As a small business owner, you have most likely spent years building up your company’s value. Now that your enterprise is successful, the thought of retirement at some point in the future may have entered your mind
Due to all the time and labor you have put into your business, it is important that you secure some estate protection for your valued business interest. For 2022 the federal estate tax exemption is $12.06 million, however, this is scheduled to revert to $5 million (plus indexing) in 2026.
With this in mind, your family may still have some tax exposure in the future, so what is the practical solution? You can plan things so that your executor elects Section 6166 estate tax relief. This provision allows a personal representative to defer payment of estate taxes for up to 14 years.
Unfortunately, there is a catch that you should be aware of. Interest must be paid each year on the unpaid portion of the estate tax. Thankfully, the estate only pays 2% on the tax that is attributable to the first $1 million of the business interest. This means that the interest rate for tax underpayments applies to any amount above $1 million, however, this is subject to inflation indexing. For 2022, the threshold was $1.64 million.
Business owners should be aware that qualifying for Section 6166 relief is not automatic. You must meet three important requirements.
First, your decedent must be a U.S. citizen or a resident at death.
Next, the interest in the business must comprise more than 35% of the decedent’s adjusted gross estate. This calculation is based on subtracting various deductions like funeral expenses, mortgages, debts, and more from the original value of the estate. These deductions are generally taken after applying any available charitable and marital estate tax deductions.
Lastly, the election has to be made by the personal representative on an estate tax return. Please note that the tax return must be filed in a timely manner. In addition to the above you must have operated the business as either a sole proprietor, a partner with an interest of 20% or more, with an interest in a partnership that has no more than 45 partners, a corporate stockholder owning 20% or more of voting stock, or you owned stock in the corporation with no more than 45 shareholders.
Overall, there is definitely a lot you have to consider when planning how to protect your estate, however, it is definitely worthwhile when the top estate tax rate is 40%. If you believe that you qualify for Section 6166 relief, it is recommended to meet with your estate and tax planner to plan the needed arrangements. Your family will definitely be happy that you took the time to do this!
