Despite the slow “death” of the federal estate tax in 2010, this onerous tax is scheduled to be revived in 2011—with a vengeance—after only a one-year repeal. At this time, congressional efforts to eliminate the estate tax for good appear to be dead in the water. So estate planning remains on the critical list for wealthy families.
Strategy: Plan now for the future. Specifically, you can instruct your executor to make a special election to defer your estate tax. By spreading out the payments this way, you’ll reduce the resulting estate tax you owe.
This special election is available to certain owners of closely held businesses and farms. It’s been around for years, but the IRS has issued new guidance on the subject.
Here’s the whole story: A federal estate-tax liability generally must be paid within nine months of the decedent’s death. But, if the value of a closely held business or farm comprises at least 35% of the estate’s value, the executor can defer the tax attributable to that business interest for five years. Then the tax may be paid in installments over the next 10 years. The annual interest rate on the estate-tax deferral under this special rule is only 2%.
It will take 15 years to pay off the estate-tax bill under the special rule. To qualify for this unique tax treatment, the qualifying business interest can be:
- A trade or business carried on as a sole proprietorship
- An interest in a partnership carrying on a trade or business if the partnership had either 45 or fewer partners, or 20% or more of the total interest in the partnership is included in determining the decedent’s gross estate
- An interest in a corporation carrying on a trade or business if the corporation had either 45 or fewer shareholders, or 20% or more of the value of the voting stock of the corporation is included in determining the gross estate.
The business must be “active” at the date of the decedent’s death to qualify for estate-tax deferral. This tax break isn’t available for passive activities.
Low-interest tax break: The IRS only assesses a 2% interest rate for the portion of estate tax deferred on the first $1 million of the taxable value of a closely held business (adjusted annually for inflation). For decedents dying in 2008, a value up to $1,280,000 is permitted.
The interest rate for the remaining portion attributable to a qualifying business is equal to 45% of the rate applicable to tax underpayments.
Finally, the ability to pay taxes on this deferred schedule is forfeited if the installment payments aren’t made on time or if at least 50% of the value of the business interest is transferred or sold to someone who is not a family member. This tax rule will encourage your heirs to hold onto the business interest.
Tip: This is just one way your family may save on potential estate taxes.