Estate Tax Deferral Under Section 6166: Paying Estate Tax on a Family Business Over 14 Years

By Eric Ridley, attorney, Ridley Law. Updated October 2026.

Estate size this page covers: $15 million and up for one person, $30 million and up for a married couple, where a family business, a farm or actively managed real estate makes up more than 35% of the estate. Most of these estates sit in the $15 million to $100 million band. Below the federal exemption there’s no estate tax to defer, and the issues are basis, Prop 19 and liquidity. See high-net-worth estate planning in California.

A $12 million tax bill nine months after death, with the wealth tied up in the business

Take a hypothetical California founder who dies in 2026 with a $45 million taxable estate, all of it stock in the operating company she built. Above the $15 million exemption, the estate tax is $12 million, and it’s normally due with the return nine months after death (IRC §§ 6075(a), 6151(a)). A family that owns a manufacturing company, a ranch or a portfolio of buildings it runs itself often doesn’t have that cash.

Her executor can write a $12 million check, or elect § 6166 for all of it. The stock qualifies as a closely held business, so the whole tax can be deferred (IRC § 6166(a)(2)).

The election turns a $12 million first payment into $374,844, and the price is about $3.56 million of interest, or 30% of the tax. The estate pays $374,844 a year for four years, then $1.2 million of tax plus declining interest for 10 years. That’s the price of keeping $12 million in the business instead of selling or borrowing against it at nine months. Whether it’s worth paying depends on what the business earns and what the alternatives cost: a forced sale at a discount, a Graegin loan at a commercial rate whose interest may be deductible, or a § 303 redemption. Rates move every quarter, so the real schedule will differ.

What the election does and what it leaves due at nine months

The election gives the executor up to 14 years past the nine-month due date, but only for the tax that comes from the business. A section 6166 election is the executor’s choice, made on a timely estate tax return, to pay the estate tax attributable to a closely held business in up to 10 equal annual installments, with the first installment due up to five years after the normal due date (IRC § 6166(a), (d)). Congress wrote it to keep families from having to sell the business to pay the tax, and the Ninth Circuit described its purpose as preventing “the forced liquidation of closely held businesses” (Estate of Bell v. Commissioner (9th Cir. 1991) 928 F.2d 901).

The election defers the tax. It doesn’t reduce it, and the interest isn’t deductible for estate or income tax (IRC §§ 2053(c)(1)(D), 163(k)). The election also covers only the share of the tax that matches the business’s share of the estate. The amount that can be deferred is the estate tax multiplied by the ratio of the closely held business amount to the adjusted gross estate (IRC § 6166(a)(2)). If the business is 60% of the adjusted gross estate, up to 60% of the tax can be paid in installments, and the other 40% is due at nine months.

An executor who isn’t sure the estate will qualify after audit can file a protective election, because it preserves the right to defer tax that turns out to be due when values are finally determined (Treas. Reg. § 20.6166-1(d)). The election itself is made on a timely filed return, including extensions (IRC § 6166(d)). If the election names no schedule, it’s presumed to be for the maximum amount, in 10 installments, with the first due five years after the normal due date (Treas. Reg. § 20.6166-1(b)).

Whether the estate clears the 35% line

The estate qualifies only if the business is big enough compared with everything else the decedent owned. The business interest, included in the estate of a U.S. citizen or resident, has to exceed 35% of the adjusted gross estate, meaning the gross estate less deductions for debts, expenses and losses under §§ 2053 and 2054 (IRC § 6166(a)(1), (b)(6)).

What counts as a closely held business

A sole proprietorship counts. A partnership or corporation carrying on a trade or business counts if the decedent’s estate holds 20% or more of the capital or voting stock, or the entity has 45 or fewer partners or shareholders (IRC § 6166(b)(1)). Stock and partnership interests held by family members, as defined in § 267(c)(4), are treated as owned by the decedent for this test (IRC § 6166(b)(2)(D)).

A family with several smaller companies can add them together. Interests in two or more closely held businesses are treated as one if the estate includes 20% or more of the total value of each (IRC § 6166(c)), which is often how such a family clears the 35% line.

What the test leaves out

Passive assets held inside the company, such as marketable securities, shrink the business for this test. A company holding $20 million of operating assets and $15 million of marketable securities is a $20 million business for this purpose, because the value of the business excludes the part attributable to passive assets, meaning anything not used in carrying on the trade or business (IRC § 6166(b)(9)).

Giving away nonbusiness assets in the last months of life won’t manufacture eligibility. An estate meets the 35% requirement only if it meets it both with and without adding back gifts made within three years of death (IRC § 2035(c)(2)).

Rental real estate has to be run as a business

Real estate qualifies only when the owner, or the owner’s employees or agents, actively runs it, which leaves out “the mere management of investment assets.” The IRS’s position is in Rev. Rul. 2006-34, and it weighs the time spent, whether there was an office with regular hours, involvement in finding tenants and negotiating leases, services beyond furnishing the space, handling of repairs and handling of tenant requests. In the ruling, an owner who ran a strip mall day to day qualified. An owner who handed an office park entirely to an unrelated management company didn’t, but the same office park qualified when the owner held 20% of the management company. A building net-leased to the owner’s own car dealership qualified because the dealership was an active business.

Families whose wealth is buildings are the ones most likely to need deferral, and the most likely to fail the active-business test if a third-party manager runs everything. A family-owned management company, or a building net-leased to the family’s own operating business, fits the ruling’s examples that qualified.

How the payments and interest run

The estate pays four years of interest and then 10 annual installments, the last one 14 years after the due date, which the IRS describes in Notice 2007-90. Interest for the first five years is paid annually, and after that it’s paid with each installment (IRC § 6166(f)). A deficiency found on audit is spread over the remaining installments unless it came from negligence or fraud (IRC § 6166(e)). An overpayment doesn’t come back as a refund. In Estate of Bell, estates holding stock of a California corporation overpaid after a valuation settlement, and the Ninth Circuit held the overpayment is credited to future installments, not refunded.

On the founder’s $12 million, all but the first $776,000 of tax carries a reduced rate that moves every quarter (IRC § 6601(j)). That first $776,000, the “2-percent portion,” carries 2%, and everything above it carries 45% of the regular underpayment rate, which is the federal short-term rate plus 3 percentage points (IRC § 6621(a)(2)). The underpayment rate for October through December 2026 is 7%, so the reduced rate is 3.15%. Interest compounds daily (IRC § 6622). Each principal payment reduces the 2-percent portion in proportion (IRC § 6601(j)(4)).

The $1,940,000 figure the IRS publishes for 2026 is easy to misread, because it’s a taxable amount, not a tax amount (Rev. Proc. 2025-32). Run through the § 2001(c) rate table above the $15 million exemption, it produces $776,000 of tax at the 2% rate. Two elections, the holding company election in § 6166(b)(8) and the election to count non-readily-tradable stock held by family members in § 6166(b)(7), each drop the 2% portion to zero and remove the five-year interest-only period.

What the IRS can ask for in return

The IRS can require security for a § 6166 deferral, in the form of a bond or a lien, but since Estate of Roski (2007) it decides case by case. A bond can run up to double the deferred amount (IRC § 6165), so the alternative is a lien: the executor can instead elect a special estate tax lien under § 6324A on designated property, signed by everyone with an interest in that property (IRC § 6324A(a), (c)). The lien property doesn’t have to exceed the deferred tax plus four years of interest (IRC § 6324A(b)(2), (e)(2)).

An estate that can’t find a bonding company isn’t out of options. For several years the IRS demanded security from every electing estate, and one Los Angeles estate beat that practice. In Estate of Roski v. Commissioner (2007) 128 T.C. 113, the IRS denied the election of a Los Angeles decedent’s estate because it wouldn’t post a bond or lien. The estate told the IRS it couldn’t find a bonding company willing to cover the 10-year installment period, and the Tax Court held the IRS had abused its discretion by requiring security in every case. The IRS now decides case by case (Notice 2007-90). The notice explains why it cares: the general estate tax lien lasts 10 years from death, so it covers only about the first nine years and three months of a 14-year deferral.

What ends the deferral early

The family loses the deferral if it sells or pulls out half the business. The unpaid tax becomes due on notice and demand if 50% or more of the business interest is distributed, sold, exchanged or otherwise disposed of, or if money and property withdrawn from the business add up to 50% or more of its value (IRC § 6166(g)(1)(A)). The count is cumulative across all dispositions and withdrawals. The election works when the family will keep the business through the 14 years, and it fails when heirs plan to sell or strip half of it, or the business can’t fund the installments (IRC § 6166(a), (g)).

A few transfers don’t trigger the acceleration. A redemption under § 303 doesn’t count if the estate pays at least that much estate tax by the next installment date or within one year (IRC § 6166(g)(1)(B)). Passing the interest to the heirs under the will, intestacy or the decedent’s trust isn’t a disposition, and neither are later transfers at death within the family (IRC § 6166(g)(1)(D)). Certain tax-free reorganizations and spin-offs don’t count either (IRC § 6166(g)(1)(C)).

Two quieter requirements can also end the deferral. Once installments start, the estate has to apply its undistributed net income to the deferred tax each year (IRC § 6166(g)(2)), and it can’t miss a payment. A missed payment accelerates everything, unless it’s paid within six months. In that case the estate owes a 5%-per-month penalty on that payment and loses the reduced rate on it (IRC § 6166(g)(3)).

Raising the cash another way

A § 6166 election works when the family means to keep the business. An estate that misses the 35% line, or whose heirs plan to sell, can look to other sources of cash: a § 303 redemption, a § 6161 extension, a loan, or insurance that funds a buyout.

A redemption when the company has cash

A § 303 redemption lets the company supply the cash, and with a basis step-up at death it usually produces little or no gain. When stock in a corporation is more than 35% of the gross estate less §§ 2053 and 2054 deductions, the corporation can redeem stock from the estate up to the amount of death taxes, funeral and administration expenses, and the redemption is treated as a sale, not a dividend (IRC § 303(a), (b)(2)). For an estate that elected § 6166, the window stays open for the installment period (IRC § 303(b)(1)(C)), but redemptions more than four years after death qualify only to the extent of taxes still unpaid or paid within a year (IRC § 303(b)(4)). A redemption done more than four years out with no tax left to pay fails.

An extension when the estate misses the 35% test

An extension is the fallback for an estate that misses the 35% test, but it’s discretionary and doesn’t carry the 2% or 45% rates. Separate from § 6166, the IRS may extend the time to pay estate tax for up to 12 months, and for reasonable cause for up to 10 years (IRC § 6161(a)).

A loan whose interest the estate can deduct

An estate that would otherwise have to sell stock can borrow to pay the tax and deduct the interest as an administration expense, but only if the loan is genuine and necessary. Borrowing to avoid a forced sale wins. Borrowing to generate an interest deduction while liquid assets sit nearby loses. In Estate of Graegin v. Commissioner, T.C. Memo. 1988-477, the estate borrowed $204,218 from a subsidiary of the family company on a 15-year note at 15%, with principal and interest due at maturity and no prepayment, and deducted the full $459,491 of interest up front. The court allowed it because the estate was illiquid and the alternative was a forced sale of stock.

The later cases turn on necessity. Estate of Duncan, T.C. Memo. 2011-255, where a trust borrowed from a family trust so the estate could pay its tax, allowed a $10,653,826 interest deduction. Estate of Black (2009) 133 T.C. 340 denied $20,296,274 of interest on a loan from the family partnership after it had sold stock to raise the cash. Estate of Koons, T.C. Memo. 2013-94, denied $71,419,497 of projected interest because the borrowing trust, a revocable trust that borrowed $10.75 million, controlled an LLC with over $200 million of liquid assets. The Eleventh Circuit affirmed in 2017 (686 F. App’x 779). Treasury proposed regulations in 2022 that would codify these factors, including that the lender shouldn’t be a substantial beneficiary of the estate or an entity a beneficiary controls (REG-130975-08). They were still proposed, not final, when this page was updated.

Insurance that funds a buyout

Life insurance that funds a buyout of the deceased owner’s shares is the other common source of estate tax cash, and how it’s owned matters. In Connelly v. United States (2024) 602 U.S. 257, the company owned $3.5 million of insurance on each of two brother-owners and had to redeem a deceased brother’s shares. The Supreme Court held the company’s obligation to redeem at fair market value didn’t offset the $3 million of insurance proceeds, so the company was worth $6.86 million, the decedent’s 77.18% was worth about $5.3 million, and the estate owed $889,914 more. A redemption also reduces the business the estate holds, which can count toward the 50% acceleration test unless § 303 applies.

A cross-purchase agreement or an insurance LLC buy-sell works when the owners want insurance cash without inflating the company’s value, and it fails when the company owns the policy and redeems the shares. See buy-sell agreements for California businesses and key person insurance.

Where California changes the decision

The § 6166 decision is a federal one for California families, because California’s estate tax equals the federal credit for state death taxes and that credit was repealed (R&TC § 13302; 26 U.S.C. § 2011, repealed 2014). The state’s effect comes through the ownership tests and the property tax bill that goes with the business.

Community property helps with the ownership tests but not with the 35% math. Stock or partnership interests held as community property are treated as owned by one shareholder or partner for the 45-owner test (IRC § 6166(b)(2)(B)), and the surviving spouse’s community half counts toward the 20% test for combining businesses (IRC § 6166(c)). But only the decedent’s half is in the gross estate, and that’s the half that has to clear 35%. The surviving spouse’s half also gets a new basis at the first death (IRC § 1014(b)(6)), which makes a § 303 redemption or a post-death sale of business assets cheaper in income tax. See community property step-up.

Prop 19 adds a property tax cost that the election doesn’t defer, and it starts with the farm. A parent-to-child transfer of a family farm can keep the parent’s taxable value, but only up to that value plus $1,044,586 for transfers from February 16, 2025, through February 15, 2027, applied parcel by parcel (R&TC § 63.2(a)(2), (d); BOE, 2025). Anything above that is reassessed.

For business real estate, the exclusion covers only a family home or family farm, and “real property” there doesn’t include an interest in a legal entity (R&TC § 63.2(e)(8)). A warehouse, an office building or a shopping center owned directly is reassessed when it passes to children or other heirs at death. Property held in an entity is reassessed when someone obtains control or when original co-owners’ interests cumulatively passing exceed 50% (R&TC § 64(c), (d)). The higher property tax is an annual cost that § 6166 doesn’t defer. See Prop 19 planning.

What to settle before death, while the structure can still change

California owners of operating companies, farms and family-run real estate whose estate is over the federal exemption, and whose wealth can’t be turned into cash in nine months, do most of this work while they’re alive. The work is structuring ownership so the business clears 35%, keeping passive assets out of the operating entity, documenting active management of real estate, and building a buy-sell that survives Connelly. See business succession planning, the S corporation owner with no succession plan and the ultra high net worth planning overview. For a side-by-side of the techniques, see estate planning strategies compared.

Working with Ridley Law

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Book my 30-minute call or call 805-244-5291. To see your exposure first, try the estate tax exposure calculator.

Frequently asked questions

What is section 6166?

It’s the Internal Revenue Code provision that lets an executor pay the estate tax on a closely held business in up to 10 annual installments, starting up to five years after the tax would otherwise be due, when the business is worth more than 35% of the adjusted gross estate.

How long can estate tax be deferred under section 6166?

Up to 14 years after the nine-month due date: four years of annual interest-only payments, then 10 annual installments of tax plus interest (IRC § 6166(a)(3), (f); Notice 2007-90).

What interest rate applies to deferred estate tax in 2026?

2% on the first $776,000 of deferred tax for a 2026 death (the 2-percent portion based on $1,940,000 in Rev. Proc. 2025-32), and 45% of the IRS underpayment rate on the rest, which is 3.15% while the underpayment rate is 7%.

Does rental real estate qualify for section 6166?

Only if it’s run as an active business. Under Rev. Rul. 2006-34, property the owner or the owner’s employees actively manage can qualify, and property handed entirely to an unrelated management company generally doesn’t.

What happens if the heirs sell the business during the deferral?

If 50% or more of the business interest is sold, distributed or withdrawn, the remaining tax becomes due on notice and demand (IRC § 6166(g)(1)). A § 303 redemption used to pay the tax is an exception if the tax is paid on time.

Is interest on a section 6166 deferral deductible?

No. IRC § 2053(c)(1)(D) bars an estate tax deduction and § 163(k) bars an income tax deduction for interest on tax deferred under § 6166.

Does California have its own estate tax deferral?

California doesn’t impose an estate tax today (R&TC § 13302), so there’s nothing to defer at the state level. California’s property tax under Prop 19 is a separate cost that deferral doesn’t cover.