Capital Planning and IRS Section 6166

Capital Budgeting Planning & Strategy Taxes

Successful enterprising families are careful and deliberate consumers of family capital.  Thoughtful capital planning comprises two distinct but related decisions.

  • Capital budgeting is a disciplined process for identifying and evaluating potential capital projects available to the family business. A well-designed capital budgeting process consists of a series of “gates” or strategic and financial criteria that help to cull worthwhile projects from the larger herd of the possible.
  • Capital structure is the mix of debt and equity financing used to fund the projects that survive the capital budgeting process. Many family businesses identify a so-called “target” capital structure that represents an optimal blend of funding costs, availability, and risk for the business and the family shareholders.

For family businesses with significant ownership concentrations, the estate taxes eventually payable upon the death of a primary shareholder can represent a significant contingent “non-operating” liability.  Unlike the uses of capital typically evaluated in capital budgeting, the obligation to pay estate taxes is not discretionary.  But if the deceased shareholder’s estate does not include sufficient liquidity, the economic burden of the tax effectively falls upon the family business, which must allocate capital toward either a redemption of the estate’s shares or a pro rata distribution.  From the perspective of the business, this obligation may “crowd out” other, more attractive uses of capital that would help build value for subsequent generations.

In specific circumstances, Section 6166 of the Internal Revenue Code provides a capital planning alternative for family businesses facing large contingent liabilities for shareholder estate tax obligations.

Key Provisions of Section 6166

Section 6166 provides qualifying estates with a five-year deferral period, followed by an installment period of up to ten years to pay estate taxes.  Estates qualify for the Section 6166 election if:

  • Ownership interests in active (not passive) closely held businesses comprise at least 35% of the adjusted gross estate;
  • The ownership interests represent at least a 20% ownership position in the subject closely held business; and,
  • The closely held business has no more than 45 shareholders.

An estate may elect to defer that portion of the aggregate estate tax liability attributable to qualifying closely held business interests under the terms of Section 6166, which include:

  • A five-year deferral period, during which only interest is payable;
  • Following the deferral period, the tax may be paid in up to ten equal annual installments (along with corresponding interest);
  • The interest rate on a portion of the estate tax obligation ($740 thousand in 2024) is fixed at 2%, and the balance of the estate tax obligation bears interest at a floating rate equal to 45% of the prevailing rate on unpaid taxes (45% x 8.0% = 3.6% for the second quarter of 2024);
  • The deferred estate tax becomes due and payable upon the occurrence of any of the following:
    • Cumulative distributions equal to 50% of the value of the ownership interest;
    • Sale of 50% or more of the underlying ownership interest;
    • Failure to make timely interest or principal payments.
  • Under certain circumstances, the business may have to pledge assets as collateral for the deferral and be subject to certain reporting and monitoring obligations;
  • Finally, any undistributed net income of the estate in years following the deferral election must be paid to reduce the outstanding principal of deferred tax.

Pros and Cons

Section 6166 can be an important element of responsible capital planning for qualifying family businesses and estates.  Taking advantage of Section 6166 probably makes more sense for some family businesses than others.

  • Family business directors need to know what time it is. If it is planting season for your family business, diverting capital from attractive investment opportunities to fund shareholder estate tax obligations could negatively affect shareholder returns for generations.  In such cases, the Section 6166 election could provide a great opportunity to ensure the family business is not starved of needed capital.
  • For family businesses in harvest mode, the distribution and sale limitations may foreclose liquidity options that would benefit the family shareholders as a group. From the perspective of these families, the ability to defer the tax payments at generally favorable rates may not offset the forfeited financial flexibility.
  • For companies already operating at or near their target capital structures, Section 6166 can represent a financially attractive opportunity for off-balance sheet funding. The interest rate is attractive (as of the date of this writing, the Section 6166 rate of 3.6% compares quite favorably to the bank prime rate of 8.5%).  Furthermore, there are no underwriting criteria for the loan.

Despite its attractive features, the Section 6166 election should not be treated as an alternative to responsible estate planning.  While reducing estate taxes is certainly laudable, tax management is only one component of a broader ownership succession planning strategy.  The availability of tax deferral under Section 6166 should not distract family shareholders from the more important work of planning for an orderly and strategic ownership succession that is both tax-efficient and promotes the sustainability of the family business.

Intentional capital planning is a key element of success for family businesses.  Directors should give careful thought to the place of Section 6166 in the capital planning toolbox for their family business.

Additional Resources

We are not tax advisors, and we are not qualified to give tax advice.  Specific provisions of the tax codes are almost always more complicated than we can do full justice to in a blog post, and Section 6166 is no exception.  Readers should consult their own tax counsel when considering the applicability of the Section 6166 election.  The following links provide additional — and, in many cases, more detailed — perspectives on Section 6166.  Check them out!

Estate taxes on a closely held business under IRC 6166 | Wells Fargo Conversations (

Deferring Estate Tax on the Death of a Family Business Owner: Why You Need to Know About Internal Revenue Code Section 6166 (

Managing Multiple Businesses with a Section 6166 Election (