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Postpone the estate tax on your small-business interests

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in Small Business Tax

Although you may have spent years building up your business, your family may be forced to sell it lock, stock and barrel soon after your death to pay the ensuing estate-tax bill. The full amount of federal estate tax is generally due nine months after death.

Strategy: Direct your executor to elect the estate-tax payment in installments. Assuming that your estate qualifies, it can spread out the resulting tax over as long as 15 years.

Similarly, you might opt for this special estate-tax election if you’re serving as the executor of an elderly family member who owns a small business.

When does an estate qualify for the estate-tax deferral? Generally, the business must comprise at least 35 percent of the adjusted gross estate (the gross estate less any expenses, debts and losses).

Also, you must have operated the business as one of the following:

-A sole proprietor.

-A partner with 20-percent-or-more ownership interest in the partnership, or with an interest in a partnership that has no more than 45 partners.

-A corporate stockholder owning 20 percent or more of the voting stock, or owning stock in a corporation with no more than 45 shareholders.

If the estate qualifies, the executor can elect to pay zero tax on the business interest for five years. Plus, you can stretch out subsequent payments over 10 years. In other words, the family can take up to 15 years to pay the tax. (Technically, it’s a 14-year period, since the due date for the last interest installment coincides with the first tax installment.)

One catch: The estate must pay interest each year on the unpaid portion of the tax. But the estate pays only 2 percent interest on the amount attributable to the first $1 million (adjusted for inflation) of the business interest’s taxable value.

For 2006, the figure is $1.2 million (increasing to $1.25 million for 2007). The going interest rate for tax underpayments applies to any excess.

Tip: You must make the election on a federal estate-tax return (see Form 706) filed in a timely manner.

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