Even with the generous $5 million estate tax exemption under current law (indexed to $5.25 million for 2013 and $5.34 million for 2014), some heirs will still be walloped by the federal estate tax. When the tax applies, the rate is a flat 40%.
Strategy: Use the installment method for paying estate tax.
With the installment method, the family can stretch out payments for as long as 14 years if business interests comprise a substantial portion of the deceased’s estate.
Here’s the whole story: Normally, estate tax must be paid within nine months of death. However, if the estate qualifies, a special election can stretch out annual payments for 10 years following a deferral period of five years. Technically, the maximum deferral period is 14 years, not 15, because of the way the payments must be structured.
This estate tax break is available only if the estate includes a farm or closely held business with a value exceeding 35% of the “adjusted gross estate” (i.e., the gross estate value minus any expenses, debts and losses). For this purpose, a closely held business may include:
- A sole proprietorship
- An interest in a partnership if 20% or more of the total capital interest in the partnership is included in the gross estate, or if the partnership had 45 or fewer partners
- Stock ownership in a corporation if 20% or more of the value of the voting stock is included in the gross estate or if the corporation had 45 or fewer shareholders.
The estate tax deferral applies only to the tax attributable to the closely held business interest(s). For example, if the interest(s) represent 50% of the gross estate, 50% of the estate tax can be spread out over the 14-year period. The remaining 50% must be paid within nine months of the estate owner’s death.
If the election is made to extend estate tax payments, the heirs will owe interest annually on the unpaid portion of the tax. However, the estate is required to pay just a 2% interest rate on the amount attributable to the first $1 million (indexed to $1.43 million for 2013 and $1.45 million for 2014) of the taxable value of the business interest.