Rev. Rul. 86-54

1986-1 C.B. 356, 1986-15 I.R.B. 44.

INSTALLMENT METHOD; CLOSELY-HELD BUSINESS; STOCK REDEMPTION

Published: April 14, 1986

Section 6166.-Extension of Time for Payment of Estate Tax Where Estate Consists Largely of Interest in Closely Held Business 26 CFR 20.6166-1: Election of alternate extension of time for payment of estate tax where estate consists largely of interest in closely held business. (Also Section 303, 1.303-2.)

  Installment method; closely-held business; stock redemption. An explanation is provided of the application of sections 303 and 6166 of the Code when shares of stock are redeemed and an election to pay the estate tax in installments is made. Rev. Rul. 72-188 modified.

ISSUE

  In the situation described below, do the redemptions of stock that qualify under section 303 of the Internal Revenue Code constitute distributions or withdrawals for purposes of the acceleration rule of section 6166(g)? Specifically, is section 6166(g)(1)(B), which excludes certain section 303 redemptions from the application of the acceleration rule, to be applied on a

'redemption-by-redemption' basis (under which the amount of each section 303 redemption must not exceed the amount of federal estate taxes paid during the

'permitted period') or on a 'cumulative' basis (under which the total cumulative amount of the current redemption and all prior section 303 redemptions must not exceed the total cumulative amount of all federal estate taxes paid on or before the close of the 'permitted period')?

FACTS

  D, a citizen of the United States, died in April 1977. Under the terms of D's will, the executors are required to pay the taxes and expenses described in section 303(a) of the Code. A Federal Estate Tax Return, Form 706, was timely filed on January 12, 1978. D's gross estate included an interest in X corporation that comprised more than 65% of the adjusted gross estate. Under the then-applicable version of section 6166(a), the interest in X qualified as a closely held business interest. Pursuant to section 6166, D's executors elected to pay $1,480x of the federal estate tax liability in installments, using the 5-year deferral permitted by section 6166(a)(3). The first installment payment became due on January 12, 1983.

  D's executors filed the federal estate tax return and paid nondeferred estate tax of $460x on January 12, 1978, when the federal estate tax return was filed. On February 11, 1980, the estate paid state death tax of $320x. Beginning on January 12, 1979, and continuing throughout the deferral period, the estate made payments of interest in varying amounts with respect to the deffered federal estate tax. The estate made installment payments of deferred tax beginning on January 12, 1983.

  X made a series of redemptions of stock from D's estate as set forth below. Each of the redemptions qualified for treatment as a distribution in full payment in exchange for the stock so redeemed under section 303(a) of the Code.

  The series of section 303 redemptions and tax payments are as follows:

            Redemption                       Cumulative
    Date                Amount              Redemptions

    1) 1/14/78          $460x                $  460x
                                                460x
    2) 2/11/80           320x                   780x
                                                780x
    3) 1/12/82            26x                   806x
    4) 1/12/83           150x                   956x
    5) 1/11/84           150x                  1106x
    6) 1/11/85           150x                  1256x

                           (Table continued)

              Payments                            Cumulative Federal
Date      Nature of Payment     Amount          Estate Tax Payments

1/12/78      Federal Tax         $460x                $460x
1/12/79      Interest               8x                 468x
1/12/80      Interest              10x                 478x
2/11/80      State Tax            320x                 478x
1/12/81      Interest              16x                 494x
1/12/82      Interest              28x                 522x
1/12/83      Installment          150x                 672x
1/12/84      Installment          150x                 822x
1/12/85      Installment          150x                 972x

LAW AND ANALYSIS

  The Tax reform Act of 1976, section 2004(a), 1976-3 (Vol. 1) C.B . 1, 338, enacted section 6166 of the Code effective for estates of decedents dying after

1976.

  Section 6166(a)(1) of the Code provides that, if the value of an interest is a closely held business that 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 (65 percent for decendents dying before January 1, 1982), then the executor may elect to pay part or all of the estate tax in 2 or more (but not exceeding 10) equal installments. Generally, under section 6166(a)(2), only the amount of estate tax attributable to the value of the closely held business interest may be paid in installments.

  For estates of decedents dying after December 31, 1981, section 6166(g)(1)(A) of the Code (the acceleration rule) provides that the privilege of paying the estate tax in installments ceases and the unpaid tax becomes due immediately, if the sum of (i) the amount of the decedent's closely held business interest that is distributed, sold, exchanged, or otherwise disposed of, and (ii) the amount of withdrawals from the trade or business, exceeds 50 percent of the value of the decedent's interest in the business. For estates of decedents dying on or before December 31, 1981, and after December 31, 1976, the installment privilege ceases to apply if (i) one-third or more in value of the decedent's closely held business interest is distributed, sold, exchanged, or otherwise disposed of, or (ii) the aggregate withdrawals of money and other property from the closely- held business with respect to the decedent's interest, equal or exceed one-third of the value of such trade or business.

  Section 6166(g)(1)(B) of the Code, as in effect for estates of decedents dying after 1976 and before 1982, provided:

  (B) In the case of a distribution in redemption of stock to which section 303

(or so much of section 304 as relates to section 303) applies-

      (i) (the acceleration of payment provisions for dispositions)
          does not apply with respect to the stock redeemed;and for
          purposes of such subparagraph the interest in the closely
          held business shall be considered to be such interest
          reduced by the value of the stock redeemed, and

     (ii) (the acceleration of payment provision for withdrawals) does
          not apply with respect to withdrawals of money and other
          property distributed; and for purposes of such subparagraph
          the value of the trade or business shall be considered to be
          such value reduced by the amount of money and other property
          distributed.

  This subparagraph shall apply only if on or before the date prescribed by section 6166(a)(3) for the payment of the first installment which becomes due after the date of the distribution (or, if earlier, on or before the day which is 1 year after the date of the distribution), there is paid an amount of the tax imposed by section 2001 not less than the amount of money and other property distributed.

  The general rule under section 6166(g)(1)(A) of the Code is that the decedent's estate may continue paying the estate tax in installments if the aggregate of dispositions and withdrawals does not exceed a specified portion of the value of the decedent's closely held interest. If the aggregate of dispositions and withdrawals exceeds the limitation of section 6166(g)(1)(A), the unpaid tax is 'accelerated' and becomes payable. However, section

6166(g)(1)(B) provides a limited exception to this acceleration rule for certain qualifying section 303 redemptions of stock. This exception only applies if by the date of the first installment payment of tax due after the distribution or, if earlier, one year from the date of the distribution, a payment of the estate tax is made that is at least equal to the total amount of money and other property distributed in the section 303 redemption. Payment of interest on the estate tax qualifies as a payment of estate tax for purposes of section 6166. See sections 6601(e)(1) and 6601(j). A state death tax payment that is creditable against the federal estate tax is not equivalent to the payment of federal estate tax for purposes of section 6166(g). See Rev. Rul.

85-43, 1985-1 C.B. 356.

  The matching of the redemption amounts with the estate tax payments as required by section 6166(g)(1)(B) of the Code is discussed in Rev. Rul. 72-188,

1972-1 C.B. 383. That ruling adopts a 'cumulative' method of applying section

6166(g)(1)(B). The cumulative method requires a comparison of the cumulative estate tax payments with the cumulative section 303 redemptions; only to the extent that cumulative redemptions exceed cumulative estate tax payments is there an amount not within the section 6166(g)(1)(B) exception to the acceleration rules.

  An alternative approach to section 6166(g)(1)(B) of the Code is suggested by regulations interpreting language in now repealed section 6166A of the Code that was identical to the flush language in section 6166(g)(1)(B). Section

20.6166A-3(d)(2) of the Estate Tax Regulations provides, in part, that the exclusion for a section 303 redemption does not apply unless after the redemption, but on or before the date prescribed for payment of the first installment that becomes due after the redemption, there is paid an amount of estate tax not less than the amount of money or other property distributed. If there is a series of section 303 redemptions, each redemption is treated separately, and the failure of one redemption to qualify does not necessarily mean that another redemption does not qualify. This method can be characterized as a 'redemption-by-redemption' approach.

  Thus, under the section 6166A regulations a section 303 redemption qualifies for the exclusion from the acceleration rule if after the redemption and within the permitted period there is paid estate tax not less than the amount of the section 303 redemption. These regulations state that each redemption in a series of redemptions is to be treated separately. Because of the identity of the flush language in section 6166(g)(1)(B) of the Code and former section

6166A(g)(1)(B), the rule in section 20.6166A-3(d)(2) of the regulations is relevant to section 6166 as well as to former section 6166A.

  Neither the redemption-by-redemption approach nor the cumulative approach is totally satisfactory to achieve the primary purpose of section 6166 of the Code making it possible to keep together a business enterprise after the death of one of the owners results in the imposition of estate tax. H.R. Rep. No. 2198, 85th Cong., 2d Sess. 7 (1958), 1959-2 C.B. 709, 713. Congress extended the period during which section 303 redemptions are permitted, in order to more closely correlate the rules of section 303 and section 6166 to allow the corportion to use earnings generated throughout the installment payment period for stock redemptions to pay the deferred federal estate tax. H.R. Rep. No. 94-1380, 94th Cong., 2d Sess. 34 (1976) 1976-3 (Vol. 3) C.B. 735, 769-770. Reliance solely on the cumulative method in applying section 6166(g)(1)(B) can produce a result inconsistent with the extension of the period for making redemptions under section 303. A redemption that qualifies under section 303 but does not satisfy the cumulative method may preclude applicability of section 6166(g)(1)(B) to later redemptions, even though such succeeding redemption is followed within the permitted period by the payment of federal estate tax not less than the amount of the redemption. Similarly, in the case of redemptions made on or before the fourth anniversary of the decedent's death, exclusive reliance on the redemption-by-redemption approach can cause acceleration of the deferred tax if nondeffered estate tax payments are made before any section 303 redemptions. In such a situation, one or more of the redemptions might exceed the amount of estate tax paid within the permitted period with the result that the redemption or redemptions in excess of estate tax paid within the permitted period would not be within the section 6166(g)(1)(B) exclusion and would count against the limitation of section 6166(g)(1)(A).

  The Internal Revenue Service has reconsidered Rev. Rul. 72-188 and, in light of the Congressional intent behind sections 303 and 6166 of the Code, will permit the cumulative approach and the redemption-by-redemption approach to be used interchangeably. Estates, therefore, may qualify for th exclusion under section 6166(g)(2)(B) if a section 303 redemption (or each of a series of redemptions) qualifies under either approach.

HOLDING

  The exclusion in section 6166(g)(1)(B) of the Code applies to a section 303 redemption (the redemption) if (I) the cumulative amount of section 303 redemptions, as of the date of the redemption, is less than or equal to the total amount of estate tax payments as of the due date of the following estate tax payment (or, if earlier, the date which is 1 year after the distribution pursuant to the redemption), or (2) the amount of the redemption is less than or equal to the amount of the estate tax payments made within the permitted period.

  Thus, in the situation described above, all of the redemptions of stock under section 303 of the Code are entitled to the exclusion from treatment as a distribution or withdrawal provided by section 6166(g)(1)(B) except that with regard to redemption 2) (the $320x redemption made on 2/11/80), only $34x (the sum of the 1/12/79, 1/12/80, and 1/12/81 interest payments, which are all made on or before the close of the permitted period) is entitled to the exclusion. Redemption 1) qualifies under the cumulative method, redemption 2) qualifies, in part, under the cumulative method, and redemptions 3)-6) qualify under the redemption-by-redemption method.

  Because the relevant parts of the acceleration rules have not been amended, this holding applies to all versions of section 6166 and 6166A since the original enactment in 1958.

EFFECT ON OTHER RULINGS

  Rev. Rul. 72-188 is modified.

Rev. Rul. 86-54, 1986-1 C.B. 356, 1986-15 I.R.B. 44.