Estate Planning Q&A: Plan for estate tax and GSTT liquidity

ARTICLE | February 11, 2025

Authored by RSM US LLP

Will your loved ones have the cash to pay the estate tax after you're gone? If your estate is made up of illiquid assets, like a family business, it can be difficult to generate sufficient liquidity by the estate tax deadline 9 months after death. Further, generation-skipping transfer tax (GSTT) may be due even sooner. Below we explore solutions to avoid a fire sale and ensure your cherished assets stay in the family.

Consider selling liquid assets

Selling readily available assets like stocks, bonds or excess cash reserves can be a valuable first step. This approach can significantly reduce the estate tax burden before needing to consider more complex strategies. It's best to prioritize selling these liquid assets to avoid the fire sale of cherished or essential illiquid assets like your family business.

Consider an extension of time to pay

The IRS understands that sometimes meeting the 9-month deadline to pay estate taxes can be difficult. A section 6161 extension offers some relief via an extension of time to pay for reasonable cause.

What are the benefits of a section 6161 extension of time to pay?

• Your executor can request one-year extensions (up to 10 years total) if you have reasonable cause, allowing your loved ones additional time to sell assets or find other ways to pay without rushing.
• Obtaining a section 6161 extension is generally easier than other options like a section 6166 election (discussed later).
• Section 6161 extension is also available for GSTT liabilities.

What are the potential downsides of a section 6161 extension of time to pay?

• The IRS has the discretion to approve or deny the request, so it is not guaranteed.
• You can only request one-year extensions at a time. This might not be enough to fully address your liquidity challenges.
• Interest is charged on the unpaid tax, although it can be deducted on the estate tax return.

Consider a payment extension from the IRS

If a large part of your estate is made up of closely-held businesses, a section 6166 payment extension from the IRS can offer valuable breathing room. This extension offers a four-year deferral followed by up to 10 years of payments on the estate tax attributable to the business. This allows time to sell assets or use business income to pay the tax without forced sales.

What are the benefits of a section 6166 payment extension?

• This option spreads out the tax burden over potentially 14 years, instead of your executor having to pay it all at once.
• Your estate can invest income generated by the business to pay the loan interest, potentially reducing the need to bring in outside funds.
• If your estate has the cash available, it can pay the tax due early without any penalty.

What are the potential downsides of a section 6166 payment extension?

• Only the estate tax attributable to the closely-held business may be deferred under section 6166.
• The IRS sets the repayment schedule and interest rate, and the interest rate can fluctuate over time.
• Your estate will need to provide bonds or tax liens as security.
• If your estate sells or distributes a significant portion of the business, the IRS may require immediate payment of the remaining tax balance.
• Undistributed income from the business each year may need to be used towards tax payments, limiting your estate’s access to those funds.
• Not all estates qualify. While a closely-held business is a key factor, there are other complex rules that determine eligibility for a section 6166 extension.
• The interest your estate pays can't be deducted from the estate's taxes, however, the interest rate is lower because it is tax effected.
• Generally, a section 6166 extension is not available for GSTT.

Consider a loan from a loved one or a bank

A ‘Graegin loan’ is a third-party loan used to pay estate taxes. It is named after a court case where the estate successfully deducted the interest paid on such a loan to avoid selling assets at a loss. This type of loan can be obtained from a bank, other financial institution, related family business or irrevocable life insurance trust.

What are the benefits of a third-party loan?

• Fixed interest rates
• Interest payments can be deducted from your estate’s tax liability, reducing the overall financial burden.
• Your estate can potentially obtain a loan from a related party lender, keeping financing costs within the family.
• There are more flexible terms compared to a loan from the IRS in terms of collateral requirements and loan covenants.
• There is no requirement for the estate to hold a qualifying closely-held business.
• These loans typically do not delay the issuance of an estate closing letter, allowing your family to wind down the estate more efficiently.
• This type of loan can be used for GSTT.

What are the potential downsides of a third-party loan?

• The IRS may closely examine the loan terms to ensure they're legitimate and not simply a tax avoidance strategy.
• If you don't use a related party lender, you'll be paying interest to a third-party institution.
• ‘Graegin loans’ typically don't allow for prepayment or renegotiation of terms once established.
• The IRS has proposed regulations to limit the benefits that may arise from a Graegin loan.

Consider life insurance

Life insurance proceeds may help bridge the liquidity gap.

What are the benefits?

• Properly structured life insurance trusts keep the death benefit out of your taxable estate, potentially lowering your overall tax liability.
• Provides immediate cash to pay estate taxes and associated costs, avoiding forced sales of illiquid assets like your business.

What are the potential downsides?

• May require ongoing premium payments for many years. If held in a life insurance trust, this may mean additional gift tax reporting and use of lifetime gift/estate and generation-skipping tax exemption.
• Improper structuring could result in the death benefit being included in your taxable estate.