Bifurcation of Tax Deferred Under Section 6166
|Bifurcation caveat: References to bifurcated section 6166 elections have been removed from the Estate and Gift Tax Internal Revenue Manuals (IRMs) as of July 30, 2019. The reason for this change is not yet known. However, we wonder if these changes might have been made in anticipation of proposed comprehensive Section 6166 regulations, which is a project that has been in progress for at least 10 years. Perhaps those proposed Section 6166 regulations will soon be published.|
Section 6166 elections requesting that the tax extended under the election be bifurcated between two separate 6166 elections, each election being for one of two closely held business interests included in the gross estate, the values of each of which exceed 35% of the adjusted gross estate, have long been accepted and billed by the IRS. The author directly worked with several such bifurcated elections during his career with IRS.
Before Aug-30-2018, Internal Revenue Manual (IRM) Part 18.104.22.168.6.4 (Campus Procedures for Estate and Gift Tax) dated Sep-11-2009 provided:
4. If the decedent owns two businesses that independently qualify for the IRC section 6166 election, the estate may elect to bifurcate the installment payments. Bifurcation allows the taxpayer to pay taxes attributable to each closely held business over the longest installment period available for that particular business. To receive this treatment, the executor must make a separate election for each business.
Revised and updated Campus Procedures for Estate and Gift Tax in IRM 22.214.171.124 was published Aug-30-2018. The materials in the current version of IRM 126.96.36.199 et seq. treat many aspects of section 6166 elections, but no longer mention bifurcation of tax extended under section 6166.
Notwithstanding the omission of any references in the current IRM to bifurcated section 6166 elections, bifurcation elections continue to be filed with and accepted by the IRS.
9. If the estate owns two businesses that independently qualify for the IRC 6166 election, the executor may elect to bifurcate the installment payments. By contrast, if the estate owns two or more businesses that do not independently qualify for the IRC 6166 election, the interests may be treated as an interest in a single closely held business to determine eligibility. IRC 6166(c).
However, Appeals Estate and Gift Tax IRM 8.7.4 was updated July 30, 2019, and a reference to bifurcation no longer exists.
The IRS has yet to publish guidance on how to do bifurcated section 6166 computations. However, existing rules for section 6166(a), 6166(b)(7), 6166(b)(8), and 6166(b)(10) computations, together with rules regarding interrelated interest deductions and allocations of payments in various scenarios, allow us to construct rules for running bifurcation computations that should agree with rules that will eventually be published by IRS.
NOTE: See CCA 201144027, released Nov-04-2011. It is not clear in this CCA whether the estate was eligible to make a true bifurcation election; the CCA says only that the estate was not permitted to bifurcate between a 14-year regular election and a 9-year §6166(b)(8) election, which would be consistent had the estate attempted to bifurcate within a §6166(c) aggregation of business values where two separate §6166 elections could not have been made because each business value did not exceed 35% of the adjusted gross estate. On the other hand, if this CCA was directed to a situation where two independent §6166 elections could have been made, it is inconsistent with other CCAs and the IRM provisions cited above. Earlier Chief Counsel email advice, such as CCA 200910042, clearly supported the concept of bifurcation, and bifurcation was previously incorporated in the IRM section for Cincinnati Campus processing (cited above). In addition, several estates filed bifurcation elections well before 2009 that were ultimately allowed by Appeals after challenges at the IRS field examination level, and those accounts have been maintained at, and billed by, Cincinnati Campus as bifurcated 6166 elections. More recent bifurcation elections have been allowed at the field examination level and are being billed as bifurcated 6166 elections.
While not specified within the advice, CCA 201144027 most likely related to an attempted bifurcation within a section 6166(c) aggregation, and its conclusion was therefore correct in that event.
Separate elections. The IRM section(s) cited above require that the executor make a separate section 6166 election for each qualifying business interest in order to bifurcate the total deferred tax. This generally precludes the use of section 6166(c), which combines the estate tax values of two or more business interests into a single aggregate value that is then treated as an interest in a single closely held business for purposes of section 6166. (But also see items 11 and 12, below.)
CCA 200910042 provides that an aggregate value determined under section 6166(c) can represent one qualifying business interest while another business interest, not included in the 6166(c) aggregation, can represent a separate qualifying business interest, and the total tax eligible for deferral under section 6166 can be bifurcated accordingly. A 6166(c) election can apply to some, but not all, of the business interests included in a decedent’s gross estate, and bifurcation is allowable for the 6166(c) interest and another independently qualifying business interest.
Consequences of Bifurcated Separate Section 6166 Elections
1. Designated Payments. Payments designated as applicable to one election would be applied only to that election. Undesignated payments would be applied pro-rata to both elections.
2. Overpayments for One Election. Overpayments (for one or more periods) in one election would be applied only within that election. If the overpayments were sufficient to completely pay off the entire amount of tax and interest due for that election, the surplus would be applied to the other election.
3. Section 6166(g)(3)(B)(iii) Late Installment Penalties. One election could incur penalties for late payments while the other election would not if payments had been timely and in the correct amounts for that other election.
4. Section 6166(g)(3)(A) Termination for One Election’s Nonpayment. One election could terminate because of non-payment while the other election continues undisturbed.
5. Section 6166(g)(1) Termination for Sale of One Business. One business interest could be sold, terminating that election under section 6166(g)(1), while the other election continues undisturbed. Notice and demand for payment would be made only for the accelerated amount of tax and interest for the terminated election. (Also see item 13, below.)
6. Section 6166(g)(2) Undistributed Net Income Penalty. The section 6166(g)(2) penalty for undistributed net income of an estate would apply only to the business interest for which installments were currently payable. For example, tax could be bifurcated between a 6166(a) election and a 6166(b)(7) election. If the estate income tax return, Form 1041, showed undistributed net income in the third year after death, the 6166(g)(2) penalty would apply only to the 6166(b)(7) election, because the undistributed net income in year 3 occurred in a "taxable year ending on or after the due date for the first installment" of the (b)(7) deferred tax. The first installment of tax under the 6166(a) election is not due until the fifth anniversary date, which has not yet occurred. Consequently, the 6166(g)(2) penalty would apply only to the (b)(7) portion of deferred tax. On the other hand, if the undistributed net income occurred in, say, the seventh year of the deferral periods, the penalty would apply to both elections because installments for both elections were payable in the seventh year.
7. Collapsing Bifurcation Elections. Valuation changes on an IRS examination could cause a collapse of the bifurcation. A valuation increase for one business interest but not the other could cause the value of the unadjusted business interest to fall below the 35% threshold. The estate would then have to choose between a default 6166(c) election for the combined value (assuming the decedent's estate included 20% or more of the total value of each business interest in the aggregation), or forego deferral of the tax attributable to the business interest that no longer exceeds 35% of the 6166(b)(6) adjusted gross estate. Each choice will have a different impact on the interrelated interest deduction allowable in computing the net estate tax and total tax deferred under section 6166. The estate would probably have 60 days from the date of notice and demand for any payment after the examination within which to make this choice, similar to the time frame for making a 6166(h) election, but IRS clarification is needed. See section 6166(h)(2). Practitioners should probably incorporate a protective 6166(c) election in their bifurcation election statements in case the bifurcation election collapses on an IRS examination.
8. Section 6324A Liens. Since bifurcation requires two separate section 6166 elections, it would seem that two separate Roski lien determinations would have to be made by IRS Advisory staff. It is not yet clear whether Advisory would file two separate 6324A liens in the event liens were required for both business interests, or if one 6324A lien would be filed combining both taxes. Advisory does have the option of adjusting the recorded lien amount(s) in response to future events.
9. Only One 2% Amount in a 6166(a) and 6166(b)(10) Bifurcation. In order to bifurcate the tax deferred under section 6166, the executor must make two separate stand-alone 6166 elections. The total deferred tax is allocated between the two elections according to the total value of each business interest that is included in the decedent’s gross estate. Sections 6601(j)(1) and 6601(j)(2) apply in both section 6166(a) and 6166(b)(10) elections. Under section 6601(j)(2) the tax attributable to the first $1,000,000 of taxable business value, adjusted for inflation, draws interest at the special 2% rate. Section 6601(j)(2) determines the total amount of tax eligible for the 2% rate. Bifurcation relates to the total amount of tax deferred under section 6166 that is computed after the applicable exclusion amount and estate tax have been determined, not before. Accordingly, the total amount of 2% tax should be prorated between the 6166(a) and (b)(10) elections; the estate should not be able to obtain two separate maximum 2% deferral amounts, doubling the amount of tax drawing interest at 2%, simply because it has filed bifurcated 6166 elections. The IRS will have to clarify this point when it publishes guidance for bifurcation computations.
10. Campus Bifurcation Billing Notices. Bifurcation requires two separate 6166 elections. It would seem logical that Cincinnati Campus should send two separate billing notices to the estate or designated representative each year. In the alternative, a single billing notice could contain detailed information about both billing accounts. However, as the number of active 6166 accounts with bifurcation elections at Cincinnati is extremely small, a definitive procedure does not yet exist for billing notices in bifurcation cases.
11. Bifurcating Two 6166(a) Elections. A decedent could own interests in two section 6166(a) businesses, A and B, neither of which have more than 45 shareholders. The estate tax values of of the decedent's interests in A and B each exceeds 35% of the 6166(b)(6) adjusted gross estate. The estate tax value of the decedent’s interest in A exceeds 20% of the total value of A, but the estate tax value of B is less than 20% of the total value of B. None of the other shareholders of B are section 267(c)(4) family members of the decedent. The decedent's interest in B qualifies for deferral under section 6166(a) because it exceeds 35% of the adjusted gross estate, but does not qualify for aggregation under section 6166(c). The executor could not combine A and B under section 6166(c) for purposes of section 6166. Bifurcation would permit the executor to elect two separate regular section 6166(a) 14-year deferrals for the tax attributable to each business.
12. Using Bifurcation to Avoid Using Section 6166(b)(7). Assume the same facts as in 11, above. In addition, family members as described in section 267(c)(4) also own interests in B. If the executor elects to defer the tax attributable to both business interests by using section 6166(c), the executor will have to make a section 6166(b)(7) election for B so that the value of the interests owned by the section 267(c)(4) family members will be attributed to the decedent for purposes of exceeding the 20% threshold of 6166(c). The 6166(b)(7) election, in turn, would apply to the total amount of tax attributable to the 6166(c) election – there is no bifurcation within a 6166(c) election. The first installment of tax would be due on the return due date. However, if the executor elects to bifurcate the tax attributable to each business interest by making separate 6166(a) elections, then each election would be for the regular 6166(a) 14-year deferral with a prorata allocation of the 2% portion of tax. Bifurcation permits the entire amount of tax attributable to A and B to be payable over 14 years (interest only for the first 4 years) pursuant to 6166(a). Without bifurcation, the entire amount of tax would be payable over only 9 years (1st installment due on the return due date, plus 9 more installments), without the 2% interest rate.
13. The Section 6166(g)(1)(A)(ii) 50% Threshold for Acceleration is Decreased Proportionately With a Bifurcation Election. If 50% or more of aggregate distributions, sales, exchanges, or other dispositions or withdrawals of an interest in a closely held business occurs, the extension of time for payment of the tax deferred under section 6166(a) shall cease to apply and the unpaid portion of tax payable in installments is payable upon notice and demand. If the total estate tax value of all qualifying closely held busines interests was, say, $40,000,000, the 50% acceleration threshold would be total aggregate distributions, etc., of $20,000,000. However, if a bifurcation election were made so that one election was for a closely held business value of $20,800,000 and the other was for $19,200,000, with each value exceeding 35% of the adjusted gross estate, the 50% acceleration thresholds would then be $10,400,000 and $9,600,000, respectively. The estate could sell or otherwise dispose of the $20,800,000 business without disturbing the ongoing 6166 election for the $19,200,000 business. See the bifurcation example at the end of the notes for PLR 201403012.
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