Tax
Section 6166 Estate Tax Deferral: What the Business Valuation Decides
Estate planning for owners of closely held companies: how the business valuation decides whether Section 6166 lets the executor pay estate tax in installments.
By 409.AI Team - 2026-10-09
# Section 6166 Estate Tax Deferral: What the Business Valuation Decides
When an owner of a small private company dies with an estate large enough to owe federal estate tax, the family can face a hard fact: the tax is due in cash, and most of the wealth is in a business nobody wants to sell in a hurry. Section 6166 of the Internal Revenue Code exists for that moment. It lets the executor spread part of the tax over many years.
This article is for owners of closely held companies and for the CPAs, estate attorneys and lenders who plan alongside them. It explains where the valuation of the business sits inside the §6166 rules, because several of the tests are decided by a number that someone has to defend. It draws no conclusion about any particular estate. Those turn on facts, state law and elections that belong to the executor and their advisors.
The relief in plain terms
Federal estate tax is generally due nine months after death. If the value of an interest in a closely held business included in the gross estate "exceeds 35 percent of the adjusted gross estate," the executor may elect to pay part or all of the tax "in 2 or more (but not exceeding 10) equal installments" ([26 U.S.C. §6166(a)](https://www.law.cornell.edu/uscode/text/26/6166)).
The first installment can be put off for up to five years after the normal due date, and each later installment follows a year after the one before. Interest is still owed in the meantime and is paid annually. So the longest arrangement runs about fourteen years: several years of interest only, then up to ten annual installments.
The deferral covers only the slice of the tax that belongs to the business. The statute scales it by the ratio of the qualifying business value to the adjusted gross estate. The rest of the tax is due on the usual date.
For 2026 the federal basic exclusion amount is $15,000,000 per person ([IRS, 2026 inflation adjustments](https://www.irs.gov/newsroom/irs-releases-tax-inflation-adjustments-for-tax-year-2026-including-amendments-from-the-one-big-beautiful-bill)), so the election matters mainly for larger estates, and for owners in states that have their own estate tax at lower thresholds. State rules are a separate question for the estate attorney.
Where the valuation enters
Three numbers drive eligibility, and the business valuation feeds each of them.
The value of the business interest. For federal estate tax purposes, the starting standard is fair market value on the date of death: what a willing buyer would pay a willing seller, neither forced to act. For stock in a company with no public market, the Treasury regulation points to the company's net worth, prospective earnings and dividend-paying capacity, among other factors ([Treas. Reg. §20.2031-2(f)](https://www.law.cornell.edu/cfr/text/26/20.2031-2)). Appraisers also work from [Revenue Ruling 59-60](https://www.irs.gov/pub/irs-tege/rr59-60.pdf), which covers the same ground in more detail.
The adjusted gross estate. The statute defines it as the gross estate reduced by deductions allowed under sections 2053 and 2054, which cover items such as funeral expenses, administration costs, debts and casualty losses. Every other asset in the estate has to be valued as well: the house, the investment accounts, the life insurance owned by the decedent.
The passive assets inside the company. Here the valuation work gets granular, and it is where estates most often lose ground. More on that below.
A worked example
All figures are illustrative.
Maria owned 100 percent of a regional distribution company. At her death:
| Item | Value | |---|---| | Distribution company (appraised) | $9,500,000 | | Residence, brokerage and retirement accounts, other assets | $16,500,000 | | Gross estate | $26,000,000 | | Deductions under §2053 and §2054 | $1,000,000 | | Adjusted gross estate | $25,000,000 |
The 35 percent line sits at $8,750,000. The company at $9,500,000 is 38 percent of the adjusted gross estate, so the test is met. If the estate tax comes to $4,000,000, the share that can be spread over the installment period is 38 percent of it, or $1,520,000. The remaining $2,480,000 is due with the return.
Now change one thing. The appraiser concludes the company is worth $8,000,000 instead. The gross estate falls to $24,500,000 and the adjusted gross estate to $23,500,000. The company is now 34 percent of it, and the election is out of reach. A difference of about 16 percent in one appraisal moved the estate from eligible to ineligible. That is why the quality of the appraisal, and the evidence behind each input, is the work product the executor ends up leaning on.
The tension with discounts
Valuation discounts pull in two directions here, and a good advisor says so out loud.
A discount for lack of marketability or lack of control lowers the value of a minority or illiquid interest. A lower value means a lower estate tax bill, which is usually what the executor wants. It also lowers the business share of the estate, which is the number the 35 percent test measures. An estate sitting near the line can find that the discount that saved tax also cost it eligibility.
There is no trick that resolves this, and an appraisal should never be shaded toward either outcome. The standard of value is fixed, the facts decide the discount, and the advisors' job is to run the numbers both ways before the return is filed so the executor knows what the election is worth. For how those discounts are built and defended, see our articles on [lack of marketability](https://www.409.ai/articles/discount-lack-marketability-dlom-409a-valuation) and [lack of control](https://www.409.ai/articles/discount-lack-of-control-dloc-409a-gift-tax-valuation).
Separately, the executor may be able to elect the alternate valuation date, six months after death, under [§2032](https://www.law.cornell.edu/uscode/text/26/2032). That election is allowed only when it lowers both the gross estate and the estate tax, so it does not exist as a way to fine-tune eligibility. If it is used, the business and every other asset get valued as of the later date.
Passive assets: the part owners do not expect
The deferral is designed for operating businesses. The statute excludes the portion of a business's value that is attributable to passive assets, which it defines as any asset other than an asset used in carrying on a trade or business ([§6166(b)(9)](https://www.law.cornell.edu/uscode/text/26/6166)). Cash that has piled up beyond working-capital needs, a portfolio of securities and a rental property owned by the company are the usual examples.
Go back to Maria's company. Suppose the appraiser finds that $2,000,000 of its $9,500,000 value is excess cash and an investment account. Only $7,500,000 counts toward the test. That is 30 percent of $25,000,000, and the estate misses the threshold even though the company itself looks big enough.
So the appraisal for this purpose has two jobs. It values the whole company, and it separates the value that belongs to operations from the value that belongs to assets sitting inside. The split is a judgment, and it needs support: what the cash balance was relative to the company's needs, what the business actually used each asset for, and how long it had been that way. Owners who see this question coming can sometimes fix it while alive, with advice from their CPA and attorney. A person cannot fix it afterward.
There is a rule for holding companies. When one corporation owns 20 percent or more of the voting stock of another, or the other has 45 or fewer shareholders, the two can be treated as one for the passive-asset test if at least 80 percent of the value of each is attributable to active business assets. Whether a given structure fits is a legal question.
Which interests count
The business has to be a trade or business, and the interest has to be one the statute recognizes. A sole proprietorship counts. A partnership interest counts if the decedent held 20 percent or more of the total capital interest, or if the partnership had 45 or fewer partners. A corporation counts on the same two tests, using voting stock and shareholder count ([§6166(b)(1)](https://www.law.cornell.edu/uscode/text/26/6166)). Stock and partnership interests held by the decedent's family are treated as held by the decedent for those ownership tests.
Those tests apply to ownership, which is a matter of documents. The valuation matters when ownership is spread among several entities, for example an operating company, a real estate company that leases it the building, and a holding company above both. Each entity's value, and how much of it is operating value, ends up in the file.
After the election: what can unwind it
The relief has strings. If the estate disposes of or withdraws money from the business interest to the point where the total equals or exceeds 50 percent of its value, the unpaid balance can come due early ([§6166(g)](https://www.law.cornell.edu/uscode/text/26/6166)). A buy-sell agreement that triggers a redemption after death can fall squarely inside that rule, which is one more reason to read the agreement and its pricing formula well before anyone needs it. We covered how a funded buy-sell can misprice a redemption in [buy-sell agreement valuation after Connelly](https://www.409.ai/articles/buy-sell-agreement-valuation-connelly-life-insurance).
The election itself must be made no later than the due date of the estate tax return, extensions included ([§6166(d)](https://www.law.cornell.edu/uscode/text/26/6166)), on a timely filed [Form 706](https://www.irs.gov/forms-pubs/about-form-706). That means the appraisal, the passive-asset analysis and the percentage test all have to be finished before the executor files, not after.
What to have ready
Whether the election is made or not, the same file helps:
1. Three to five years of tax returns and financial statements for each entity, plus the most recent interim period. 2. Every document that shows ownership: stock ledgers, operating agreements, buy-sell agreements, trusts. 3. A balance sheet at the date of death that distinguishes operating assets from cash, securities and real estate not used in the business. 4. A normalized earnings schedule. The owner's own pay is usually the first adjustment, and we walk through it in [owner compensation and add-backs in SDE and EBITDA](https://www.409.ai/articles/owner-compensation-add-backs-small-business-valuation-sde-ebitda). 5. For an S corporation, the treatment of income taxes in the value. See [tax-affecting a pass-through entity](https://www.409.ai/articles/tax-affecting-pass-through-entity-s-corp-valuation).
An independent appraiser should prepare the valuation, one with no stake in whether the estate qualifies. Our [small business valuation service](https://www.409.ai/products/smb-valuation) delivers an expert-reviewed report starting from $899 for situations like this one.
The takeaway
Before an estate plan settles on how the tax will be paid, ask the appraiser for three numbers instead of one: the value of the whole company, the value of the operating part and the share of the adjusted gross estate each represents. If the business sits within a few points of 35 percent, treat the appraisal as the central document of the estate, and have the owner's attorney and CPA read it alongside the return that depends on it.