It seems like the rules around estate taxes might be changing soon. If they do, more people might have to pay taxes on their estates when they die. As lawyers, we help our clients figure out how to pay as little tax as possible and in the least disruptive way. In this article, we talk about two ways to do that: delaying payment and finding ways to borrow the money to pay the tax. If a person owns a big part of a business when they die, their family might be able to wait to pay some of the taxes. This is called a §6166 election. To qualify, the business interest must be worth more than 35% of the person’s total estate. If the business is a partnership or a corporation, it has to be actively doing business. Also, the estate has to own at least 20% of the business or the business can’t have more than 45 other owners. There are some special rules for counting owners, like if family members own part of the business. For example, if the person who died and their spouse and kids all own part of the business, they can be counted as one owner for this rule. The 20% ownership test for estate tax can be tricky, but if the estate is close but not quite there, the executor can choose to count the stock owned by the deceased person’s son as part of the estate. This can help the estate meet the test.
If the executor chooses to defer the estate tax payment using a 6166 election, they can spread out the payment over 10 years, starting five years after the tax is due. The amount of tax that can be deferred is based on the value of the closely held business interests in the estate compared to the total value of the estate. For example, if the estate is worth $100 million, with $45 million in closely held business interests, and the estate tax is $40 million, the executor can defer $18 million of the tax. The IRS allows estates to defer paying some estate taxes if they own a closely held business. In exchange, the estate has to make annual interest payments on the deferred amount. The executor has to be careful because certain actions, like selling part of the business or missing a payment, can make the entire tax amount due immediately. There’s a special rule for holding company stock that allows the estate to treat it like owning the underlying business directly. If the person who handles a dead person’s estate chooses to delay paying estate taxes by putting the business into a holding company, they will lose some benefits and only have five years to pay instead of ten. Also, if the business has assets like cash or stock that it doesn’t use for business purposes, those assets won’t count when calculating how much tax needs to be paid. For example, if someone who died had $80 million, with $40 million in cash and stock, and $40 million in a business, but 25% of the business’s assets are just extra stock, the business’s value for tax purposes would be lower. If a person owns stock in a company, it is usually considered a passive asset. However, if the company is a holding company and meets certain requirements, the stock can be considered as a non-passive asset. This exception applies if the holding company and its subsidiary are both actively involved in a business, and if certain percentages of their assets are used in active business. If these requirements are met, the stock in the holding company can be treated as a non-passive asset for tax purposes. If a partnership only owns stock in other companies, it’s not clear if it can use certain tax benefits that a corporation can use. If an estate owes a lot of money in taxes, it can either sell its assets or borrow money to pay the taxes. Borrowing money can sometimes give the estate a tax deduction. If an estate needs to borrow money to pay its taxes, the interest on the loan can usually be deducted as an expense on the estate tax return. The estate must show that the loan was necessary and had a legitimate non-tax purpose. If the estate has enough cash or easily sellable assets to cover the taxes, it may not be able to deduct the interest. Courts generally respect the executor’s decision about whether the loan was necessary. For example, in a case where an estate had stock in a company and could have deferred paying taxes, the executor decided to borrow money instead, and the court agreed that it was necessary. The court said that it wouldn’t question the executors’ decisions to borrow money to pay estate taxes, as long as it was the best choice for the estate. For the interest on the borrowed money to be tax-deductible, the estate must be unable to pay its debts with its own money. If the estate’s financial situation changes, the tax deductions for the interest may change too. The case of Estate of Black v. Commâr dealt with whether a loan taken out by the executor of an estate was necessary to pay estate taxes. The executor borrowed money from a partnership to pay the taxes, claiming the interest expenses as a deductible expense. The partnership had to sell assets to make the loan. The court had to decide if the loan was really necessary to prevent the forced sale of assets. In a court case, the IRS said a loan taken by an estate was unnecessary, and the court agreed. The estate’s only valuable assets were shares in a company, and the company didn’t make enough money to cover the loan payments. The court decided that the company would have to give the shares to the estate anyway, so the loan wasn’t needed. So, if an estate only has shares in a company, the court will look at the company’s history of making money and decide if the loan is necessary. It’s also a good idea for the person in charge of the estate to not have too much control over the company. In this case, the person in charge argued that they couldn’t get the shares from the company, but the court said that the rules of the company could be changed to allow that, and it wouldn’t be a problem. Interest expenses can be deducted as administrative expenses if they can be accurately calculated and will definitely be paid. Estates sometimes use Graegin loans to deduct future interest expenses on a loan used to pay estate taxes. To qualify as a Graegin loan, the loan must have a fixed maturity, a fixed interest rate, and not allow for prepayment. The loan must also serve a legitimate non-tax purpose and have a genuine intention to be repaid. Loans between people or companies with a close relationship need to be carefully looked at, but just having a close relationship doesn’t automatically mean the loan is not real. In one case, a loan from a company owned by a trust to pay taxes was considered real because it had specific terms, was approved by a court, and there were other shareholders who might complain if the loan wasn’t paid back. On the other hand, in another case, a loan from a partnership owned by the estate and one of its executors was not considered real because the same people were on both sides of the loan, making it seem like the only reason for the loan was to get a tax deduction. In general, if there are different people or companies involved, a loan is more likely to be considered real. But if it’s all the same people, the loan might not be considered real. If an estate takes out a loan to pay estate taxes, the loan must benefit the estate and not just the individual beneficiaries in order for the interest expense to be tax-deductible. A recent court case showed that borrowing money through family trusts may not qualify for this deduction. With the estate tax exemption expected to decrease in the future, estate planners and executors need to carefully consider strategies to minimize the impact of estate tax and ensure that loan interest is deductible. This text contains a lot of information about certain sections of the Internal Revenue Code related to estate taxes, deferral of estate tax payments, and eligibility criteria for deferral. It also includes references to legal cases and regulations. The court doesn’t question the decisions made by the executors of an estate. Interest obligations subject to fluctuating rates may be deductible, and the full amount of interest may be deductible if there’s no possibility of accelerated payment. Different scenarios involving interest and payments are considered, and a lawyer focuses on tax planning and compliance for estates. Nathan R. Brown and Melissa M. Price are lawyers who specialize in estate planning and tax issues. They help people with their wills, trusts, and other important financial matters. They are part of a group that focuses on these types of legal issues and are recognized for their expertise in their field.
Source: https://www.floridabar.org/the-florida-bar-journal/funding-the-estate-tax-defusing-the-liquidity-time-bomb/
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