annual installments. The first installment can be set as late as 5 years after the regular due date. In the years before that, the estate pays interest only. The longest path is roughly 14 years from the original due date to the last installment.

Only the tax attributable to the business interest can be deferred. Tax on the rest of the estate (cash, securities, a residence) is due on time.

Who qualifies

• The 35 percent test. The value of the closely held business interest included in the gross estate must exceed 35 percent of the adjusted gross estate (the gross estate less deductions allowed under Sections 2053 and 2054).
• Closely held business. A sole proprietorship carrying on a trade or business; a partnership interest if 20 percent or more of capital is in the estate or the partnership had 45 or fewer partners; or corporate stock if 20 percent or more of the voting stock is in the estate or the corporation had 45 or fewer shareholders (Section 6166(b)(1)).
• An active trade or business. Passive assets held inside the business do not count (Section 6166(b)(9)). Real estate qualifies only if the decedent's activity was active enough; Rev. Rul. 2006-34 gives safe harbors and factors for rental and other real property.
• Timely election. The election is made on a timely filed Form 706 (Form 706 instructions).

The interest rate

Under Section 6601(j), interest on the "2-percent portion" of the deferred tax is 2 percent. The rest is charged at 45 percent of the regular underpayment rate. For a decedent dying in 2026, the dollar amount used to figure the 2-percent portion is $1,940,000 (Rev. Proc. 2025-32, section 4.51); in practice it covers the tax on about the first $1,940,000 of taxable value above the exemption. The trade-off is that this interest is not deductible for estate tax or income tax purposes (Sections 2053(c)(1)(D) and 163(k)).

Who it fits, and who it does not

Good fit: estates above the federal exemption ($15,000,000 per person in 2026) whose main asset is an operating company, a farm or actively managed real estate, with heirs who will run it and whose cash flow can carry the installments.

Poor fit: estates under the exemption (nothing to defer), estates where the business will be sold soon after death (acceleration), and businesses whose value sits mostly in passive investments. Investment real estate managed by third parties often fails the active business test.

Worked example

This example is qualitative because the engine does not model estate tax. Assumptions: an owner dies in 2026, unmarried, with a taxable estate well above the $15,000,000 exemption. Her manufacturing company is 60 percent of the adjusted gross estate, so the 35 percent test is met. The executor elects 6166 for the share of the estate tax attributable to the company. For years 1 through 5 after the due date, the estate pays interest only: 2 percent on the tax attributable to the first $1,940,000 of taxable value above the exemption and 45 percent of the underpayment rate on the rest. Starting in year 5, it pays the deferred tax in up to 10 equal annual installments, funded from company distributions. If the heirs sell the company in year 7, the unpaid balance becomes due on notice and demand.

IRS stance and audit risk

• Qualification disputes. The IRS examines whether the business is active, what share is passive assets, and whether the 35 percent test is met after valuation adjustments.
• Security. The IRS can require a bond or a special lien on estate property under Section 6324A.
• Acceleration. Under Section 6166(g), if 50 percent or more of the value of the business interest is distributed, sold or otherwise disposed of, or money attributable to it is withdrawn, the unpaid tax becomes due. A missed installment also accelerates the balance, unless paid within 6 months, in which case a penalty applies and the 2 percent rate is lost for that payment.
• Long exposure. The estate stays open with the IRS until the last installment is paid.

Costs and fees

Estate attorney and Form 706 preparation fees, valuation of the business, possibly a bond or the cost of granting a lien, and 10 to 14 years of administration and compliance. Interest is paid but is not deductible. The executor may stay personally responsible in some situations until the lien or bond is in place, which is one reason executors take the security requirement seriously.

How it compares with a Section 453 installment sale

Both tools spread a tax bill, but they apply to different taxes and point in opposite directions. A Section 453 installment sale spreads income tax for an owner who sells during life. Section 6166 spreads estate tax for heirs who keep the business after death.

The interaction is worth modeling. If an owner sells the business during life on an installment note, the estate holds a note receivable instead of an operating business, which generally does not count toward the 35 percent test, and the unpaid gain is income in respect of a decedent with no step-up. If the owner keeps the business, the heirs get a step-up and can use 6166, but they carry the operating risk and the estate tax. Which path leaves the family more depends on the estate's size, the business's cash flow and the heirs' plans.

Frequently asked questions