6166(b)(9) Passive Asset Rules Do Not Apply After Date of Death For Purposes of The 35% Test

The Passive Asset Rules of Section 6166(b)(9) Do Not Apply After Date of Death for Purposes of The 35% Test

Section 6166(a)(1) provides:

(a) 5-year deferral; 10-year installment payment

(1) In general

If the value of an interest in a closely held business which is included in determining the gross estate of a decedent who was (at the date of his death) a citizen or resident of the United States exceeds 35 percent of the adjusted gross estate, the executor may elect to pay part or all of the tax imposed by section 2001 in 2 or more (but not exceeding 10) equal installments.


Section 6166(b)(2)(A) provides:

(2) Rules for applying paragraph (1)

For purposes of paragraph (1)-

(A) Time for testing

Determinations shall be made as of the time immediately before the decedent's death.


Section 6166(b)(9)(A) provides:

(A) In general

For purposes of subsection (a)(1) and determining the closely held business amount (but not for purposes of subsection (g)), the value of any interest in a closely held business shall not include the value of that portion of such interest which is attributable to passive assets held by the business.


Section 6166(g)(1)(A) provides:

(g) Acceleration of payment

(1) Disposition of interest; withdrawal of funds from business

(A) If-

(i)(I) any portion of an interest in a closely held business which qualifies under subsection (a)(1) is distributed, sold, exchanged, or otherwise disposed of, or

(II) money and other property attributable to such an interest is withdrawn from such trade or business, and

(ii) the aggregate of such distributions, sales, exchanges, or other dispositions and withdrawals equals or exceeds 50 percent of the value of such interest,

then the extension of time for payment of tax provided in subsection (a) shall cease to apply, and the unpaid portion of the tax payable in installments shall be paid upon notice and demand from the Secretary.


PLR 9427029:

This PLR involved a reverse triangular merger of various entities after date of death. The estate sought rulings to the effect that certain changes in the business structure, which constituted mere changes in form for purposes of section 6166, were not now subject to the holding company rules of section 6166(b)(8) or the passive asset rules of section 6166(b)(9). In pertinent part here, the IRS ruled:

The determination as to whether section 6166(b)(8) or (9) of the Code applies to an estate is made at the time of death. If an estate qualifies to pay its estate taxes in installments under section 6166 without invoking the rules contained in section 6166(b)(8) or (9), an estate does not have to subsequently comply with those sections if its circumstances change. The estates of A and B did not contain stock in a holding company nor passive assets at the time of the deaths of A and B. Thus, the estates of A and B qualified for section 6166 treatment without application of the special rules contained in section 6166(b)(8) and (9). The proposed formation of a holding company does not now subject the estates to the requirements of section 6166(b)(8) and (9).


Example:

May-20-2018 Date of death.
Feb-20-2019 §6075(a) statutory return due date. Form 4768 filed requesting an automatic 6-month extension of time to file under §6081.
Jun-17-2019 Sale of a section 6166 business asset to an unrelated 3rd party. Sale negotiations and contract execution all occurred after date of death. Sale was completed before the estate tax return and section 6166 Notice of Election are completed.
Aug-20-2019 Form 706 filed with the section 6166 Notice of Election. The closely held business value in the Notice of Election includes the value of the asset that was sold before the return was filed.

Section 6166(a) Consequences

20,000,000 Estate tax value of the decedent's interest in the closely held business immediately before death.
4,600,000 Estate tax value of section 6166 business asset sold to an unrelated 3rd party, which converts an active business asset to a passive asset (cash, which came from outside the estate).
15,400,000 Estate tax value of section 6166 business after asset sale to an unrelated 3rd party, which is net of the passive asset value.
20,000,000 Estate tax value of qualifying section 6166 business in the Notice of Election filed with the estate tax return after the section 6166 business asset was sold to an unrelated 3rd party remains valid.

Section 6166(g) Consequences

20,000,000 Estate tax value of the decedent's interest in the closely held business immediately before death.
4,600,000 Estate tax value of section 6166 business asset sold to an unrelated 3rd party, which converts an active business asset to a passive asset (cash, which came from outside the estate).
23.00% Percentage of section 6166 business that was sold. This sale constitutes a disposition of an interest in the closely held business pursuant to section 6166(g)(1)(A). However, the 50% acceleration threshold of section 6166(g)(1)(A) has not been breached. The section 6166 election based on the date of death closely held business value of $20,000,000 therefore continues undisturbed.. 

6166(b)(9)(A) and 35% Test; 6166(g) Consequences, Comment 1:   While post-death events might cause active business assets in a closely held business to become passive assets, or change the elements that initially qualified for a §6166(a) 14-year election to what would now qualify for only a 9-year (b)(8) election (as in PLR 9427029), the changed qualifications did not exist at the time immediately before the decedent's death and are ignored for the §6166(a)(1) 35% test computation pursuant to section 6166(b)(2)(A).

However, the phrase "( but not for purposes of subsection (g))" in section 6166(b)(9)(A) causes a different result for purposes of section 6166(g)(1)(A) accelerations. Post-death changes in the nature of assets that qualified for section 6166 at the time immediately before death do constitute "distributions, sales, exchanges, or other dispositions and withdrawals" of such interests and must be counted in determining whether the 50% acceleration threshold has been breached.

 

6166(b)(9)(A) and 35% Test; 6166(g) Consequences, Comment 2:   Does the phrase "( but not for purposes of subsection (g))" in section 6166(b)(9)(A) include passive assets owned by a closely held business immediately before death for purposes of the §6166(g)(1)(A) 50% threshold computation? In other words, if a closely held business owned passive assets immediately before the decedent's death, they would not qualify for the initial section 6166 election. Nevertheless, would their sale or disposition after death count toward the (g)(1)(A) 50% acceleration threshold?

The answer is no, they would not be included in that computation. Section 6166(g)(1)(A) applies only to "any portion of an interest in a closely held business which qualifies under subsection (a)(1)". Since passive assets existing immediately before the decedent's death are not qualified under section 6166(a)(1), they are not included in the (g)(1)(A) 50% acceleration computation.

Note: The Conference Committee Report on implementation of section 6166(b)(8) - P.L. 98-369 (Deficit Reduction Act of 1984) - contains the following statement:

Additionally, the conference agreement retains the rule that in the case of all corporations and partnerships, only active business assets are considered for purposes of the installment payment provision. The conference agreement does not apply to this rule, however, for purposes of the acceleration rules of section 6166(g).

The Conference Committee statement would be consistent with the concepts mentioned above, however, when one considers that such passive assets would be those that formerly qualified for installment payments at the moment immediately before the decedent's death, but which became passive at some point thereafter.

 

6166(b)(9)(A) and 35% Test; 6166(g) Consequences, Comment 3:   The same results would occur if, for example, one of several buildings that were used in a qualifying business on the date of death was to be abandoned two years after date of death and left vacant thereafter. While not a sale, the cessation of business use would constitute a "withdrawal" from the business for purposes of section 6166(g)(1)(A). The tax initially deferred under the section 6166 election would not be affected by such post-death changes until the aggregate of all such changes equalled 50% or more of the total closely held business value included in the decedent's estate, at which point the 6166 election would be automatically terminated.