Statute of Limitations on Collection of an Estate Tax Liability when a Section 6166 Election Is in Place by LACEY STRACHAN
Generally, payment of estate tax is due nine months after the date of death of a decedent.[i] However, there is an election that can be made under certain circumstances to defer payment of all or a portion of estate tax due, where part or all of the estate tax is attributable to interests in certain closely held businesses. Section 6166 provides that 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 estate tax in up to ten equal installments, with the first installment being due up to five years after the original due date for payment.[ii] Therefore, if elected, this section allows the estate tax covered by the election to be paid (with interest) over a fifteen year period. The election applies both to the amount originally determined to be due, as well as to any subsequently determined deficiencies, as long as the deficiency is not due to negligence, intentional disregard of rules and regulations, or fraud.[iii]
Eligibility for Section 6166 Election. An “interest in a closely held business” is defined to include (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% or more of the total capital interest in the partnership is included in determining the gross estate of the decedent, or if the partnership had 45 or fewer partners; or (3) stock in a corporation carrying on a trade or business, if 20% or more in value of the voting stock of the corporation is included in determining the gross estate of the decedent, or if the corporation had 45 or fewer shareholders.[iv] The requirement that the value of the interest must exceed 35 percent of the adjusted gross estate limits the availability of the election to only those situations where the interest in the closely held business makes up a significant portion of the estate—excluding estates where the adjusted gross estate is expected to have substantial other assets from which the estate tax liability could be paid. Under this election, only the portion of the estate tax attributable to the value of the interest in the closely held business may be deferred.[v]
The Section 6166 election is designed to prevent heirs from having to liquidate closely held businesses in order to pay the estate’s estate tax liability. Congress was concerned that where the decedent had a substantial portion of his estate invested in a closely held business, the heirs may be confronted with the necessity of either breaking up the business or of selling it to some larger business enterprise, in order to obtain the funds necessary to pay the tax liability.[vi] Section 6166 is intended to make it possible for the estate tax to be paid out of earnings of the business, or to at least allow time for the heirs to obtain funds to pay the estate tax without having to sell the business.[vii]
Statute of Limitations on Collection when a Section 6166 Election Is in Place. While the Section 6166 election is in place, the IRS is prevented from pursuing collection efforts to collect the unpaid estate tax liability that is being paid in installments, and accordingly, the statute of limitations for collection of the tax is suspended during this time. The statute of limitations on collection generally is ten years from the date of assessment of the tax.[viii] Section 6503(d) provides, in pertinent part, that the statute of limitations on collection of an unpaid estate tax liability is suspended “for the period of any extension of time for payment granted under the provisions of section…6166.”[ix]
This raises the question of when the statute of limitations on collection begins to run when a Section 6166 election is terminated early. There are three situations in which a Section 6166 election will be terminated and the amounts due will be accelerated, in whole or in part: (1) If any portion of the closely held business interest is disposed of or money or other property is withdrawn from the business, and the dispositions and withdrawals in the aggregate equal or exceed 50 percent of the value of the interest, then the extension will cease to apply and the unpaid portion of the tax will be accelerated and due upon notice and demand from the IRS; (2) If the estate has undistributed net income for any taxable year ending on or after the due date for the first installment, an amount equal to such undistributed net income must be paid on or before the due date (including extensions) for the income tax return for that year in liquidation of the unpaid portion of the tax payable in installments; and (3) if any installment payment or interest payment is not paid on time, the unpaid portion of the tax payable in installments must be paid upon notice and demand from the IRS.[x]
United States v. Godley, Jr. The court in United States v. Godley, Jr., No. 3:13-cv-00549 (DC NC, 09/29/2015) recently addressed this question in the third situation—where the taxpayers have missed a payment due under the Section 6166 election and have defaulted on the Section 6166 installment agreement.[xi] In Godley, Jr., the estate had made a Section 6166 election regarding a portion of the estate tax liability of the decedent who had passed away on May 11, 1990, but had not made any payments required under the election after October 3, 1994.[xii]
As a result, on October 15, 2001, the IRS issued a notice to the estate, which included a “statement of Tax Due IRS” that informed the administrator of the estate that the past years’ missed installments and the then-currently due installment were due, plus penalties and interest, and instructed him to pay the balance within 10 days—the notice did not include any instructions or warnings regarding termination of the Section 6166 election or acceleration of the total amount due.[xiii] The following year, on September 18, 2002, the IRS sent another notice after not receiving any payments, stating: “The Section 6166, Installment Agreement is in default due to non-payment and the account is in danger of being accelerated, making the full account balance due immediately. In order to avoid this, we must receive the installment payment by September 30, 2002.” The statement also indicated: “In order to avoid ACCELERATION OF THE ACCOUNT, please send the amount due by September 30, 2002….”[xiv] Finally, on October 15, 2003, the IRS issued a third notice, notifying the Estate that its account was being accelerated due to its Section 6166 election default.[xv]
The IRS did not taking any collection action after sending the 2003 notice until 2012, when it filed Notices of Federal Tax Liens against the estate and sent Notices of Federal Taxes Due to the administrator of the estate, the past co-executors of the estate, and the estate’s beneficiaries. On September 27, 2013, the Government filed a suit to collect the unpaid estate tax liability. At issue in Godley, Jr. was whether the Government’s suit was filed within the statute of limitations for collection. To determine that, the court had to decide when the Section 6166 election was terminated, causing the running of the statute of limitations to be triggered.[xvi]
The court explained that an estate’s default on its Section 6166 plan alone is not sufficient to trigger the statute of limitations.[xvii] The suspension of the statute of limitations under section 6503(d) is lifted and the ten-year limitations period begins running only when: (1) an estate fails to pay any principal or interest payment pursuant to its Section 6166 election; and (2) notice and demand for taxes due is made by the IRS. Because there was no dispute that the estate had defaulted on the Section 6166 installment agreement, the issue in Godley, Jr. turned on when the IRS made notice and demand.[xviii]
Requirement of a Notice and Demand for Taxes Due. The defendants in Goldey, Jr. argued that either the 2001 notice or the 2002 notice constituted a notice and demand, triggering the ten-year statute of limitations. The Government did not dispute that both the 2001 and 2002 notices were notices and demands, but contended that those two correspondences “did not constitute the kind of notice and demand necessary” to trigger the statute of limitations under Section 6166.[xix] Citing Section 6166(g)(3)(A) and United States v. Askegard, 291 F. Supp. 2d 971, 979 (D. Minn. 2003), for support, the Government argued that a notice and demand operates to lift the section 6503(d) suspension of the statute of limitations only if the notice and demand affirmatively terminates the Section 6166 Election, accelerates all future installments, and demands payment thereof, which the Government argued did not happen until the 2003 notice.
The court instead followed the holding of Estate of Adell v. Commissioner, 106 T.C.M. (CCH) 377 (T.C. 2013), and concluded that the statute of limitations started running on September 30, 2002—the deadline for payment given by the IRS in the 2002 notice.[xx]
The court acknowledged that Section 6166(g)(3)(A) gives the IRS flexibility to work with taxpayers in default, instead of having the Section 6166 election automatically terminated and the tax liability accelerated—the election is terminated and the liability accelerated only if an affirmative notice and demand is issued by the IRS. The notice and demand requirement serves to give taxpayers fair warning before the IRS terminates the Section 6166 election and demands immediate payment of all taxes.[xxi] However, the court held that the IRS did not have the ability to unilaterally and periodically suspend the statute of limitations, explaining that it would be against Congressional intent to allow the IRS to circumvent the limitations period and keep the door open for potential future litigation by regularly issuing notices that threaten to terminate the Election rather than filing a lawsuit.[xxii]
The court concluded that to trigger the statute of limitations, the notice and demand must communicate to an estate only that its Section 6166 election will be terminated if payment is not made, which was contained in the 2002 notice. Noting that the 2002 notice mirrored the notice at issue in Estate of Adell, the Court held that the statement in the 2002 notice that the Section 6166 election will be terminated if the payment demanded in the notice was not made within ten days was sufficient to terminate the Section 6166 election when the payment was not made within that ten-day period, with no further notice being necessary. As a result, the court dismissed the Government’s suit, finding that it was filed after the expiration of the statute of limitations, which was at the latest ten years from September 30, 2002—the deadline for payment contained in the 2002 notice. [xxiii]
Although United States v. Godley, Jr. addressed only the situation where an estate has missed payments due under a Section 6166 installment agreement (Section 6166(g)(3)), the same “notice and demand” language appears Section 6166(g)(1), which sets forth the circumstances where a disposition of the interest in the closely held business or a withdrawal of funds from the business will cause a termination of the Section 6166 election. Therefore, this same analysis will likely apply to the determination of when a Section 6166 election is terminated under Section 6166(g)(1) as well.
LACEY STRACHAN – For more information please contact Lacey Strachan at Strachan@taxlitigator.com. Ms. Strachan is a senior tax attorney at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. She routinely represents and advises U.S. taxpayers in foreign and domestic voluntary disclosures, sensitive issue domestic civil tax examinations where substantial civil penalty issues or possible assertions of fraudulent conduct may arise, and in defending criminal tax fraud investigations and prosecutions. She has considerable expertise in handling matters arising from the U.S. government’s ongoing civil and criminal tax enforcement efforts, including various methods of participating in a timely voluntary disclosure to minimize potential exposure to civil tax penalties and avoiding a criminal tax prosecution referral. Additional information is available at https://www.taxlitigator.com.
[i] IRC § 6075. The estate tax return is generally due nine months after the date of death of a decedent, but a six month extension is available if requested prior to the due date and the estimated correct amount of tax is paid before the due date. Although this extends the date for filing the estate tax return, it does not extend the due date for payment of the estate tax. IRC § 6151.
[ii] Under Section 6166, the estate tax may be paid in two to ten equal annual installments. IRC § 6166(a)(1). If an election is made, the first installment must be paid on or before the date selected by the executor, which is not more than 5 years after the original due date for payment of the estate tax, and each succeeding installment shall be paid annually thereafter. IRC § 6166(a)(3) Prior to the due date of the first installment, only interest is required to be paid annually. IRC § 6166(f)(1).
[iii] IRC § 6166(h)(1); Treas. Reg. § 20.6166-1(a).
[iv] IRC § 6166(b)(1).
[v] IRC § 6166(a)(2).
[vi] H.R. Rep. No. 2198, 8th Cong., 1st Sess. (1958), reprinted in 1959-2 CB 709,713.
[viii] IRC § 6502(a).
[ix] IRC § 6503(d).
[x] IRC § 6166(g)(1), (2) & (3).
[xi] Under IRC § 6166(g)(3)(B), there is a provision that provides for a six-month grace period to make a missed payment and avoid termination of the election.
[xii] United States v. Godley, Jr., No. 3:13-cv-00549 (DC NC, 09/29/2015).
[xvii] Id. (citing IRC § 6166(g)(3) and United States v. Askegard, 291 F. Supp. 2d 971, 979 (D. Minn. 2003)).
[xviii] United States v. Godley, Jr., No. 3:13-cv-00549 (DC NC, 09/29/2015).
[xxi] Id. (citing Jersey Shore State Bank, 781 F.2d 974, 978 (3d Cir. Pa. 1986)).
[xxii] United States v. Godley, Jr., No. 3:13-cv-00549 (DC NC, 09/29/2015).
[xxiii] The court did not address whether the 2001 notice was sufficient to terminate the election, because the issue became moot after the court’s findings regarding the 2002 notice.