Lewes CPA
officeProgar & Company, P.A.
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Estate tax deferral for estates including closely-held business (MS Word)
Estate tax deferral for estates including closely-held business(.pdf)
Estate tax deferral for estates including closely-held business.
Dear Reader:
A special estate tax deferral election is available if a large
portion (more than 35%) of an estate is comprised of a farm or other
closely-held business. The election can substantially ease the
immediate estate tax burden. If the estate qualifies, the tax is
deferred for up to five years and is then paid off over a ten-year
period. Interest on the deferred amount, subject to a limitation
discussed below, is set at only 2%. Even though federal tax
legislation enacted in 2001 repeals the estate tax, the repeal is
not effective until 2010. In the meantime, the estate tax deferral
election provisions remain in force.
How to qualify. The business interest test.
The business interest must be of the type that qualifies for this
treatment. If the decedent was the sole proprietor of the business
(or farm), then it was his business entirely and you can proceed to
the 35% test, below.
If the decedent had partners, however, you can proceed to the 35%
test only if either (i) there were no more than 45 partners in the
partnership or (ii) the decedent's interest in partnership capital
was at least 20%. Similarly, if the business was a corporation, you
can proceed to the 35% test only if either (i) there were no more
than 45 shareholders or (ii) the decedent's ownership of voting
stock was at least 20%.
In applying the 45 partner or shareholder test, above, interests or
shares owned by the decedent's spouse, siblings, ancestors, and
descendants are treated as owned by the decedent. And any interest
owned jointly by a married couple is counted as one partner or
shareholder.
In applying the 20%-interest test (tests (ii), above, for both
partnerships and corporations), the executor may elect to have the
interests of these family members counted as the decedent's.
However, if this is the way the decedent's interest qualifies for
the deferral, then (1) the five-year deferral period is lost (i.e.,
the ten-year payment period starts right away), and (2) the
favorable 2% interest rate is not available on deferred amounts.
Example (1).
M's adjusted gross estate (as defined below) is $2 million. Included
in his estate is a partnership interest valued at $800,000 (i.e.,
40% of the estate). However, there are 48 partners in the
partnership (unrelated to M), and M held only a 16% interest.
Result: M's estate does not qualify for the deferral
provisions.
Example (2).
The facts are same as in Example (1) except that M's wife, brother,
sister, father and mother were among the 48 partners in the
partnership. These five interests plus M's are treated as a single
interest. There are only 42 other partners. Thus, in this case,
there would be only 43 partners and M's estate would qualify for
deferral.
Example (3).
The facts are same as in Example (1) except that M's daughter was
also a partner and her partnership interest was 8%. (The other 46
partners were unrelated to M.) Here, if the executor elects, the
daughter's 8% interest is combined with M's 16% interest, so the 20%
test is met. However, when this election is used, the estate loses
the five-year deferral period and the benefit of the 2% interest
rate.
The 35% test.
The value of the business interest must be more than 35% of the
“adjusted gross estate.” (This is the gross estate minus deductions
for expenses, debts, taxes, and losses.)
Businesses can be combined for purposes of this 35% test if
additional tests are met.
How much estate tax qualifies for deferral?
If the above tests are met, the part of the estate tax bill
allocable to the qualifying business interest is deferred.
Example.
M's estate's tax bill is $1 million. The amount included for the
qualifying business interest was 38% of the total adjusted gross
estate. Thus, 38% of $1 million, or $380,000, qualifies for
deferral.
How much of the tax being deferred qualifies for the 2% interest
rate?
The special 2% rate applies to the portion of the deferred estate
tax that is attributable to the first $1,330,000 (in 2009; subject
to an adjustment for inflation) in taxable value of the closely held
business. The first $1,330,000 in “taxable value” of the business is
the first $1,330,000 above the applicable exclusion amount. Thus,
for example, in 2009, when there is an effective estate tax
exclusion of $3.5 million, the amount of estate tax attributable to
the value of the closely held business between $3.5 million and
$4,830,000 is eligible for the 2% interest rate. The interest rate
on deferred estate tax attributable to (1) the taxable value of the
closely held business in excess of $1,330,000, (2) holding
companies, and (3) non-readily tradable business interests is
reduced to an amount equal to 45% of the tax applicable to
underpayments of tax. The interest paid isn't deductible for estate
or income tax purposes.
Tax payments on the deferred amounts will be applied to each portion
of the liability proportionately. (For example, assume one-third of
the deferred amount qualifies for the 2% rate, and the remaining
two-thirds is subject to the regular rates. A tax payment of $90,000
reduces the 2% portion by $30,000 (1/3 ) and the regular portion by
$60,000.)
Losing the deferral benefits.
Lateness in paying tax due or interest can result in loss of the
deferral benefits. And if the business interest is disposed of
outside the family, the deferral benefits may be lost.
This is a complex area, but qualifying for deferral can
significantly ease the immediate estate tax burden. If you have
additional questions or would like my assistance in seeking to take
advantage of these rules (for example, by combining business
interests), please call.