Active Trade or Business Requirement

Section 6166 and related regulations provide:

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

(2) Limitation

The maximum amount of tax which may be paid in installments under this subsection shall be an amount which bears the same ratio to the tax imposed by section 2001 (reduced by the credits against such tax) as-

(A) the closely held business amount, bears to

(B) the amount of the adjusted gross estate.


(b) Definitions and special rules

(1) Interest in closely held business

For purposes of this section, the term "interest in a closely held business" means-

(A) an interest as a proprietor in a trade or business carried on as a proprietorship;

(B) an interest as a partner in a partnership carrying on a trade or business, if-

(i) 20 percent or more of the total capital interest in such partnership is included in determining the gross estate of the decedent, or

(ii) such partnership had 45 or fewer partners; or

(C) stock in a corporation carrying on a trade or business if-

(i) 20 percent or more in value of the voting stock of such corporation is included in determining the gross estate of the decedent, or

(ii) such corporation had 45 or fewer shareholders.


(5) Closely held business amount

For purposes of this section, the term "closely held business amount" means the value of the interest in a closely held business which qualifies under subsection (a)(1).


(9) Deferral not available for passive assets

(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.

(B) Passive asset defined

For purposes of this paragraph-

(i) In general

The term "passive asset" means any asset other than an asset used in carrying on a trade or business.

(ii) Stock treated as passive asset

The term "passive asset" includes any stock in another corporation unless-

(I) such stock is treated as held by the decedent by reason of an election under paragraph (8), and

(II) such stock qualified under subsection (a)(1).

(iii) Exception for active corporations

If-

(I) a corporation owns 20 percent or more in value of the voting stock of another corporation, or such other corporation has 45 or fewer shareholders, and

(II) 80 percent or more of the value of the assets of each such corporation is attributable to assets used in carrying on a trade or business,

then such corporations shall be treated as 1 corporation for purposes of clause (ii). For purposes of applying subclause (II) to the corporation holding the stock of the other corporation, such stock shall not be taken into account.


Reg. 20.6166A-2 provides:

Definition of an interest in a closely held business.
(a) In general. For purposes of §§ 20.6166-1, 20.6166-3, and 20.6166-4, the term “interest in a closely held business” means:

(1) An interest as a proprietor in a trade or business carried on as a proprietorship.
(2) An interest as a partner in a partnership carrying on a trade or business if 20 percent or more of the total capital interest in the partnership is included in determining the decedent's gross estate or if the partnership had 10 or less partners.
(3) Stock in a corporation carrying on a trade or business if 20 percent or more in value of the voting stock of the corporation is included in determining the decedent's gross estate or if the corporation had 10 or less shareholders.

(b) Number of partners or shareholders. The number of partners of the partnership or shareholders of the corporation is determined as of the time immediately before the decedent's death. Where an interest in a partnership, or stock in a corporation, is the community property of husband and wife, both the husband and the wife are counted as partners or shareholders in arriving at the number of partners or shareholders. Similarly, if stock is held by co-owners, tenants in common, tenants by the entirety, or joint tenants, each co-owner, tenant in common, tenant by the entirety, or joint tenant is counted as a shareholder.

(c) Carrying on a trade or business.

(1) In order for the interest in a partnership or the stock of a corporation to qualify as an interest in a closely held business it is necessary that the partnership or the corporation be engaged in carrying on a trade or business at the time of the decedent's death. However, it is not necessary that all the assets of the partnership or the corporation be utilized in the carrying on of the trade or business. [The last sentence was made ineffective by the enactment of the passive asset rules of section 6166(b)(9).]

(2) In the case of a trade or business carried on as a proprietorship, the interest in the closely held business includes only those assets of the decedent which were actually utilized by him in the trade or business. Thus, if a building was used by the decedent in part as a personal residence and in part for the carrying on of a mercantile business, the part of the building used as a residence does not form any part of the interest in the closely held business. Whether an asset will be considered as used in the trade or business will depend on the facts and circumstances of the particular case, for example, if a bank account was held by the decedent in his individual name (as distinguished from the trade or business name) and it can be clearly shown that the amount on deposit represents working capital of the business as well as nonbusiness funds (e.g., receipts from investments, such as dividends and interest), then that part of the amount on deposit which represents working capital of the business will constitute a part of the interest in the closely held business. On the other hand, if a bank account is held by the decedent in the trade or business name and it can be shown that the amount represents nonbusiness funds as well as working capital, then only that part of the amount on deposit which represents working capital of the business will constitute a part of the interest in the closely held business. In a case where an interest in a partnership or stock of a corporation qualifies as an interest in a closely held business, the decedent's entire interest in the partnership, or the decedent's entire holding of stock in the corporation, constitutes an interest in a closely held business even though a portion of the partnership or corporate assets is used for a purpose other than the carrying on of a trade or business.

 

Reg. 20.6166A-2(c) Comment 1:  Regulations 20.6166A-1 through 20.6166A-3 must be read with caution. To the extent that any provision in those regulations is inconsistent with the statute existing today, such inconsistent provision in the regulation is not given effect. Sub paragraph (c)(1), above, provides that, unlike for a decedent's sole proprietorship, it is not necessary that all the assets of a partnership or corporation be used in an active trade or business; i.e., passive assets can be included in the value of a decedent's interest in a partnership or corporation for purposes of section 6166.

Reg. 20.6166A-2 was first published in 1960 (redesignated with the "A" in 1980). Section 1021(b) of PL 98-369, the Deficit Reduction Act of 1984 [a very slow loading PDF file], added passive asset rules of new subsection (b)(9) to section 6166, effective for estates of decedents dying after July 18, 1984. Henceforth, passive assets cannot be included in the value of a partnership or corporation for purposes of section 6166, which now applies the same rule for a decedent's interest in a partnership or a corporation as was formerly applied only for a sole proprietorship.

 

(d) Interests in two or more closely held businesses. For purpose of paragraphs (a) and (b) of § 20.6166-1 and paragraphs (d) and (e) of § 20.6166-3, interests in two or more closely held businesses shall be treated as an interest in a single closely held business if more than 50 percent of the total value of each such business is included in determining the value of the decedent's gross estate. For the purpose of the 50 percent requirement set forth in the preceding sentence, an interest in a closely held business which represents the surviving spouse's interest in community property shall be considered as having been included in determining the value of the decedent's gross estate.

    [T.D. 6522, 25 FR 13888, Dec. 29, 1960. Redesignated by T.D. 7710, 45 FR 50745, July 31, 1980]

 

Reg. 20.6166A-2(d) Comment 1:  Sub paragraph (d), above, provides that, where two or more business interests exist, more than 50% of the total value of each business must be included in the gross estate before their values can be combined to be treated as an interest in a single closely held business.

Reg. 20.6166A-2 was first published in 1960 (redesignated with the "A" in 1980). Section 2004 of PL 94-455, Tax Reform Act of 1976 [a very slow loading PDF file], redesignated former section 6166 as section 6166A and added a new section 6166. Included therein was new section 6166(c), which provided:

(c) SPECIAL RULE FOR INTERESTS IN 2 OR MORE CLOSELY HELD BUSINESSES.—For purposes of this section, interests in 2 or more closely held businesses, with respect to each of which there is included in determining the value of the decedent's gross estate more than 20 percent of the total value of each such business, shall be treated as an interest in a single closely held business. For purposes of the 20-percent requirement of the preceding sentence, an interest in a closely held business which represents the surviving spouse's interest in property held by the decedent and the surviving spouse as community property or as joint tenants, tenants by the entirety, or tenants in common shall be treated as having been included in determining the value of the decedent's gross estate.

Section 6166(c) was amended by section 422(a)(2) of PL 97-34, the Economic Recovery Tax Act of 1981, which substituted "20 percent or more" for "more than 20 percent." Regulation 20.6166A-2(d) is therefore rendered ineffective by section 6166(c) as amended.


Note: Section 6166(b)(10) provides:

(b) Definitions and special rules
. . .

(10) Stock in qualifying lending and finance business treated as stock in an active trade
or business company

This means that if the statutory qualifications for a section 6166(b)(10) election have been met, an estate does not have to separately establish that the business was engaged in an active trade or business. The passive asset rules of section 6166(b)(9) do not apply to any asset used in a qualified lending and finance business. Further, see section 6166(b)(10).