Estate tax deferral for closely held businesses under IRC Section 6166

One of the ways a successful family business can lose value is to be consumed by the need to sell assets to meet estate taxes. Those who inherit a business have several ways to handle estate taxes after the death of an owner, including deferral of the estate tax payment for those who qualify.

According to Internal Revenue Code (“IRC”) Section 6166, a personal representative may defer payment of federal estate taxes if the value of the decedent’s interest in a closely held business included in the gross estate exceeds 35% of the decedent’s adjusted gross estate (as defined under IRC §6166(b)(6)).

Section 6166 spells out several criteria that must be satisfied before the estate may be eligible to defer the payment of federal estate taxes:

• The decedent must have been a U.S. citizen or resident at death.
• The interest in the closely held business must represent at least 35% of the decedent’s adjusted gross estate.
• The estate’s personal representative must make a timely election under section 6166 on a Form 706 Federal Estate Tax Return.

Meeting these requirements may allow the estate to defer the portion of federal estate tax attributable to the closely held business interest, with payment spread over a period of up to 14 years. This period generally includes up to five years of interest only payments, followed by ten annual installments of principal and interest. The guidelines for deferring estate taxes and calculating and making payments are complex. Be sure to work with your tax advisors to understand the requirements and how they may apply to your situation.

If you are considering using section 6166 to defer payment of estate taxes, work with your tax advisor to determine whether the estate’s interest in the closely held business is at least 35% of the decedent’s adjusted gross estate. Calculations start by taking the gross estate and subtracting deductions allowable under IRC sections 2053 and 2054, such as debts, funeral expenses, administration costs, mortgages, and liens, whether or not those amounts have been paid at the time the return is filed.

However, these deductions are applied before taking into account any available charitable or marital estate tax deductions.

For example, consider these two scenarios of decedents who were U.S. citizens and died in 2026, leaving behind a closely held business, investments, and cash.

This information is hypothetical and is provided for informational purposes only. It is not intended to represent any specific return, yield, or investment, nor is it indicative of future results.

If you do not qualify for section 6166, one option to consider is a loan from a third party lender. Commonly referred to as a Graegin loan, this strategy, which resulted from the Graegin v. Commissioner U.S. Tax Court case, may permit an estate to borrow funds to pay estate taxes and, if properly structured, may allow a current deduction for the projected interest obligation on the loan, thereby reducing the federal estate tax liability.

To be deductible, the interest must be reasonably ascertainable and it must be certain that the interest will be paid. Typically, a bank or other financial institution is the lender. In certain circumstances, a loan may be made by an irrevocable life insurance trust or a related family business; however, those transactions are closely scrutinized by the IRS. Be sure to consult with your tax and legal advisors before pursuing this option.

If you plan to use section 6166, you should be aware that certain actions may accelerate the payment of all unpaid tax that has been deferred. If the estate or heirs dispose of, in the aggregate, 50% or more of the decedent’s interest in the closely held business after the date of death through distributions, sales, exchanges, or other dispositions, the remaining deferred tax generally becomes due. In addition, acceleration may occur if a required installment payment is not made within six months of its due date.

If, on the other hand, the business redeems shares in a manner qualifying under IRC §303 to pay estate taxes, funeral expenses, and administrative expenses, the redemption generally will not result in acceleration of the unpaid tax.

Similarly, the liquidation of business assets in the ordinary course of operations generally will not cause acceleration if the assets continue to be used or owned by the business. Acceleration may occur, however, if the business liquidates assets and distributes the proceeds to shareholders for use in unrelated activities.

Although section 6166 has been widely used to address estate tax obligations for closely held businesses, its rules are complex, its application can be ambiguous in certain circumstances, and it may be unsuitable for certain business structures. As a result, you should conduct thorough due diligence with your tax and legal advisors to determine whether section 6166 is appropriate and cost efficient, or whether another strategy may be more suitable.

Wells Fargo and Company and its affiliates do not provide tax or legal advice. This communication cannot be relied upon to avoid tax penalties. Please consult your tax and legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your tax return is filed.

Wells Fargo Trust is a part of WIM and offers services through Wells Fargo Bank, N.A. and Wells Fargo Delaware Trust Company, N.A.

Insurance products are offered through nonbank insurance agency affiliates of Wells Fargo & Company and are underwritten by unaffiliated insurance companies.